What is the meaning of a budget number?

Filed Under (Environmental Policy, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Oct 7, 2011

With all the argument in Washington about how to balance the budget, a reminder is worthwhile that none of these numbers make any sense at all!  What “should” be the meaning of the government budget?  And, does any number provided by anybody actually have that meaning?

In general, a budget deficit is supposed to mean that one’s current consumption exceeds income, which would indicate a decrease in wealth.  Indeed, that’s the problem with a deficit – drawing down our wealth (which could even turn from positive to negative!).  The U.S. Federal budget numbers fail to provide such a meaning, for several reasons.

First, the Federal budget includes ALL spending, not just consumption.  Some of that spending is actually investment, such as new spending on buildings, bridges, roads, airplanes, and any long-lived military equipment.  The budget does not show the breakdown between what we really use up this year, and what spending is really investing in the future.

Second, Social Security is “off-budget”, unless you are looking at a unified budget.  Okay, I said that in a way that is intentionally confusing!  The basic problem here is that social security is SUPPOSED to run a surplus, so that we can set aside some funds from those now working to pay them when they are retired.  If it does not run a surplus to save for the retirement of the baby boom generation, then we’ll be in big trouble when the baby boom generation retires!  The current social security surplus is too small for that.  Then, however, the big problem is that the unified budget mixes the social security budget with the rest of federal spending.  So when you see a deficit in that account, it’s really worse than it looks, because it includes the small social security SURPLUS that’s already not a big enough surplus for social security to break even!

Third, the U.S. Federal Budget is confusing about what is a “Tax Expenditure” and what is government “Spending”.  A tax expenditure is really ‘spending via tax break’, as when a taxpayer gets a special credit or deduction for doing some particular activity.  The Congress could instead have accomplished the exact same thing by an ACTUAL spending program, providing subsidy to the same set of eligible individuals for doing the exact same activity.  So it really does not make much sense to say you want to cut spending and not raise taxes, because eliminating one of those tax breaks is really the same as eliminating an equivalent spending program.

Fourth, a Federal “mandate” might require a certain kind of spending by a firm.  To take a simple example, suppose some safety regulation requires construction firms to provide a hard hat to all workers.  That’s really equivalent to a tax on that firm, equal to the amount they have to spend on hard hats, where the revenue of that “tax” is spend by government on the provision of hard hats.  But then the problem is that mandates are so pervasive.  Some ‘true’ measure of the size of government would be HUGE, if we counted the dollar cost of all mandates as a “tax”, as if it were in the government budget.

Is Social Security a Ponzi Scheme?

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Sep 25, 2011

A hot topic in the recent Republican presidential candidate debates has been whether it is fair to characterize Social Security as “Ponzi scheme,” as Governor Rick Perry has done.  For this assertion, he has come under criticism from, among others, former Massachusetts Governor Mitt Romney.  Political rhetoric aside, this raises an interesting question.  Is Social Security a Ponzi scheme?

 Many individuals may be hoping for a simple “yes” or “no” answer to this question.  But like so many policy questions, the answer is a somewhat less satisfying “sort of.” 

 To explain, we need to start with a definition of a Ponzi scheme.  According to the U.S. Securities and Exchange Commission, a Ponzi scheme is:

 “an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.”

 The name of this scheme comes from the exploits of Charles Ponzi, who back in the 1920s promised his “investors” an enormous rate of return (according to the SEC, 50% in just 90 days, relative to the 5% people could get in a bank account) by investing in postage stamp speculation.  The modern-day equivalent is Bernie Madoff, who more recently defrauded individuals, non-profits and institutional investors out of enormous sums of money (on the order of $50 billion according to Forbes) in order to support his lavish lifestyle. 

 So let’s compare Social Security to the likes of Ponzi and Madoff. 

 How does Social Security look like a Ponzi scheme?

