Eliminate the payroll tax. Seriously.
The best way to reform Social Security is to eliminate the payroll tax. Seriously.
Social Security is going bankrupt, but official Washington can’t agree on how to fix it. Payroll tax receipts are insufficient to pay promised benefits. For decades, the trustees of the Social Security program have annually warned that the trust fund is out of balance and, absent reforms, will go broke. Current projections show the fund will be exhausted by the early 2030s (15 to 20 years from now).
At that point, there will be only enough tax revenue coming in to fund about 75 percent of promised benefits. The options will be unpleasant. Either everyone’s monthly Social Security check will have to be reduced by 25 percent, or payroll receipts will have to be increased by 25 percent, or millions of retirees will have to be dropped from the rolls. Realistically, politicians will balk.
Acting sooner makes reform somewhat easier, but there are still only three ways to remedy this problem: a) cut benefits, b) increase receipts or c) both.
Cutting benefits is unpopular, so politicians never embrace benefit cuts, except to the extent they only affect future generations not yet old enough to vote. /1
Increasing taxes is also bad politics, but a bit more politically acceptable, because there’s less pain per person: it’s spread over a larger population. There are about 59 million retirees, but 144 million workers.
House Ways and Means Committee Chairman Paul Ryan has called Social Security’s bankruptcy the ‘most predictable’ crisis in history. All can see it coming, yet none takes evasive action. Why? Because conservatives and progressives can’t agree on the remedy and don’t trust each other enough to compromise. And voters don’t seem to like any of the proposed remedies. So the default position is to do nothing.
Progressives want to raise the payroll tax. Conservatives are opposed. Conservatives want to reduce benefits. Progressives are opposed. Conservatives want to create personal accounts. Progressives are opposed. Progressives want to increase benefits. Conservatives are opposed.
Progressives probably have the upper hand with their preferred remedy of increasing the payroll tax that currently funds Social Security. But that doesn’t make it a good idea. It’s a bad idea, because the tax is already too high (15.3 percent of wages, including the employer share), and destroys jobs and hurts workers, especially those with the lowest incomes. Some progressives want to increase the tax only on upper-income earners, who are currently exempted from it on wage income above $118,500 a year. That would help restore balance, but only partly.
Conservatives have a basically sound idea with their proposal to invest some or all of Social Security’s receipts in the stock market via personal accounts. Doing so would fetch higher returns than the government can provide. But it’s also risky. Crashes happen. Either retirees would lose money or taxpayers would be forced to provide bailouts. At any rate, the idea is going nowhere, because Democrats strongly oppose it, and so, quietly, do many Republicans. President George W. Bush’s 2005 personal accounts proposal never came to a vote in either house of Congress, even though Republicans controlled both. Voters love the security part of Social Security, and that means avoiding risk.
The most practical, and in my view, the best way to restore system balance would be to simply supplement the payroll tax from other revenue sources, and in particular from the general fund (i.e., income taxes). That would make the program solvent forever. Presto! No more bankruptcy threat.
Which leads to a further idea: Why not supplant the payroll tax altogether, and as soon as possible? The payroll tax is the biggest tax most Americans pay, and regressive. It falls hardest on low-wage workers. Eliminating it would provide meaningful relief to every American wage-earner, with the greatest relief going to those who need the the help the most. Abolishing it would be economically beneficial and politically popular. To avoid increasing the deficit, we could raise or impose other taxes that are less regressive—although, to be honest, I’m not sure we really need to. If anything, America’s less-than-stellar economy could stand a tax cut right now, and what better kind of tax cut than one that reduces burdens on job creation?
The conventional wisdom says we’ll eventually meet in the middle by swallowing a mixture of tax hikes, benefit cuts, and a higher retirement age. Don’t believe it. No such ‘grand bargain’ will materialize until demanded by voters. Realistically, that will only happen when the crisis is upon us, by which point, it will be too late. The closer we get to bankruptcy, the less effective, and less politically viable, each of the traditional remedies becomes. It’s a game of chicken, and seems destined to end badly, absent some creative thinking.
But wait. Isn’t a ‘grand bargain’ exactly what happened back in 1983, when the trust fund was on the brink of exhaustion and a Democratic Congress and President Ronald Reagan reluctantly came together to enact the Greenspan Commission’s proposed compromise of payroll tax hikes and a higher retirement age?
