Wednesday, June 4, 2008

WSJ: Obama's Social Security Plan Draws Critics, Even Some Dems

From today's
Wall Street Journal. I've already said my bit on this, but I'll put a couple comments at the end. Overall, this piece covers the pros and cons fairly well.

WASHINGTON -- Some Social Security experts -- including Democrats and liberal economists -- are wary of a proposal from presumptive Democratic nominee Barack Obama to shore up the federal retirement program by raising taxes on the highest earners.

Sen. Obama has said he wants to raise limits on wages that are subject to the 12.4% federal Social Security tax. That is the only specific proposal in documents from the Obama campaign directed at helping make the Social Security program solvent over the long term.

Under current law, Social Security taxes are collected only on the first $102,000 of an individual's income, indexed for inflation. Proposals to increase or eliminate that cap have been around for years, advanced mostly by Democrats who claim that the wage cap unfairly burdens lower and middle-class workers.

But some economists and politicians warn that lifting the cap jeopardizes a feature that has underpinned the success of the Social Security system since its inception in 1935 -- the notion that one will ultimately benefit from the system in proportion to what one has paid into it.

"As someone who has contributed to Obama's campaign and will vote for him in November, I don't think that's one of his better proposals," said Henry Aaron, an economist at the Brookings Institution, of Sen. Obama's plan to lift the Social Security wage cap.

Defenders of the wage cap say it serves in part to protect the integrity of the Social Security program as a social insurance plan, rather than a welfare-type plan that redistributes income.

"The linkage between the payroll tax and benefits paid through Social Security has had over the years enormous symbolic value to liberals and conservatives," Mr. Aaron said.

Underscoring the divisions between Democrats on the issue, Sen. Hillary Clinton in an April debate said that Sen. Obama's Social Security payroll tax proposal would "impose additional taxes on people who are, you know, educators here in the Philadelphia area or in the suburbs, police officers, firefighters and the like."

The Social Security system faces long-term deficits and, without tax increases or benefit cuts, will be unable to pay scheduled benefits starting in 2041, the Social Security Board of Trustees reported in March. The Trustees estimated that shortfall at $4.3 trillion over 75 years, in their March report.

Sen. Obama hasn't laid out a detailed plan for Social Security reform, but rather has embraced the general approach of making more earnings subject to the payroll tax. In campaign documents, he has rejected raising the retirement age or directing payroll taxes into private accounts as ways to bolster Social Security financing.

"Obama supports increasing the maximum amount of earnings covered by Social Security and he will work with Congress and the American people to choose a payroll tax reform package that will keep Social Security completely solvent for at least the next half century," according to the Obama campaign statement.

But Sen. Obama does offer one innovation: a plan to ensure that the majority of middle-income earners don't see their payroll taxes increased. Dubbed the "donut hole," it would tax all income below the current cap -- $102,000 -- and all income above a certain threshold. That threshold could be set around $250,000, although the campaign hasn't released an official number.

A key question that the Obama campaign hasn't yet answered is whether higher earners under his plan would collect more in Social Security benefits than under current law, to reflect the additional payroll taxes paid.

Many economists argue that if the earnings cap is lifted, it would be unseemly to pay benefits according to the current formula to wealthy CEOs who don't need to rely on Social Security for financial support in retirement.

But the alternative, to tax more earnings while not paying more benefits, would veer towards a means-test for Social Security benefits, an approach many Democrats have rejected.

"When you say, we're going to begin means-testing the program, you begin to convert Social Security from an insurance program to a welfare program," says former Rep. Charles Stenholm now a senior policy adviser at the law firm of Olsson, Frank & Weeda.

Mr. Stenholm said an increase in the payroll tax cap can be part of the solution to making Social Security solvent over the long term, but it must be paired with other measures including curtailing benefits.

A 2005 analysis from the National Academy of Social Insurance found that eliminating the payroll tax wage cap all together would raise 116% of the revenue needed to cover that shortfall, if additional taxes paid don't count toward benefits.

If benefits are increased to reflect the larger Social Security wage base, removing the cap would still cover 93% of the shortfall, NASI found.

Supporters of raising the wage cap argue that even if doing so would move the program further away from a strict social insurance system, it would only be a small movement. Social Security's benefit formula is already designed to pay out much less per dollar collected on higher incomes than it pays for lower average annual incomes.

And continuing to fund the system through payroll taxes may be preferable, from the point of view of protecting Social Security's integrity, to drawing on the general fund or diverting estate taxes to keep the program functioning, as some have proposed.

Paul van der Water, a senior fellow at the Center on Budget and Policy Priorities, said calls for raising the wage cap are a response to the enormous growth in income in recent years among the wealthiest Americans.

As a result of that increasing earnings gap, only about 84% of all wages fall under the $102,000 cap, he said. The 1983 reforms that established the payroll tax cap intended that payroll taxes apply to about 90% of all income, said Mr. van der Water.

Increasing the current cap to about $208,000 would restore that level to 90%, he said. Such an increase need not be seen as threatening the link between what one pays into the system and what one collects, he said.