 The characteristic of Social Security that most closely parallels the misdeeds of Ponzi and Madoff (and gives rise to the claim that Social Security is one giant Ponzi scheme) is that Social Security pays one generation using the contributions of the next.  Just as Ponzi and Madoff used the money from new investors to pay off prior investors, rather than actually investing the funds in real assets, so too does Social Security take contributions from current workers and use it to pay off current retirees.  Like the Ponzi schemes, Social Security is not investing the money in productive real assets.  We economists refer to this design as a “pay-as-you-go” system (as opposed to a funded system where the money would be invested to pay off future benefits).  But it sounds an awful lot like the part of the SEC definition above that states “payment of purported returns to existing investors from funds contributed by new investors.” 

 How does Social Security NOT look like a Ponzi scheme? 

 The first difference between Social Security and the likes of Ponzi and Madoff is that the Social Security system is legally enforceable.  Ponzi schemes do not “blow up” until the purveyor of the fraud runs out of new money at a time when some of the old money wants out.  With Social Security, the government has the ability to force contributions by levying taxes on current and future generations or by borrowing money (which is just another way of levying taxes on future generations).  Nobel prize winning economist Paul Samuelson showed the world many decades ago that pay-as-you-go systems can go on forever, offering a rate of return equal to the rate of population growth plus productivity growth, so long as demographics are stable.  The problem facing Social Security is that people are living longer, working less, and having fewer children.  So as the ratio of workers-to-retirees falls, it becomes more and more expensive for today’s workers to pay for today’s retirees.  So the system may be fiscally unsustainable (i.e., we may not like the tax rates required to keep the program going), but the government does have the ability to keep it going if it is willing to impose such high taxes.

 A second difference is that Social Security does not purport to offer “high returns” as did Madoff or Ponzi.  It is true that it offered higher than market returns to the early generations, who received back far more than they contributed, but nobody today serious argues that the rate of return on Social Security is greater than that which can be achieved in the market.

 A third difference is that nobody in the government is skimming money off the top or personally profiting from the money.  I suppose one could argue that the U.S. Congress and every President since Ronald Reagan have all conspired to “skim the money” by using Social Security surpluses to mask the magnitude of the deficits we were running in the rest of government.  And in that way, these politicians may have “profited” in a political sense, as it allowed them to provide higher services to the public while not paying the full price.  This is a fair point.  But it is also the case that the very same people who are “investors” in the program (e.g., taxpayers) are largely the same individuals who benefit from whatever largesse the government doles out. 

 Summary        

 I understand the temptation to call Social Security a Ponzi scheme, particularly when a politician is looking for an easy way to explain a fairly complex program (I certainly don’t consider it a “crime,” as does the Huffington Post).  But it is certainly not the most accurate description of the program.  Most of all, the problem with calling it a Ponzi scheme is that name-calling does not really help us understand how to solve the problem.  In a real Ponzi scheme, we bring in the Feds, we shut down the fraudster, and we let the courts sort out who loses.  With Social Security, we need our leaders in both parties to provide meaningful ideas on how they will bring Social Security’s finances back onto a sustainable path.  If calling the program a Ponzi scheme somehow helps us to get a solution, then so be it.  But I suspect it will do little more than stir the political juices on both sides of the aisle, allowing both Democrats and Republicans to demagogue the issue, rather than suggesting meaningful solutions.

 

A Global Problem with No Solution

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy) by Don Fullerton on Sep 25, 2011

If one town’s water pollution flows into another town, the two towns can negotiate a solution with no need for the state to intervene.  But if all towns are polluting all neighboring towns, the lines of communication are too complex to negotiate – requiring the state to pass a law to solve the problem.

If one state’s water pollution flows into another state, the two states can negotiate a solution with no need for Federal intervention.  But if all states are polluting all neighboring states, the lines of communication are too complex to negotiate – and it takes a national government to solve the problem.

