A piece from me in today's Wall Street Journal:
The Obama Tax Hike
Until recently, Sen. Barack Obama took a responsible position on Social Security, noting the urgency of reform and saying all options should be on the table.
But having cornered himself among Democratic activists whose attitudes toward Social Security reform range from demagoguery to denial, Mr. Obama has recently veered sharply left. He now proposes to solve the looming Social Security shortfall exclusively with higher taxes."Once people are making over $200,000 to $250,000," Mr. Obama says, "they can afford to pay a little more in payroll tax." No shared sacrifice, no outreach to moderates or conservatives, here.
Mr. Obama's proposal is to make a significant change to the payroll tax system. Currently, all wages below about $100,000 are subject to a 12.4% Social Security payroll tax. But all wages above that amount are not subject to the tax. Mr. Obama wants to eliminate the cap, but, in a concession to taxpayers, exempt wages between $100,000 and $200,000. He wants to create a "donut hole" in the taxing mechanism that pays for the nation's largest retirement program.
The problem is two-fold: His proposal would be a very large tax hike, yet it won't be enough.
Mr. Obama's plan fixes less than half of Social Security's long-term deficit, making further tax increases inevitable. The Policy Simulation Group's Gemini model estimates that Mr. Obama's proposal, if phased as Mr. Obama suggests, would solve only part of the problem. A 10 year phase-in, for example, would address only 43% of Social Security's 75-year shortfall. And this is assuming that Congress would save the surplus from the tax increases -- almost $600 billion over 10 years -- rather than spending it, as Congress does now.
What's more, Mr. Obama's plan would keep Social Security in the black for only three additional years. Under his proposal, annual deficits would hit in 2020, instead of 2017. By the 2030s the system would still run an annual deficit exceeding $150 billion.
Mr. Obama's modest improvements to Social Security's financing come at a steep cost. The top marginal federal tax rates would effectively increase to 50.3% from 37.9%, equivalent to repealing the Bush income tax cuts almost three times over.
If one accounts for behavioral responses, even the modest budgetary improvements from Mr. Obama's plan are likely to be overstated. If employers reduce wages to cover their increased payroll-tax liabilities, these wages would no longer be subject to state or federal income taxes, or Medicare taxes. A 2006 study by Harvard economist and Obama adviser Jeffrey Liebman concluded that roughly 20% of revenue increases from raising the tax cap would be offset by declining non-Social Security taxes. Assuming modest negative behavioral responses, Mr. Liebman projected an additional 30% reduction in net revenues, leaving barely half the intended revenue intact.
Mr. Obama's plan would also dramatically raise incentives for tax evasion, further degrading revenue gains. Many high-earning individuals evade the Medicare payroll tax by setting up "S Corporations," paying themselves in untaxed dividends rather than taxable wages. John Edwards avoided $590,000 in Medicare taxes this way in the 1990s. Under Mr. Obama's plan, Mr. Edwards's savings would have exceeded $3 million. With that much at stake, the incentive to follow Mr. Edwards lead will be that much greater.
Mr. Obama's plan shows the limits to taxing the rich as a solution to Social Security's problems. Top earners would effectively be tapped out, with taxes as high as economically and politically feasible, yet most of Social Security's deficit, and the much larger shortfalls in Medicare, would remain.
The U.S. already collects far more Social Security taxes from high earners than other countries do. Social Security taxes here are currently capped at about three times the national average wage -- far above other developed countries. In Canada and France payroll taxes are levied only up to the average wage. In the United Kingdom, taxes stop at 1.15 times the average wage; in Germany and Japan at 1.5 times. Social Security is already more progressive than these countries' pension programs, and Mr. Obama's plan would make it more so.
President Bill Clinton considered lifting the wage ceiling modestly, but was skeptical of eliminating it outright. Doing so would "tremendously change the whole Social Security system . . . We should be very careful before we get out of the idea that this is something that we do together as a nation and there is at least some correlation between what we put in and what we get out," Mr. Clinton said in 1998. "You can say, well, they owe it to society. But these people also pay higher income taxes and the rates are still pretty progressive for people in very high rates."
Social Security's shortfalls are primarily attributable to society-wide trends of lower birth rates and longer lifespans. If we want to retain the shared character that underpins its political support and distinguishes it from traditional welfare programs, we need to share the burdens of reform proportionately. Mr. Obama should drop his exclusive focus on raising taxes and return to his previous view, that Social Security faces significant problems requiring prompt attention. All options should be on the table.
Mr. Biggs, a former principal deputy commissioner at the Social Security Administration, is a resident fellow at the American Enterprise Institute.
Commentary on the op-ed from:Ryan Ellis
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