Wednesday, March 12, 2008

Obama's Social Security Proposal

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:

Donald Luskin

Ryan Ellis

Ankle Biting Pundits


Jason F said...

Your posts have been admirably educational and even handed. Which is why I would not have included the postponement of the cash flow deficit as a metric to evaluate solvency options. For example, the fact that progressive price indexing postpones cash flow insolvency by about two months does not tell you much about its impact on the long-run solvency of Social Security. And we could construct three policies that would each add only two months to cash flow surpluses but collectively would extend surpluses indefinitely.

Maybe the WSJ made you do it?

Andrew G. Biggs said...

A fair comment, given that the actual cross-over data doesn't have a direct effect on anything. That number will come out of the longer version of the piece.

A better description might be to say that, when phased in, Obama's proposal makes annual cash flows about 1 percent of payroll better than current law. Which is good, but given that long-term annual deficits are above 5 percent of payroll it's just not enough.

Bruce Webb said...

"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."

The only way that Congress could 'save' any additional surplus 'rather than spending it' would be to divert the cash stream into something other than Treasuries. Not necessarily a bad proposal but not in itself improving solvency much over the current system that has surpluses invested in Special Treasuries.

The whole notion that somehow Congress has been 'raiding', 'looting' or otherwise doing something nefarious with the Trust Fund derives entirely from the implication that the Special Treasuries are not in fact hard investments, which is to say one or more versions of the 'phony IOU' argument.

Well I am not buying. I believe in the Full Faith and Credit of the United States, further I have a pretty good idea of the political firestorm that would erupt at any suggestion that the General Fund as the representative of taxpayers at large would refuse to replay legal obligations to that subset of taxpayers that paid for all those surpluses to start with.

2017 and shortfall only become a key date if we assume that government at that point would simply abrogate the debt, which would make them thieves, or that the gap between total income and cost would be considered some strain on the overall economy, which would make them innumeric imbeciles.

The dollar figures are just not that big. Whether expressed in Constant dollars in Table VI.F7 or in Current dollars in Table VI.F8 the SSA Trustees own numbers show a gap that starts out small at about $20 billion constant and $30 billion current in 2017 then rising to $171 bn constant and $279 bn current in 2025. As late as 2035 the constant dollar gap is only $330 billion or less in inflation adjusted terms than the $410 billion projected for this year, in fact the demand for borrowing to pay interest and principal never gets above current levels. And of course under current law would reset to zero in 2041.

The notion that it will be difficult to finance the redemption of the Trust Fund only works if you build in the assumption that Congress will never discipline itself on the General Fund side. The economic challenge represented by Social Security is small compared to the impact of either Reagan or Bush level general fund deficits.

And please don't resort to unfunded liability figures whether expressed as $4.7 trillion over 75 years, or $14 trillion over the Infinite Future. Legally there is no such thing, once the Trust Fund goes to depletion, if it ever does, the liability is strictly limited to then current income. This would result in a cut in benefits to 75% of levels received in 2040. Given that benefits under the current schedule are set to be 160% in real terms compared to today, we are left with a crisis calculation of 75% x 160% = 120%. That is all 'crisis' amounts to, a check 20% better than equivalently situated retirees get today.

There are some really good reasons why Baker and Weisbrot titled their book the way they did. Most of it falls away after encounter with the numbers.

Andrew G. Biggs said...

The question regarding saving the surplus probably deserves its own post, so I'll put something together on that.

Regarding the burden on the non-Social Security budget of repaying the trust fund, here's a piece I wrote a long time ago that presents the costs in terms of other spending programs ( It's a little out of date and I may not phrase things today exactly as I did in 2001, but the numbers are qualitatively correct.

Bruce is right that, even post-Trust Fund exhaustion, average benefits would be higher in real terms than they are today. This is a point many on the right also make (I'm sure I've made it myself). Social Security's protection against absolute deprivation would not be reduced and the number of seniors in poverty wouldn't be higher than today. However, benefit replacement rates -- benefits as a percentage of pre-retirement earnings -- would fall by a great deal. The question is whether this is an acceptable outcome. The reaction on the left to President Bush's plan to reduce scheduled benefits for higher earners was quite negative, and this plan wouldn't even have impacted low earners. So it's not clear this is the standard most people would follow.