In other words, those problems have solutions.  If one nation’s water pollution flows into another nation, then (potentially, at least) the two nations can negotiate a solution with no need for a global government to intervene.  But if all nations are polluting all neighboring nations, the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

I’m currently pessimistic about two of the worst problems the world has faced: global climate change, and global financial contagion.  Both are “externalities” in the classic sense.  Each nation’s greenhouse gas emissions pollute the whole world, and the only really effective solution is a worldwide global agreement to reduce emissions.  In fact, we don’t really “need” all nations to reduce emissions; all we really need is an agreement among all nations saying that if SOME countries reduce emissions then the other countries won’t increase emissions to steal their business.  But the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

Environmental policy is my usual bailiwick.  At the moment, however, I’m even more worried about global financial contagion.  It seems that one small country can have lax financial regulations that allow banks or investment companies to take on too much risk.  Or a small country can overspend, taking on too much debt.  In the olden days, that country could go down in flames, with no big problem for the rest of the world.  With tremendously increased globalization, however, all financial markets are highly integrated.  One country’s borrowing may come from any or all other countries of the world, and one nation’s problem become the world’s problem.  If banks in other countries loan to that small country, then a financial crisis in that small country may create fear about the financial well-being of the banks that lent to them, causing a run on the banks in all those other countries.  Moreover, globalization means much more trade in commodities.  If one small country faces severe financial difficulties and must cut back all spending, that reduces aggregate demand worldwide, and can spread a recession worldwide.

A strong global government could rein in the poorly managed countries by requiring larger capital requirements, careful financial scrutiny, and only tax-financed spending.  But we don’t have any such global government.  As a result, even a small country like Greece can over-spend for years without oversight.  The situation in Greece may be made worse when banks in other countries raise the rate at which Greece can turn over its debt and borrow again, making the financial situation in Greece even worse.

The problem may be caused by Greece or not.  Regardless of “fault”, if Greece any small country were to go into default in years past, then the cost would be primarily on that small country.  Now Greece could go bankrupt and impose horrible costs on the entire World?!?

Sensible Talk on Ponzi Schemes

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on Sep 16, 2011

  of the Washington Post has an excellent piece today on the “Great Ponzi Scheme Debate” over whether Rick Perry is correct when he calls Social Security a Ponzi scheme.  It’s not fancy or technical, but it is right on point.  Here’s the link.

What Happens When the Disability Insurance Trust Fund Runs Out of Money?

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Aug 29, 2011

Last week, the non-partisan Congressional Budget Office (CBO) put out an update of the financial status of the Social Security system’s finances (using, by the way, new “infographics” to illustrate the issues).  To policy wonks like myself who follow Social Security’s more closely than we do the Major League Baseball standings, the report simply confirms what we already know – namely, that the Social Security system is on a financially unsustainable course and that it is doomed to insolvency unless Congress gets its act together and makes some difficult decisions.

What really hit the news cycles in the past week, however, was the fact that the expected date of insolvency of the Disability trust fund is now just five years and a few months away – the year 2017.  This is a couple of decades earlier than we usually talk about exhausting the Social Security trust funds, and thus, I suspect, this news has caused some confusion.  So this blog attempts to explain how the trust funds work, and what the exhaustion of the trust fund means for recipients of disability payments.

First, it is worth knowing that the Social Security program is really more than one program.  Formally, there is the OASI program (Old-Age and Surivivors’ Insurance – think of this as the program for retirees and their widowed spouses), and the DI program (Disability Insurance – this is the one that pays benefits to workers who have a disability that severely limits their ability to work).

Second, while we often talk about the “Social Security trust fund,” there are, in fact, two separate funds – one for OASI, and one for DI.  While these are legally separate funds, they are often talked about as a “combined trust fund,” and most of the debate about the long-term problems facing Social Security use data on the combined trust fund.  This masks, however, the fact that the current financing status of the OASI and DI programs are not exact duplicates.  Specifically, the DI trust fund is expected to be exhausted much sooner than the OASI trust fund – 2017 according to the CBO’s most recent estimate.

Third, while we economists can forever debate the economic meaning of the trust funds (I will spare you this debate for now), there is little question about the legal meaning of the trust funds.  Specifically, it is widely understood that so long as the DI trust fund has a positive balance, the Social Security Administration can continue to send out benefit checks to DI recipients, even if the tax revenue flowing into Social Security from the DI portion of the payroll tax (known as the FICA tax) is insufficient to cover benefit payments.  This is because the DI trust fund can redeem the U.S. government bonds that it is holding.  And as long as the U.S. Treasury does not default on its obligations, this means that the Social Security Administration has the legal authority to issue checks.