"Someone could argue that we have exactly the right balance now, and that anything that makes the program more redistributive would weaken the program," he said. "But it's hard to think that you ever are exactly right."

Two thoughts: first, Sen. Obama seems to be aiming only at an improvement in Social Security's financing – e.g., "for at least the next half century," which would mean to 2058 – rather than the traditional goal of 75-year solvency or the more recent goal of sustainable solvency.

Second, Paul van der Water's argument that rising earnings inequality justifies increasing the payroll tax cap to maintain coverage at 90% of total earnings (around $208,000) is a reasonable one. What's strange about Obama's plan is that folks earning between the current cap $102,000 and around $250,000 would be exempt from the tax increase. I'm not keen on raising taxes, but it's hard to see why – other than for political reasons – you'd leave these people out. They're not exactly middle class, plus by doing so you're exempting from taxation a good chunk of income even for people who do earn more than $250,000.

8 comments:

Bruce Webb said...

A good article particularly when compared to most of what is published. But it largely left out the point that there is no incidence of FICA on income from capital gains and that there is a big difference between a 90% level of wages and a 90% level of income. If we have to move Social Security farther in the direction of a transfer program it is difficult to see why we would give the truly wealthy a free pass or limit the obligation to wage earners up to but not beyond 90%. Either it is worker paid insurance or it is a societal obligation to be shared by all. Insisting that a relatively narrow band of upper middle class wage earners pick up the entire tab is rather odd.

Because Hillary's point was a little off. Since Social Security applies to individual rather than household income a cap increase will not hit much of the public sector at all, beyond some University Presidents and Football coaches and maybe a Police Commissioner here or there few public servants are dragging down significant amounts over the current cap. But what a cap increase is is a direct assault on the professional and managerial classes each of which is in position where they could likely manage or bargain for a change in the composition of their compensation packages to make more of it look like returns on capital rather than wages.

Center-right economists argue that people will react strongly even to small changes in top marginal rates. A cap increase would be a huge increase in top rates of either 6.2% or 12.4% (depending on where you fall down on where the incidence of the employer match really falls). From what I can see the best title for such a bill would be the Compensation Consultant and Tax Lawyer Relief Bill of 2009, because some of people are going to make out like bandits on this one, a group that maybe doesn't include the Trustees. The proposal seems to ignore the idea of tax planning altogether. (I don't believe in tax avoidance per se, which doesn't mean I would consider setting up a partnership or corporation in a way that minimized my burden to necessarily rise to that level.)

(And it should be mentioned that the short term impact of a cap increase is potentially negative by swelling the interest owed on an even bigger Trust Fund. You have to be pretty naive to believe that Washington had the discipline to use these new dollars dollar for dollar to lower other borrowing, which would be the only way to offset this new interest obligation for future taxpayers.)

Bruce Webb said...

You don't have to be a cynic to notice that the 'donut hole' that is being floated conveniently includes the salary range enjoyed by Congressmen. Nice move Senator!

Anonymous said...

Is incrementalism a bad approach when we do not yet have a consensus on how to achieve "sustainable solvency".

The worry over turning Social Security into a means tested, "welfare" program is way way overblown.

First, we are talking about changes that affect no more than 6% of earners per year, and it is not like we are kicking them out of the system. That means benefits are still practically universal. Welfare, at it most generous covered what 5% of the population.

Second, right now there is no cap on Medicare payroll tax. And we are charging higher premium to higher earners. No one calls that a welfare program (welfare for the sick, infirm and disabled--try that one at home). There are people paying $1,000,000 in medicare taxes and $8,000 in Social Security.

Third, the benefit formula is pretty darn progressive right now with marginal additions to benefits at the tax max of 15%.

And fourth let's remember that the right's preferred solution is to reduce benefits,. There most palatable version, is also geared towards massively reducing the rate of return for the highest earners.

If we do not adjust the cap upward by some amount, less and less of the nation's cumulative earned wages will support Social Security. Unless you actually believe that the trend to greater income inequality is going away anytime soon. The burden of paying for the deficit will fall increasingly on those less well off.

Andrew Biggs said...

A quick comment on anonymous, who said: "let's remember that the right's preferred solution is to reduce benefits,. There most palatable version, is also geared towards massively reducing the rate of return for the highest earners."

That's all true, but even if the net reduction in high earners' returns from Social Security is the same, the policies don't necessarily have the same economic effect. In general the increase in marginal taxes from raising the tax max will discourage work and encourage tax evasion; reducing benefits will tend to encourage work and private saving. While people will disagree about the degree of the effects, I think the latter is a better direction to go.

JG said...

... reducing benefits will tend to encourage work and private saving. While people will disagree about the degree of the effects, I think the latter is a better direction to go.

From the angle of economic efficiency yes, *but* the standard most popular form of benefit cut that comes first to everybody's mind is delaying the retirement age -- it seems so logical since "everybody is living so much longer than back in 1940".

The problem is that's regressive as it hits the poor and sick who have work ability limitations worst, which defeats the "social insurance" purpose of SS, and when push finally comes to political shove there's going to be blowback on that.

