Wednesday, January 26, 2011

That Leaves You With Precisely One Choice…

The Washington Post reports, and the President's State of the Union Address confirms, that "[President] Obama won't endorse raising retirement age or reducing Social Security benefits," scotching rumors that Obama would support the recommendations of his deficit commission to do both those things. Of course, ruling out those two options for Social Security reform means you only have one left: raising taxes, and by a lot.

According to Social Security's Trustees, to make the program permanently solvent—which they measure as being solvent over 75 years and financially healthy at the end of the period—would require an immediate and permanent increase in the current 12.4 percent Social Security payroll tax to 15.7 percent, a 27 percent increase in what is already the largest tax for most workers. If we delay raising taxes—and I'm not sensing any urgency from the administration to get on with the job—then the required tax increase only gets larger.

Alternately, we could increase or eliminate the cap on earnings subject to payroll taxes. Currently, only the first $106,800 in earned income is subject to payroll taxes, and retirement benefits are based upon those same earnings. (For a good reason, I've pointed out.) We could make Social Security solvent over 75 years (though not permanently solvent) by eliminating that "tax max."

But think about what that would do to top marginal tax rates. Currently, the top federal income tax rate is 35 percent. Adding in the 2.9 percent Medicare tax and a typical state income tax rate of around 6 percent, the all-in top marginal tax rate on earned income is around 44 percent. In some high-tax states it could be as much as 49 percent.

Under the Obama administration's plans, after the current tax cut extensions run out the top income tax rate will rise to 40.8 percent, due to an increase in the top rate to 39 percent and the phasing out of itemized deductions for high earners. The Medicare tax rate on high earners is scheduled to rise to 3.8 percent as of 2013 as part of the recent health reform legislation. Assuming, probably optimistically (see: Illinois), that state income tax rates remain constant, the top marginal tax rate will rise under current plans to 51 percent, with a maximum in states such as Hawaii and Oregon of around 56 percent.

Now imagine that we eliminate the Social Security payroll tax ceiling. The net tax rate—that is, the statutory 12.4 percent Social Security tax net of benefits that would be paid in return—is approximately 10 percent. We then are in a situation where high earners pay approximately 61 percent of each additional dollar they earn to the government. And these tax increases, which would leave high earners essentially tapped out in terms of revenues, would be before we've addressed Medicare and Medicaid's multi-trillion dollar funding shortfalls.

But, Mr. President, by all means go ahead and propose what you like. It's not as if we're facing a budget crisis or anything.

1 comment:

Yachtsman said...

Obama will not do the diffiuclt things. He will leave it to the Republicans. What a LAME duck.