So, what happens if and when the DI Trust Fund runs dry in 2017?  Well, if Congress failed to act in any way (an outcome I consider implausible, and will say more about below), the Social Security would find itself in a position in which it did not have sufficient dedicated revenue to cover benefits.  The most likely scenario is that they would begin delaying the issuance of checks to beneficiaries.   Eventually, the backlog of checks would grow so long that it would amount to a benefit cut – beneficiaries may only get 11 checks per year instead of 12, for example.  This would be a terrible outcome, because no matter what your views on the role or size of government, it is hard to explain how reneging on payments to some of our most financially vulnerable citizens is the best way to close a budget shortfall.

You may wonder why the Social Security Administration could not just “borrow” some of the OASI money to pay the DI beneficiaries.  And the short answer is that the agency does not appear to have the authority to do this.  Rather, it would require an act of Congress to re-allocate the proportion of the payroll tax revenue that goes to each program.  As they did in the 1980s, for example, Congress could simply state that a larger fraction of the existing FICA tax go to DI instead of OASI.  This patches the short-term problem facing DI, and allows checks to go out.  Of course, it is also “robbing Peter to pay Paul” because it simply makes the OASI trust fund go dry that much sooner.

What we really need is thoughtful reform of both the OASI and DI programs.  Both are important programs to the well-being of individuals who are retired or disabled, but both programs are also not financially sustainable.  We need to adjust benefits, taxes or eligibility in order to bring the system back into long-term balance.

So the good news is that those who rely on the Social Security Disability Insurance program most likely have little to fear about the 2017 insolvency date, because Congress will most likely paper over that problem by reallocating the FICA tax.  But the bad news is that their ability to do so will most likely lead to further delays in making the serious reforms that these programs so badly need.

Are U.S. Taxes Too High?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Aug 19, 2011

The last-minute deal between Congress and the President managed to save the day, just before the deadline, but it’s not a very specific plan.   Any coherent long term plan for serious deficit reduction will still have to include cuts to defense and cuts to entitlement programs like Social Security and Medicare.  But the Republicans did not want to cut defense, the Democrats did not want to cut Medicare, and they can’t cut the large portion of the Federal budget that goes to interest payments on existing debt.  So instead, in the short run, they load high percentage cuts onto the small percentage of the remaining Federal budget that could be called discretionary.  Thus it seems we will experience very large cuts to items like National Parks, environmental programs, highways, training, education, and social infrastructure.

If the American people really want a government that is extremely small, especially compared to other developed economies such as those in the OECD, then the deficit problem could conceivably be solved by spending cuts alone (as long as those cuts include defense and entitlements).  Certainly some Tea Party Republicans want a Federal budget that small.  But I suspect that some other Republicans only think they want a Federal budget that small and would change their minds once they see the decimation of so many Federal programs.

In 2009, before the current round of cuts, the United States ranked third-to-last among the 23 OECD countries for the percentage of GDP collected by government.  I’m sure we would not want to match the 48% collected by some Scandinavian countries, or even the 40% collected by other European countries.  Somewhere in the middle, Canada appears with 31% of GDP collected by government.  The United States stood at only 24%, which exceeds only Mexico and Chile.  With only spending cuts and no increase in taxes, the U.S. could soon have the smallest government among all 23 nations of the OECD.  The following graph is from the Toronto Globe and Mail.

 

What might this mean for our state? Illinois is quite unusual, having just raised the State income tax to cover some of the growing annual deficit.  Other states with new Republican governors have drastically cut spending instead of raising taxes.  These actions might nudge Illinois upward, in the ranking of states by the ratio of tax collections to total state income, but it may allow Illinois to meet more of its obligations (including unfunded pension liabilities).  If Illinois did not raise any taxes, it may have had to renege on some such promises.

