Friday, October 24, 2008

New article: Obama Wants Social Security to Be a Welfare Plan

I have a piece in today's Wall Street Journal that builds on posts and comments here and here.

Obama Wants Social Security to Be a Welfare Plan

His tax credit amounts to a radical change in the system.

By ANDREW G. BIGGS

Imagine this: Barack Obama proposes a Social Security payroll tax cut for low earners. Workers earning up to $8,000 per year would receive back the full 6.2% employee share of the 12.4% total payroll tax, up to $500 per year. Workers earning over $8,000 would receive $500 each, with this credit phasing out for individuals earning between $75,000 and $85,000.

This tax cut would make an already progressive Social Security program even more redistributive. Under current law, a very low earner receives an inflation-adjusted return on his Social Security taxes of around 4%. That's a good return, given that government bonds are projected to return less than 3% above inflation. A high-earning worker, on the other hand, receives only around a 1.5% rate of return. Under Sen. Obama's proposal, returns for very low earners would rise to around 6% above inflation -- about the same return as on stocks, except with none of the risk. Compounded over a lifetime's contributions, the difference in the "deal" offered to workers of different earnings levels would be extreme.

While Social Security has always been progressive, many would say this plan goes too far and risks turning Social Security into a "welfare program." Low earners receive more in benefits than they pay in taxes -- meaning their "net tax" is already negative -- and Mr. Obama's plan would increase net subsidies from the program.

Moreover, this payroll tax cut plan would reduce Social Security's tax revenues by around $710 billion over the next 10 years. If made permanent, the Obama tax cut would increase Social Security's long-term deficit by almost 60% and push the program into insolvency in 2034, versus 2041 under current projections.

To fill the hole in Social Security's finances, Mr. Obama would increase income taxes on high earners and pour that money into Social Security. This would be the first time that income tax revenues have been used to finance Social Security, which has always relied on its own dedicated payroll tax to differentiate itself from other government programs. Filling the gap with higher taxes on high earners would further increase Social Security's progressivity, pushing it closer toward a welfare-program approach.

Now, you haven't heard Mr. Obama describe anything like this plan. If you had, it's likely you wouldn't support it. But it's almost exactly what his headline "tax cut" would do. The Obama campaign took the idea described above and made it much more complicated.

Under the plan, which he claims would cut taxes for 95% of Americans, provides an income tax credit worth 6.2% of earnings up to $8,000, for a maximum credit of $500 per worker or $1,000 per couple. The 6.2% figure is important, because it matches the employee share of the Social Security payroll tax. Because around a third of Americans currently pay no income taxes -- a fraction that would rise to almost half under Mr. Obama's plan, according to the Tax Policy Center -- Mr. Obama's tax credits would be refundable, meaning you could collect the credit even if you paid no income taxes.

While Mr. Obama calls his plan "Making Work Pay," under standard economic assumptions his plan would actually discourage work for anyone earning over $8,000 per year. The tax credit itself would increase workers' take-home pay, an "income effect" that reduces incentives to work. Moreover, for workers in the $75,000 to $85,000 income range, where the tax credit is phased out at five cents for each dollar of additional income, this would add five percentage points to their marginal tax rate.

So Mr. Obama has in essence proposed cutting Social Security taxes for low earners, which would shift the system toward a "welfare" approach and sharply increase its long-term deficit. To fill the funding gap, he will raise taxes on high earners and funnel the money into Social Security, making the system even more progressive and breaking a long tradition against funding Social Security with income taxes.

The complex way in which Mr. Obama structures and describes his plan would make it harder to administer than a straight payroll tax cut. But it is also more difficult for the typical American to understand. This may explain why he chose complexity over clarity.

14 comments:

Sherwin L. said...

This is a detail that has been overlooked by both campaigns as well as the rest of America.

I'm curious to know if the WSJ editorial board plans to make any endorsements this year.

Jonathan Kaufman said...

Thank you for your detailed analysis of how Obama's tax cut and Social Security plan would work. This is an excellent program and I now support Obama all the more. Our country has fostered many a program to benefit high income individuals. It's time to right the ship.

Anonymous said...

It's all preparation for the new Socialistic America. Obama, (Abomination) will have us all paying for welfare of illegals and the lazy shiftless moochers.There won't be Social Security left for those who paid into it for 50 years-he's committing a criminal offense.

Welcome to the new world. If only America would have looked to a third party it could have turned around.

MS said...

I understand your argument. But then, where does it stop?

Say you wanted to cut income taxes by one percentage point on those making a taxable $632,400 to reduce their tax liability by $6,342.