The much more progressive form of benefit cut is means testing -- cut out the rich. That in fact started in 1983 with the progressive income tax being applied to SS benefits but the tax proceeds remitted to the SSA instead of the treasury's general fund -- a quite effective disguise. And it's been surreptitiously and steadily increased since then as the dollar threshold at which income tax begins to apply hasn't been indexed to inflation. (And the Clinton tax increase of course further increased the income tax overtly).

In the future, additional means testing will have to be visible and overt. A lot of people get very upset over that idea -- but every parent who sends a kid to college these days has to go through full financial means-testing as per govt requirements, so I don't see what the big objection with SS is supposed to be. (At least, no university-employed professor who's salary is paid from means-tested tuition collections should object!)

When political push comes to shove on this I'll guess the result will be the opposite than with delaying the retirement age, opposition will soften. In fact, ultimately I can't see any other political possibility.

Today, Warren Buffett's minimum-wage employees at Dairy Queen paying cash transfers to him via Social Security (not to mention Medicare) is the accepted norm because of the "social insurance" myth that's carried forward in the popular mind "that one will ultimately benefit from the system in proportion to what one has paid into it" -- though the real data in all the true-life moneysworth ratios hardly back that up.

But come 2030 when a 15% income tax increase is needed on everybody to be sure all benefits get paid via the trust fund, that myth is going to be put to the political test for sure.

Not only are average working people -- including retirees facing this tax hike on their fixed income from IRAs, pensions and even Social Security benefits(!) -- going to be asking why the have to pay this new tax to be sure Bill Gates gets his, every other interest group that gets its money from the Treasury is going to be asking the same thing.

Social Security won't have its own dedicated revenue stream any more -- no more "out of the Treasury forever" as per FDR. It will be back in the Treasury using general revenue. The farm subsidy people, defense department, education department, all of them will be asking: "Why is general revenue going to Bill Gates and all the millionaires of the US instead of to poor deserving us??"

Today all the rationalizers for the status quo have it easy saying "those trust fund bonds simply guarantee that all benefits will be paid in full until 204x", because it's politically free to do so -- they don't have to exlain to anyone about any tax increase needed to pay them. It's "progressive" to believe in the trust fund today.

But in 2030, how "progressive" will it be to argue to increase taxes on the working classes to make full cash transfers to the rich? I mean, after years and years of arguing it is so bad to let "the rich" keep more of their own money through tax cuts, how is it suddenly going to be a good idea to increase taxes on the poorer to make transfers of poorer people's money to "the rich". I hope to live to see Krugman expain that. ;-)

The "progressive, pro-social insurance" solution is going to be to further means-test the rich out, avoid the mass income tax increase on average people, and keep the retirement age where it is, all to the extent possible. (With the need for all this made the more urgent by the massive tax & spending increases needed at the same time for Medicare.)

I don't see how the top 20% of the income distribution isn't going to take the big means-test hit. (Especially since they will probably be for it, because they'd rather see their modest-for-them SS benefits cut rather than take an income tax buzz cut across all their other income.)

And yes, once that makes it visible that SS has become a rich-pay-for-poor transfer program, and that if you are a success in life you aren't going to collect, there will be polticial consequences for the program.

But let's be realistic. We are going into the back end of a paygo program where, as per the Treasury, people living today are going to get back from SS $13.6 trillion less than they put in.

So fundamentally, what else is possible?

Paul Lawin said...

I won’t comment on the details of Obama’s SS position, but I will give him 2.5 points (out of a possible 4) for “political courage”.

We all know that getting SS to “balance” with the intermediate assumptions means raising taxes or reducing benefits. Almost all politicians run away from this fact. So Obama gets a full point for acknowledging this, and actually stating that he would raise taxes.

The remaining 3 potential points are awarded based on how specific he is and how close he comes to making the numbers work.

Obama gets credit for specifying that he would raise the payroll tax and also specifying how (raising the cap). He doesn’t get full credit because he seems to be unclear on the donut hole, and he doesn’t specify whether the higher cap is also factored into benefits.

Regarding the numbers, if we take the strongest tax increase (no donut hole and no additional benefits) I believe that he covers the whole 75 year actuarial deficit, but he does not achieve paygo in the out years. That’s pretty good. However, the other possibilities probably don’t cover the 75 year deficit.

Hence I give Obama 2.5 points out of 4.

In comparison, McCain gets 0.5 out of 4.

He says that he would reduce benefits, but provides no specifics on whose benefits or how much. He leaves the impression, with an implied “carve out”, that he can also provide individual accounts without raising taxes. That should give him a negative number on the “make the numbers add up” scale, but I’ll be generous and give him a zero.

Again, I’m not opining on the “plans” themselves, just on the courage to be honest about the bad news.

Andrew Biggs said...

Paul,
A good comment and I like your scoring system. I might give Obama a bit less because I'm not so keen on his policy and McCain a bit more, but it's nevertheless true that Obama has been more vocal about the Social Security problem than McCain or anybody who ran in the primaries. Given how much I've bashed Obama myself, it's clear he opened himself up for criticism he could have avoided by keeping quiet, and he deserves credit for that.

Paul Lawin said...

Andrew,

Thanks for the comment.