Republicans would tell you that smaller government and a smaller tax bite is always better for job growth.  But it’s a matter of degree, and a matter of balance.  A state with the smallest possible budget would have very little spending on infrastructure, road quality, sanitation, police protection, education, training, and other social services.  Yet many of those programs are important for businesses to be able to function properly.  The trick is to find the right balance, with spending on the minimal decent level of such programs, as necessary for businesses and employees alike.

With no increase in Federal taxes, the recent deal on cuts in spending is likely to mean cuts in all kinds of Federal discretionary spending, including grants to the states.  The U.S. Congress will then be likely to enact more unfunded state mandates, which means requiring the states to spend their own money to provide basic services that the Federal government used to provide.  State governors and legislators will be unhappy about these changes, with even more pressure on state governments.

The Worst Tax of All is Not Even a Tax: The Case of the Social Security Earnings Test

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Aug 8, 2011

Most people dislike paying taxes because every dollar sent to the government is one less dollar they have to spend themselves.  Because taxes make people “poorer” (ignoring, for a moment, the fact that many of those tax dollars are returned to citizens in the form of Social Security income, health benefits, or other government services), they have less money to spend on goods and services.  This is what economists call the “income effect” of taxes.  While this is the part that most normal people dislike, it is not what economists typically care about. 

You see, economists recognize that if you need to raise revenue, then it has to come out of somebody’s pocket.  And whoever’s pocket you choose to take it from will cause that person to have less money to spend.  That is just arithmetic. 

We can also have very spirited debates about whose pocket we should take those taxes from.  This is the “distributional” question.  Or to put it in laymen’s terms, this is the issue of “fairness” or “equity.”  While economists have a lot to contribute to these discussions in terms of analytical rigor, at the end of the day, one’s views on this are determined by non-economic factors, such as ideology, religion, one’s sense of justice, and so on.  Economists may get passionate on these issues, but there is really no reason that a randomly drawn economist’s view of the “fair” level of income redistribution should be given any more weight than a randomly-drawn non-economist’s view.

But there is a third factor – one that is at the heart of economics.  It is the issue of the “efficiency” of a tax system.  And by efficiency, we don’t mean something as narrowly conceived of how much it costs the IRS to collect your taxes (although that is a part of it, albeit a tiny one).  Rather, what we really care about are the incentive effects of taxation.  To use economics terms, we care about “substitution effects” of taxes (as opposed to the income effects above).  And we care about the “deadweight losses” that arise when taxes distort incentives. 

Put simply, for a given amount of revenue raised, some taxes destroy more economic activity and/or population well-being than do others.  This is because of the natural human behavioral response to switch away from taxed goods or activities and towards untaxed (or lower taxed) goods or activities.  So, when we tax labor earnings, people work less.  When we tax capital, people invest less.  When we tax wage income more heavily than health insurance, people get paid a higher share of their compensation in the form of health insurance.  When we tax dividends more highly than interest, firms issue more debt and less equity.  When we levy tariffs on foreign-made goods, people buy more American-made and fewer foreign-made goods.

In all of these cases, the taxes distort decisions, leading to a reallocation of economic activity.  And it is this reallocation that is inefficient, because in addition to raising revenue, the reallocation of activity destroys value.  So, for every dollar raised by levying a tax, we might destroy two dollars of economic value.  The amount of value destroyed over and above the revenue raised is what we refer to as a “deadweight loss.”  And this is what economists really dislike.  (As an aside, there are some unusual cases where imposing a tax is actually good for social well-being, such as when we tax something that the private market fails to account for on its own, such as pollution.  This is the basis for my earlier blog in which I called for an Osama bin Laden tax on carbon to reduce our dependence on foreign oil.)

So, if you wanted to design the PERFECT example of the WORST possible tax, what would it look like?  It would be a tax that created a lot of deadweight loss, but raised no revenue.  That is, you would impose a tax that changed the way people behave, making them worse off, while raising no revenue.

Why would anyone ever want to do this?  Well, my hope is that no one ever would want to do it.  But that does not stop politicians from actually doing it. 

My example?  The Social Security Earnings Test.

If you want an explanation of how the Earnings Test works, you can read all about it by clicking here.  But the quick version is this: If you claim Social Security benefits at age 62 but continue to work and earn money over a threshold, then Social Security reduces your monthly benefit by 50 cents for each additional dollar you earn.  This is on top of any income and payroll taxes you may have to pay.

