Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Feb 17, 2012
In 1941, President FDR explained why he chose to fund Social Security through a payroll tax in as follows:
“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program”
For more than seven decades, FDR’s strategy has proven effective. Talk to someone in or near retirement – even people who consider themselves small government conservatives – and you will often hear them state that they have a right to their Social Security benefit because they paid for it over their working life.
President Roosevelt knew that the key to the political sustainability of Social Security was the establishment of an entitlement mentality, and the key to establishing an entitlement mentality was the linkage between payroll contributions and benefits. If Social Security were structured as a means-tested welfare-style program – that is, it if were financed by a progressive income tax rather than through payroll contributions – it might have never lasted this long.
Given this, it is important that President Obama and Congress have just agreed to extend the payroll tax cut and to continue to use budget gimmickry to turn Social Security into a partly general-revenue-financed program.
Here is how it works. The 2% payroll tax cut reduces revenue to Social Security by about 15 percent. But Social Security does not have a spare 15 percent of revenue lying around: rather, it is currently running quite close to break-even on a cash flow basis, and faces enormous long-run deficits. To get around this, President Obama and Congress have decided to replace the lost payroll tax revenue by transferring money from general revenue (which derives primarily from the income tax) into the Social Security trust funds.
This budget gimmick has the short-term political benefit of making the Social Security trust funds seem unaffected by this tax cut. But it also means that we are deviating substantially from FDR’s vision of a retirement program being paid for (on a pay-as-you-go basis) by participant contributions. By moving down the path of general revenue financing of Social Security, we achieve the short-term “progressive” aim of increasing the degree of income-based redistribution (because income tax rates rise with income, whereas payroll tax rates do not).
But in the long-run, this has the potential to erode political support for the program. By shifting the funding burden onto the income tax, the program starts to look more like a welfare program than a contributory social insurance program.
I am not the first to notice the irony of this. My very good friend Chuck Blahous, who served eight years in the National Economic Council for President George W. Bush, and who was appointed by President Obama as one of two Public Trustees for Social Security, just released a paper explaining why this payroll tax cut is bad policy. Among the seven reasons he provides is that doing so destroys the “historical Social Security compact.” In a Washington Post article back in December, Dr. Blahous stated that these budget gimmicks are “a grave step for Social Security.”
This view is not limited to experts on the Republican side: the other Public Trustee of Social Security (a Democrat) – Robert Reischauer, the highly respected president of the Urban Institute — agrees with Dr. Blahous. While Reischauer was more sympathetic to the tax cut, he also noted that it “could, if it continues for a substantial period of time, undermine one of the foundational arguments that makes the Social Security program inviolate.”
Perhaps the most succinct summary of the irony comes from Jason Fichtner, a Senior Research Fellow at the Mercatus Center and former Chief Economist and (acting) Deputy Commissioner for the Social Security Administration. He summed it up the situation quite succinctly in an email to me by noting that “in 15 years we might look back on this time in history and discuss how President Obama, as a Democrat, was the president that started the path to killing Social Security.”
So, maybe President Obama really is the Damn Politician that FDR was worried about?