Yes, that did happen. But this is not 1983. The problem is much bigger now, thanks to the baby-boom generation, which began retiring in 2010 and is now joining the rolls at the rate of 10,000 seniors a day. Back in 1983, there were 3.2 workers for every retiree. By 2030, there will be only about 2 workers for every retiree. The Greenspan age hike was phased in slowly, over 40 years. In fact, it’s still being phased in. Any large, last-minute age hike would be politically unacceptable to those near-retirees directly affected by it. And while the Greenspan tax hike amounted to a 63 percent increase, that was from a smaller base. It went from 9.35 percent of wages in 1983 to 15.3 percent in 1990 and thereafter. A solvency-restoring tax hike in 2030 would take us from 15.3 percent to at least 19 percent. It’s hard to imagine voters going along with that high a rate.
The best time to reform Social Security was four or five decades ago. The next best time is today. But lacking a consensus, we procrastinate. And the more we procrastinate, the more politically impractical our options become—and the further a second Greenspan ‘grand bargain’ recedes into the mists of fantasy-land.
I can predict with near-100 percent certainty what will actually happen. Barring the miraculous, Congress will bail out the Social Security trust fund from the general fund, supplementing payroll tax receipts with other kinds. It’s the path of least resistance, and therefore the path most likely to be taken.
So the real question is not whether to tap the general fund, but when? And if we’re going to move away from reliance on the payroll tax, why not eliminate it altogether?
Question: Won’t abolishing the payroll tax hurt Social Security politically? Voters view the tax as a contribution for insurance, as funding for a ‘pension.’ Won’t ending the tax make Social Security look like welfare and thus expose it to deficit-reduction efforts?
Response: That won’t happen. What actually protects Social Security benefits is their tremendous popularity with voters. And that popularity will not diminish when we change how they’re funded, something we will inevitably be forced to do. Believe me, seniors will still cherish and defend their monthly checks, and politicians will still be scared to death of touching them, regardless of the funding source. The fact is, legally speaking, the payroll tax is not a contribution for insurance, it’s just another tax. The Supreme Court has repeatedly affirmed this. The benefits and the tax are technically unrelated. They have to be, for the courts to view them as constitutional. In fact, Congress could abolish all Social Security benefits this afternoon, and no court in the land could restore them. Likewise, if Congress were to repeal the tax, the benefits would go on being calculated and paid according to law, as they have since 1935. The payroll tax is ornamental, not essential.
Question: Without the payroll tax, how would we calculate each person’s benefit amount?
Response: The same way we do today, by tracking workers’ wages.
Question: How would we fund Medicare Part A, which also relies on the tax?
Response: The same way we’d fund Social Security, from general revenue.
Question: Why now? Why not wait till ‘the crisis is upon us’? We’ve got 15 to 20 years, after all.
Response: Actually, we’ve got fewer than 15 years. Social Security’s disability fund, which is separate from its retirement fund, is projected to go bankrupt next year. Most likely, Congress will bail it out by diverting money from the retirement fund, and thus accelerate the latter’s exhaustion. If, alternatively, Congress taps the general fund, well, I rest my case. /2
Think of the upsides. With this one simple reform, we’d not only make Social Security permanently solvent, we’d also increase workers’ paychecks, make taxes less regressive, and create more jobs. Admittedly, absent other reforms, we’d also increase the deficit. But that’s a problem we need to tackle in any case. The benefits of this Social Security reform would outweigh the downsides. And I suspect voters would love it.
The best way to reform Social Security is to eliminate the payroll tax.
Dean Clancy, a former senior official in the White House and Congress, writes on U.S. budget, health care, and constitutional issues. Follow him at deanclancy.com and on twitter @deanclancy.
[Originally published at usnews.com, April 27, 2015. Republished at deanclancy.com. Edited slightly for readability. Footnotes added subsequent to publication.]
Notes
1. Congress has on two occasions tried to delegate to the president the unpleasant task of cutting entitlement benefits, in hopes of shielding themselves from political blowback, but in both cases (the Economy Act of 1933 and the IPAB law of 2010) the attempt failed when the politicians got cold feet and reversed themselves.
2. In the autumn of 2015, Congress ‘saved’ the disability fund from bankruptcy by diverting a share of payroll tax receipts from the retirement fund to the disability fund. That, of course, accelerated the exhaustion date of the retirement fund. As of this writing, in September 2018, the disability fund is projected to run out of money in 2032, the retirement fund in 2034.