Thursday, August 14, 2008

NY Times on Social Security in Campaign ‘08

The New York Times has a story today on how the McCain and Obama campaigns are treating Social Security reform. It's a good story overall and it's great to see some attention paid to the policy details rather than just the politics.

However, I think the story's title --"Social Security Too Hot to Touch? Not in 2008" – misses the point a bit. What the story shows is that for both Sen. McCain and Sen. Obama Social Security has been a politically difficult issue to address. McCain has had trouble with his conservative base over his willingness to put everything "on the table" (Obama had the same problem when he made a similar statement) while the vagueness of Obama's own proposal is clearly designed for purposes of political protection.

One section is worth highlighting (and not simply because I'm quoted in it):

To begin to attack the problem now, Mr. Obama would subject all wages above $250,000 a year to the payroll tax. That concept has been nicknamed the "doughnut hole" because it would exempt wages between $102,000 a year, the current ceiling for contributions, and $250,000.

"What Barack Obama is doing is different from what people running for president traditionally have done," Jason Furman, Mr. Obama's chief economic adviser, said in an interview. "He's putting an option on the table, not just saying he wants to work with Congress, but also saying what he wants to work on."

While more specific than Mr. McCain's plan, the Obama proposal raises questions. The tax rate Mr. Obama would apply to wages over $250,000 has not been established, but it would be lower than the combined 12.4 percent that employees and employers now jointly pay. "We've studied a range of plans with combined employer and employee rates between 2 and 4 percent," Mr. Furman said.

By itself, the Obama proposal will not guarantee the solvency of Social Security. Andrew Biggs, a Social Security expert at the conservative American Enterprise Institute, calculates that the plan would reduce the gap by 15 percent to 43 percent, depending on the level of the surtax, which he complains "is being fuzzed up to prevent people like me from running the numbers."

It is also not clear whether those paying the additional payroll tax would receive more benefits, as the system now mandates. Mr. Furman said "it is factually inaccurate to say that a decision has been made to de-link taxes from benefits," because "that is something you'd want to work out with Congress."

While Sen. Obama deserves credit for putting an option on the table – something Sen. McCain hasn't done to date – as it currently stands Obama's option is barely a policy. We know people earning over $250,000 will pay more, but we don't know how much and we don't know whether they'd earn any extra benefits. This forces people (like me) to make the best assumptions we can about how things would work.

Here I estimated the effects of a 4 percent surtax on earnings over $250,000, on which no extra benefits would be paid. This would improve the 75-year actuarial balance by around 0.27 percent of payroll, reducing the total 1.7 percent deficit by around 15 percent. This is about the most the Obama approach could get. If benefits were not delinked from taxes, the improvements would be smaller (by around one-fifth, I believe). If the tax rate were 2 percent rather than 4 percent, the gains would be cut in half. You get the drift.

The point here is that under a reasonable range of assumptions, Sen. Obama's plan doesn't get you very far – certainly not far enough that you could rule out raising the retirement age or reducing benefits.

Update: See today's Wall Street Journal op-ed by Jason Furman and Austan Goolsbee for a few more details on the Social Security side of things. One new detail is that the tax increase would not begin until "a decade or more from now." The numbers I cite above assume a 2015 start date, so the solvency improvements would be a tiny bit smaller than before.

Another key point: Goolsbee and Furman argue that Obama's plan is similar to one floated by Sen. Lindsey Graham several years ago, which Sen. McCain at the time said he could support. This is a valid point, but several key differences should be pointed out. First, under Graham's plan any tax increases would be used to fund personal retirement accounts, not finance the curent program or build the trust fund. Second, Graham's proposal included a surtax along with a number of other policies. Obama proposes a surtax but rejects any other changes, putting him on the wrong side of the mathematical divide.


Bruce Webb said...

According to the standard theory put forth by Chicago style inspired folk economic actors are acutely sensitive to even small changes in marginal rates. And history shows that people will change their tax strategy in ways that minimize exposure to higher rates. The Obama plan such as it is seems to assume that higher income taxpayers as a whole do not have the ability to negotiate a change in their compensation package away from wages exposed to FICA. I don't see this as being true at all.

So in this case history supports theory with the result that the take from the Donut Hole proposal will be much less than simple scoring would suggest.

Andrew G. Biggs said...

In the first piece I wrote on Obama for the WSJ ( I cited a paper by Jeff Liebman on the effects of raising the tax max. Looking only at the impact on labor force participation and on how the increased employer contributions would no longer be subject to other taxes, the rough conclusion was that the net take would be around 50% of the gross. That estimate excludes the possible effects of tax evasion, such as shifting earnings into dividends, etc. So you could easily end up netting well below 50%.