The Case Against Raising the Social Security Tax

A week ago, an ABC/Washington Post poll asked Americans about Social Security reform:

On Social Security, as noted, a majority of Americans, 53 percent, support collecting taxes on all the money a worker earns, not just the first $107,000. That’s similar to what it was in 2005.

Two others come fairly close to half: Forty-six percent support trimming early-retirement benefits, up 10 points from six years ago; and 45 percent support cutting the rate of growth in benefits, up 8 points since 2005. Among other items, 42 percent favor raising the retirement age for full benefits from 67 to 68 – still short of a majority, but up 9 points from 2005. Just 35 percent favor raising the Social Security tax rate and 32 percent back reducing guaranteed benefits for future retirees; the first is up by a scant 4 points from 2006, but the latter – while still last on the list – is up 12 points.

That led Ezra Klein to note that this poll gives us a roadmap for what to do to reform Social Security, especially since Republicans have requested that the program be on the table before they agree to raise the debt ceiling.

The only fix that garnered majority support was lifting the payroll-tax cap so that all income, rather than just the first $107,000, got taxed. That’s a reform, I’m confident to say, that the Senate’s liberals would have less trouble swallowing, and according to the Congressional Budget Office, it would wipe out virtually all of Social Security’s shortfall.

So if this is just about balancing Social Security’s books, it shouldn’t be too difficult. We can pass the reform and raise the debt ceiling with no problem. Huzzah! On the other hand, if we’re in one of those conversations where we’re pretending to talk about balancing the country’s books but we’re actually only talking about “cutting spending” and revenues are off the table, well, that’ll be harder.

Klein is right that this is the only fix that gets support from a majority of Americans right now. But that doesn’t mean it’s the right thing to do. In fact, it is likely to work against the stated objective of saving Social Security.

Here is how it looks on paper: Eliminating the cap on covered earnings would subject all wage income to the 12.4 percent OASDI payroll tax (half paid by employers and half by employees). Based on the Social Security Trustees’ Report, that revenue would be enough to close the gap between the revenues Social Security is projected to receive and the benefits it has to pay over the next 75 years, which would make the system “solvent.”

But it would be an illusion of solvency: More tax revenues today would just result in tax-revenue surpluses that would go into the trust fund, which would have to invest the money in Treasuries. IOUs would be issued to the Social Security system, giving the illusion that the system is solvent. Meanwhile, the cash would be spent by the federal government and would continue to put even a greater burden on future taxpayers to fund future benefits.

Andrew Biggs of the American Enterprise Institute makes an even more important point in his new paper, “The Case Against Raising the Social Security Tax Max”: The existence of a positive trust-fund balance seems to give an incentive to lawmakers to spend more money, borrow more from the public, and reduce taxes in non–Social Security areas.

The evidence suggests that Social Security surpluses, rather than building savings to help pay future Social Security benefits, instead tend to subsidize present consumption. Social Security surpluses allow current spending to be higher, or current taxes lower, than they otherwise would be. It would therefore be ironic, to say the least, if Congress approved a strategy to fix Social Security that relied on trust funds that both economic research and the Congressional Budget Office have concluded do not effectively prefund future benefits.

Biggs points to data and analysis from  three studies by well-respected economists such as Kent Smetters of the Wharton School, Barry Bosworth and Gary Burtless of the Brookings Institution, John B. Shoven of Stanford, and Sita Nataraj of Occidental College. He also notes that the Congressional Budget Office has embraced this view as well.

In other words, it would be counterproductive to raise more revenue and pour it into the trust fund. Not to mention that raising taxes and increasing spending would have a counterproductive effect on the economy.

More productive solutions would include ensuring that the program truly benefits those who need it the most, and creating private accounts so people aren’t stuck in a system that produces low returns and confiscates their lifetime payments if they die before they can collect. Biggs’s suggestion is “to reduce Social Security benefits for middle and high earners while encouraging greater individual saving and longer work lives.”

One final point: I always find it strange that people who are against cutting benefits are in favor of keeping the system as it is or just finding temporary revenue fixes. If we do not reform Social Security, the program is scheduled to cut benefits across the board by over 20 percent, including for those who need it the most, as soon as the trust funds run out of IOUs. That date may seem far down the road, but it really isn’t, especially considering that each year the date is revised and gets closer to the present. It is incredibly inconsistent to claim to be in favor of the program, especially for poor people, and yet refuse to reform a system that will slash benefits for all, including the neediest.

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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