Mirroring your argument, the $6,342 figure is important because it matches the employee share of the Social Security payroll tax for the person earning $632,400.

Then, would you say that this tax relief "would reduce Social Security's tax revenues"? Or that the payroll taxes from low-income workers are financing the tax cut?

I think the main message of your argument is well taken: the tax structure is much more progressive than it seems once we include things like Social Security. OK. But this doesn't answer the question of whether the system is progressive enough to match the voters' preferences. With Obama, voters might be saying that it is not.

Adam said...

To ms,

The important point that the op-ed makes is that many people pay zero income tax. For those people, Senator Obama's refundable income tax credit is really a credit against payroll taxes, which are used to fund Social Security.

Your point about the employee share of income for the person making $632,400 is correctly calculated. (The $6,342 is 6.2% of 102,000--the current income cap that can be taxed under Social Security). Unfortunately, its also unlikely.

A person making $632,400 a year likely has sizable income taxes. Any tax reduction that reduces their income taxes but does not reduce them below zero will not impact Social Security financing through payroll taxes.

Your second point about the desired level of Social Security progressivity is a valid point. Policymakers could reconsider the progressivity of Social Security.

In fact, Senator Obama has made a proposal to change the cap on taxable income on Social Security. His plan calls for additional payroll taxes on income over $250,000 with a "donut hole" between the current $102,000 and $250,000. This plan would alter the progressivity of Social Security benefits in a transparent way.

Sadly, Sen. Obama's "Making Work Pay" alters Social Security financing in an opaque way. It is designed to look like an income, rather than a payroll tax credit as it will be for those who pay not income tax.

There is a legitimate argument to be made that voters may wish to change the Social Security system; disguising proposals that do that is counterproductive to that goal.

Anonymous said...

This is partially misleading as the analysis does not take into account the fiscal imbalance between the General Budget and the Social Security fund

Joe said...

This is interesting.

How would it effect those who own their own businesses and give themselves 'reasonable compensation' of 25 or 30k in order to avoid payroll tax on the bulk of thier income?

Anonymous said...

"Moreover, for workers in the $75,000 to $85,000 income range, where the tax credit is phased out at five cents for each dollar of additional income, this would add five percentage points to their marginal tax rate."

I fall right into this income range- Can someone explain what this means exactly? And what happens when I earn more than 85k? This is disturbing.

Thanks.

Frank said...

Nice piece but you actually understate the redistributionist nature of the Obama plan because the EITC already more than offsets (more than double in fact) both the employee and employer payroll taxes on low income workers:

http://divisionoflabour.com/archives/005277.php

chard said...

imagine all the adjustments, reconfiguration, reprinting of accounting software programs, circular e, - and what well states with a personal income tax do? What about SUTA & FUTA tax rates?
Does O have -ANY- breaks at all for small employers who already pay hundreds of thousands- if not millions in payroll taxes? A small construction company pays $100k/year for W/C? SUTA is 5.4% per dollar!
I know Democrats are obsessed with the employee...the average JOE, but what is it about employers that the DNC hates so much?
What must it be like to work as an underling in Pelosi's office?

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Anonymous said...

If my married filing jointly retirement income is over $68K The marginal tax rate on my Social Security pension is 85%. Isn't that "progressive enough"?

Andrew G. Biggs said...

Thanks for the comments. A couple quick (and belated) replies:

MS: You're right that taxes are fungible so you can make a cut in any tax look like it's a cut in any other. That said, a) the Obama tax credit is equal to 6.2% of wage earnings, which is in fact the employee share of the Social Security tax; and b) the Obama folks make plain that's what they're intending. So while you have a point, I don't think it holds here.

Anonymous: I'm not sure what you're arguing about the fiscal imbalance.

Joe: If you own your own business then you've got the opportunity to shape things a bit more. In general I'd guess people would keep wages as low as plausible, but other issues may factor in.

Anonymous 2: The phase out between $75-85k means that you lose five cents in the credit for each extra dollar you earn. This is equivalent to a marginal tax rate of 5%, in addition to whatever other taxes you're paying. Once you reach $85k, there's no more tax credit to be deducted, meaning those folks get zero.

Frank: I didn't mention the EITC for space reasons, but it's a good point. The EITC was set up to offset payroll taxes for certain folks (low income workers with kids). Obama wants to expand the EITC, plus put in place this new credit. So folks can potentially be even double compensated for their payroll taxes.

Truth First: You scare me.

Bradley said...
This comment has been removed by the author.