The Earnings Test is actually not a tax in reality.  It raises no revenue whatsoever.  Why?  Because the money that Social Security reduces your benefit by is actually returned to you in the form of higher future Social Security payments!  And the calculation is roughly “actuarially fair” – meaning that for the average person, you get back the same amount with interest that you put in. 

In other words, the government raises NO revenue from this tax.  That is ingredient #1 for the worst possible tax.

Ingredient #2 is that the earnings test distorts behavior, causing people to work less than they otherwise would.  At least that is my working hypothesis.  The issue is this – if people understood that the earnings test is not really a tax, then it should have very little impact on the work versus retirement decision.  But most people do not understand this.  Rather, they view it as a 50% tax on earnings.

As evidence of this, the AARP conducted a survey of Social Security knowledge.  When they asked people what would happen to a hypothetical 63-year old who continues to earn $40,000 per year while collecting benefits, four out of 5 people ages 55 -66 correctly answered that this would reduce his current benefit.  Then, equally importantly, 3 out of 5 respondents believed that this person would never get the money back. 

So there you have it.  The “tax that is not a tax.”  You get all the negatives (i.e., distortion of labor supply decisions) and none of the revenue.

This idea was implemented so poorly that one might just think it was thought up by the U.S. Congress.  And you’d be right.

Vacation Blog

Filed Under (Environmental Policy) by Don Fullerton on Aug 6, 2011

Carbon Dioxide Causes Global Warming of Climatologists

Dateline: August 6, 2011, Champaign, Illinois

Researchers at the University of Illinois have discovered new environmental damages from the burning of fossil fuel with resulting emissions of carbon dioxide (CO2) and other Greenhouse Gases (GHG).  In particular, when these anthropogenic emissions accumulate in the atmosphere and react with sunlight, they may cause climatologists to become hotter and hotter.  So far, this effect has only been observed experimentally in the laboratory, but these experiments confirm the theory among atmospheric chemists that continuation of such emissions for several decades is bound to result not only in global warming of these climatologists and other environmentalists, but also extreme behavioral events similar to hurricanes, floods, and droughts.  

The next key step of this research program, at the University, is to increase data collection quickly, in order to try to ascertain whether the recent aberrations in climatologists’  behavior is within the normal statistical variations or may in fact already by caused by the existing increases in atmospheric levels of greenhouse gases.  The stronger hypothesis, yet to be tested, is that the increased concentrations of these gasses in the atmosphere is not just predicted globally to cause agitation and warming of these environmental scientists, but that it is already having such effects.  Already, certain climatologists have experienced high blood pressure, increased internal temperatures above 98.6 degrees Fahrenheit, and occasional apoplectic seizures.  These extreme behavioral events could be occurring naturally, however, so the hypothesis is not yet proven that these events can be attributed to anthropogenic greenhouse gas concentrations in the atmosphere.  More research is required, and researchers at the University of Illinois are applying to the National Science Foundation for that research funding, which may require millions of dollars.

Should we raise the amount of income subject to Social Security taxes?

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Jul 18, 2011

 The political climate in Washington has finally shifted to one in which long-term deficit reduction has become a priority.  This is definitely a good thing, given that our long term fiscal path is unsustainable and that any changes we enact will have to be much more painful the longer we wait to enact them. 

While Social Security is only one piece of the federal budget, it is a topic that merits attention.  As part of the debate, one idea that seems to be gaining traction (at least among Democrats) is the idea of raising the amount of income subject to the 12.4% Social Security payroll tax.  Currently, this tax is applied to the first $106,800 of income.  Consistent with this, only income up to $106,800 is counted in the computation of Social Security benefits.  This cap is indexed over time so that it rises with average wage growth.

