Politics & Policy

Tax Hikes Won’t Fix Social Security

Hillary Clinton and John Edwards are proposing the exact wrong medicine to fix an ailing program.

In the recent Democratic presidential debate, former Sen. John Edwards said he would impose taxes on the wealthy to address Social Security’s long-term funding problems, but “would create a protective zone [for people earning] between $97,000 up to around $200,000.” The Associated Press reports that Sen. Hillary Rodham Clinton said privately that she also would consider levying the Social Security tax for people making over $200,000. 

The federal government currently imposes Social Security payroll taxes on the annual earnings of workers up to a cap of $97,500. Most Democrats have traditionally supported raising the payroll-tax wage-cap to address the entitlement budget crisis, instead of creating personal retirement accounts and slowing expenditure growth.

#ad#However, raising the payroll-tax cap will not solve Social Security’s long-term financial problems. Here are some very crude but directionally correct estimates of how this would work:

Were the cap to be raised from $97,500 to about $171,000, according to Social Security Administration data we’d solve about 10 percent of the long-term shortfall. (Caveat: This is not the way Sen. Clinton would measure it;  she would probably rely on the discredited seventy-five-year actuarial balance measure. By that measure it would solve more than 40 percent of the problem. But for the most part that’s illusory. In the long run the annual deficits would be reduced by only about 10 percent.)

Now suppose the payroll-tax cap was eliminated entirely and applied to all earnings above $97,500. If we credited the extra contributions towards benefits we would solve about 24 percent of the problem, and if we didn’t we’d solve about 4 percent. (Again, this is using real numbers, not seventy-five-year actuarial imbalance. The latter metric allows the Democrats to claim, misleadingly, that the whole problem would be solved.)

Therefore, if raising the current payroll tax cap to $171,000 solves about 10 percent of the problem, and if eliminating it solves 24 percent, then it would seem that levying Social Security payroll taxes again on earnings above $171,000 would solve about 14 percent of the problem (24 percent minus 10 percent). Or, if we didn’t pay benefits on the extra payroll-tax contributions, we would solve about 30 percent (40 percent minus 10 percent) of Social Security’s funding problem.

Basically, Clinton and Edwards would face a choice: Do we pay extra Social Security benefits to the richest of the rich? I find it hard to see the social value in that. And we would only solve, at most, about 14 percent of the problem if we did. Or do we collect extra taxes from the rich, but not credit them to benefits, basically severing the contribution-benefit connection and turning Social Security essentially into a pure-redistributionist welfare program? We could solve up to 30 percent of the problem by doing that, but we would destroy Social Security’s basis as a contributory system.

As noted, the Democrats pretend that these proposals accomplish more than they would in actuality. They do so by relying on the seventy-five-year actuarial balance. Basically, this pretends that the government saves Social Security money and that it earns interest. It doesn’t. But by pretending that it does, the Democrats make the long-term deficit appear much smaller since they subtract the interest-compounded value of money the government would be given now to spend. This is particularly ludicrous when you consider they even would assume that past Social Security surpluses have been saved, where clearly everyone agrees they have not.

Of course, none of this touches upon the economic downsides of raising taxes of this magnitude. Increasing taxes by this amount would expand the payroll-tax base by nearly 10 percent — a huge additional drag on employment. Moreover, raising the top tax rate to pre-Bush levels, as most of the leading Democratic candidates have proposed, and lifting the payroll-tax wage-cap would hurt the economy and ultimately raise far less tax revenue than static-revenue estimating models would predict.

The combination of these two proposals would place dramatically higher tax rates on economic success. Assuming that these tax hikes became effective in 2008, the maximum federal tax rate would rise from the current 38.44 percent (35 percent income-tax rate plus the Medicare payroll tax) to 52.89 percent. Such an increase would severely reduce after-tax incentives for productive efforts while encouraging tax avoidance.

Raising Social Security taxes is the exact wrong medicine for Social Security’s financial problems. Without action to fix Social Security, today’s thirty-year-old workers can expect a 27 percent benefit cut when they retire.  Instead of raising taxes, the best way to save Social Security is to create voluntary personal accounts so that younger workers can achieve higher rates of return on their retirement dollars.

– Cesar Conda, formerly assistant for domestic policy to Vice President Cheney, is an advisory board member of International Economy Magazine.   He also is an outside policy adviser to the Romney for President Campaign.

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