Bruce Webb said...

"The reaction on the left to President Bush's plan to reduce scheduled benefits for higher earners was quite negative, and this plan wouldn't even have impacted low earners."

Among the admittedly small number of left commenters who were actually familiar with the numbers this plan appeared to be something of a Trojan Horse designed to undercut support for Social Security for that band of earners at or near cap levels.

There is in fact a group of workers who get kind of a raw deal under Social Security. If you are lucky enough or skilled enough to enter employment earning something close to the cap, which these days would require at least a Masters and so put the new worker about 25, you would be faced with 42 years of near maximum contributions only to receive a capped annuity. In insurance terms these people might well benefit by self-insuring under some sort of opt out provision (if they had confidence in their income security). Their incentive to stick with Social Security is precisely because of uncertainty about future income and because Social Security outputs are only mildly progressive. You wouldn't want to try to live on the Social Security check earned by a lifetime minimum wage worker, while the check earned by someone who spent much of his life near the cap will pay for more than dues at the country club, you could probably throw in a cruise or two. Still these are exactly the group most fertile for the privatization argument, benefit cuts just adding one more incentive to jump ship.

Frankly we didn't trust that President Bush wasn't taking his real advice from the group that together were responsible for the Fall 1983 Issue of the Cato Journal Social Security: Continuing Crisis or Real Reform?. It makes for some interesting reading and particular with Butler and Germanis' 'Achieving Social Security Reform: A "Leninist" Strategy'. Because from where I am sitting it would appear that opponents of Social Security, led in large part by you and your colleagues at the Cato Project for Social Security Privatization, followed the strategy to perfection, first in pushing IRAs as an alternative and then convincing younger workers that Social Security simply would not be there for them. At all. I can't tell you how many people are simply and totally convinced that Trust Fund Depletion equates 'Bankruptcy' or total cessation of benefits. Maybe because prominent supporters of private accounts keep using the term. For example a certain very, very prominent person said this in a forum universally attended to by the entire political class and by much of the public.

"By the year 2042, the entire system would be exhausted and bankrupt . If steps are not taken to avert that outcome, the only solutions would be dramatically higher taxes, massive new borrowing, or sudden and severe cuts in Social Security benefits or other government programs."

That person was the President and the forum was the 2005 State of the Union Address. That language is at best misleading, the tax increase would not need to be 'dramatically higher' particularly if it were accompanied by cuts that were neither 'sudden and severe'. And all this ignoring the fact that the growth assumptions of IC are at best biased to the negative side, outcomes between IC and LC being likely, and outcomes at or above LC certainly possible. said...


Where did Obama say this? This looks like what he was proposing for 2019 in his campaign if a deficit in SS actually appeared by then (long after he would be out of office). Is he now pushing this tax increase for action in the near future? The rather sketchy reports I saw in WaPo suggested that he was dropping making any proposals about social security for now, which is fine with me and Bruce Webb, but we know not so with you.

BTW, I think part of the problem with the methodology of the stochastic projections you have been relying upon has been the assumption of independence of the various variables entering in that get varied in ceteris paribus manner with Gaussian assumptions. But this very likely understates the probability of a combined good performance of the variables that could make LCA work out. After all, it held in more years than not in recent times, but then gets dismissed as highly unlikely by "credible experts." This may well be the same sort of credibility shown by those forecasting that financial markets were unlikely to collapse because of risk spreading across a variety of assets, underforecasting the degree of correlation between them.

Andrew G. Biggs said...

This is a pretty old post; at that time, Obama was proposing a pretty much immediate tax increase instead of delayed til 2017 or so. And I think this may even have been before he said that he'd want a 2-4% surtax on earnings over $250k rather than applying the full 12.4% tax. Currently, his position is the 2-4% tax on earnings over $250k, beginning in around 10 years. That would fix around 15% of the long-term shortfall.

The stochastic models used by SSA and CBO incorporate some short-term interdependence between variables, although it's far from total and it doesn't work from any sort of longer term macro model. I believe that a more integrated model would probably narrow the range of possibilities. However, as I believe the Trustees Report states, inclusion of some other factors (such as uncertainty regarding the long-term mean values of the underlying distributions) could increase uncertainty as well. So at the end of the day we're still pretty uncertain, although these models are still the state of the art.

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