Wednesday, April 15, 2009

How does Social Security affect tax progressivity?

The Economist weighs in on tax day on how the Social Security program affects the overall progressivity of the tax code. People on the right often point that that the vast majority of income taxes are paid by high earners. On the left, however, folks point out that payroll taxes are a large and regressive tax that often isn't included in these kinds of analysis. That's a fair point. However, as I discussed here, Social Security is a program in which taxes and benefits are linked. And low earners generally receive more benefits relative to their taxes than do high earners. So the progressivity of the benefit formula needs to be factored in.

This chart shows the lifetime net Social Security tax rate paid by current retirees of different earnings levels. The net tax rate reflects the legal tax rate – 12.4 percent of earnings – minus the benefits generated by those taxes. If you received lifetime benefits equal to 12.4 percent of your lifetime earnings, for instance, your net tax rate would be zero. If you received even more than that, your net taxes would be negative – this means that you receive a subsidy from the program.

As the chart shows, for low earners the net tax rate is highly negative, meaning that they receive significantly more from the program than they pay in. Subsidies are smaller for middle earners, and non-existent for individuals in the top 20 percent of the earnings distribution.


Bruce Webb said...

Absolutely right.

But then we would need to dynamically score the benefits flowing back to capital via the investments by the government in such things as airplanes and highways and the traditional efforts of the Fed to use any sign of employment under the so called NARU as an excuse to clamp down on monetary policy in an effort to protect bond yields. One man's high cost of borrowing is another man's Fed protected rate of return on Treasuries.

WilliamLarsen said...

Combining Payroll taxes and Federal income taxes into one large pot misses the point of both taxes. In 1935 FDR signed the Social Security Act. This act created the SS-OASI tax and set it at 2%. It is now 10.6%. The sole purpose of this tax was and still is to pay for Social Security benefits. It does not and cannot be used for any purpose other than paying SS-OASI benefits. FDR wanted this tax to be broad based and shared by all workers. He did not want it to be seen as a weapon used by politicians to pit low wage earners against high wage earners. He did not want to create a class warfare. Class warfare would doom any chance of SS. That is the sole reason the wage base was set at about 110% of the average wage. The SS benefit is not based on taxes paid, but wages earned subjected to the SS-OASI tax or more commonly known as the SS-OASI wage base.

Federal Income Taxes are used to pay for defense, running the government, Medicaid, food stamps, national parks, paying the interest on the national debt and more.

Combining the two distinct taxes is not conducive to the discussion of overall progressivity. Those paying SS-OASI taxes are being a promised a benefit. Those paying federal income taxes are paying for cost of our government. Those who do not earn enough to pay Federal Income Taxes are not pay for the cost of Defense, food stamps, Medicaid, SSI or any other government program.

Those who pay SS-OASI taxes are paying for a promise that when they reach full retirement age, that future workers will feel compelled to pay SS-OASI taxes to pay them a SS-OASI benefit.

Percentages used in this manner is wrong.

John Bailey said...

I wonder if this analysis takes into account life expectancy.

According to Census Bureau data,
the average black male didn't live to reach 65 until 1995. That is 45 years after the average while male's life expectancy exceeded 65 in 1950.

Andrew G. Biggs said...

My analysis does account for life expectancy. African Americans (and lower income Americans, which is the real driver) do have shorter lives, the progressivity of the program is more than enough to account for it.

Jim Glass said...

I would like to see this exact same chart projected for persons retiring 30 years from now, and plays "compare the bars".

For that matter, I'd like to see another one for persons who retired 30 years ago, before the changes of '83.

Just wishin'. ;-)

Andrew G. Biggs said...

I can do the future folks no problem, it's just a matter of finding the time! The past retirees are harder, though I did a paper for SSA here ( that looked at progressivity from the past through the future. There was a dip in progressivity over the 80s/90s, but we expect it to remain roughly constant going forward.

WilliamLarsen said...

When you speak of life expectancy, what age are you referring to?

Increased life expectancy is the culprit behind social security's problem
“Life expectancy at birth in 1930 was indeed only 58 for men and 62 for women. But life expectancy at birth in the early decades of the 20th century was low due to high infant mortality, and someone who died as a child would never have worked and paid into Social Security. A more appropriate measure is probably life expectancy after attainment of adulthood.

Since average life expectancy at birth is now about 76, this is interpreted as implying that people collect benefits for 14 to 18 years longer than they used to. However, as Table 1 indicates, the average life expectancy at age 65 (i.e., the number of years a person could be expected to receive unreduced Social Security retirement benefits) has only increased a modest 5 years (on average) since 1940. So, for example, men attaining 65 in 1990 can expect to live for 15.3 years compared to 12.7 years for men attaining 65 back in 1940. So the actual increase in time that males can anticipate receiving Social Security is closer to 3 years than to 14.” [9]

What you need to do is look at life expectancies of this race not at birth, but at some later age where at least they are old enough to pay the payroll tax which would be age 16. You might then look at what meaningful employment is and that might be age 20. However, using life expectancy at birth is incorrect.