It has been pointed out by many scholars and analysts that the share of the overall payroll in the U.S. that is above this “taxable maximum” has grown over the decades, a consequence of rising income inequality.  As such, many are calling for this cap to be gradually raised so that it covers a fraction of total payroll that is consistent with decades past.  A common benchmark is to raise contributions by an additional increment – such as an additional 2% per year – until 90 percent of all earnings are covered.  Social Security Actuaries have estimated that, at this rate, it would take about four decades to reach the new, higher taxable maximum, which would be equivalent to about $215,000 today (so roughly a doubling of the income subject to the tax).

Many have argued for this in terms of “fairness.”  Basically, the argument goes, why should the rich not have to pay these taxes on the income above the cap?  The usual argument against raising the cap is that this is essentially 12.4% increase in marginal tax rates on mid/high level earners, and that this level of a tax hike would reduce labor supply incentives and lead to loss of efficiency and reduced economic growth.  In short, it is a classic example of “equity versus efficiency.”  Or so it seems …

In some very good testimony before the House Ways and Means Committee a few weeks ago, Dr. Mark Warshawsky presented some additional arguments against raising the cap.  [Full disclosure – Mark and I are former co-authors, and we also served on the Social Security Advisory Board together for two years.]  In his testimony, Mark raises four additional points that have are often missed, some of which call into question the argument that raising this tax is “fair.”  These four points are:

  1.  “It unfairly targets a specific segment of the population that has not seen particularly large gains in earnings.”  Mark gives a great explanation of this, showing that the vast majority of the increase in earnings for the top 20 percent of the income distribution is actually concentrated in the top 1 percent (in other words, there is growing income inequality even at the top).  Raising the cap from $106,800 to $215,000 would be slamming those who have experienced only moderate earnings growth.
  2. “It is an extra burden in addition to the new taxes imposed on this and other groups to finance Medicare and in the recent health care legislation to finance health insurance coverage for poor and middle-income households.“  The populist tendency is to want to “tax the rich.”  But Mark points out that we have been hitting this group pretty hard.  As he notes, “In 1991, the earnings cap for Medicare Health Insurance (HI) payroll taxes was increased, and in 1994, it was lifted entirely. So these workers already have seen a significant payroll tax increase of 2.9 percent of earnings. Moreover, under the new health care law, an additional HI payroll tax of 0.9 percent will be collected from workers with earnings over $200,000 for single filers and $250,000 for joint filers, effective for taxable years after December 31, 2012. These earnings thresholds are not indexed and hence many of the workers to be hit by this HI tax rate increase will be the same individuals to be hit by the proposed increase in the Social Security taxable maximum. In addition, there is a new tax of 3.8 percent on unearned income of individuals with modified adjusted gross income above $250,000 (in the case of a joint return) or $200,000 (in the case of a single filer return). On top, of course, a progressive income tax structure exists at the federal level and in most states and localities.”
  3. “It will cut private retirement savings.”  Mark calculates that those people affected by this would reduce their private savings by about 4 percent, this coming at a time when personal savings rates are already abysmally low (and even if you do not care about their savings rates directly, it is important to remember that savings is what drives investment, which in turn is what drives economic growth.)
  4. “It represents an unnecessary expansion of the Social Security program.”  This arises because these proposals would grant some additional benefits in return for the additional taxes (although the incremental benefits are a small fraction of the incremental taxes), meaning that we are expanding a fiscally unsustainable program for people who do not really need it (high earners).  You might object by stating that we should treat it as a pure tax and not provide any incremental benefits, but then that just magnifies the other downsides.

 

Let’s be clear – our fiscal situation is pretty dire, and we need to balance the budget.  As much as I would like this to be done primarily on the spending side, I recognize that we are going to need to raise some revenue.  But of all the possible ways of expanding the nation’s revenue that might providing some efficiency gains (e.g., carbon tax, eliminating numerous corporate tax deductions, limiting tax expenditures, etc.), raising the cap on Social Security should be pretty low on the list.

 

How Generations of Seniors Were Framed …

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on May 13, 2011

I had planned to post a blog discussing my research about how the way the Social Security Administration framed the benefits claiming decision may have led generations of seniors to claim benefits earlier than they otherwise would have.  But the U.S. News and World Report beat me to writing about my own research.  So I will simply link to their blog here.  Enjoy!