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.