Thursday, January 24, 2013

New paper: “Don’t raise Social Security taxes: But if it’s necessary, here’s how.”

I have a new paper in AEI’s Retirement Policy Outlook series, titled “Don’t raise Social Security taxes: But if it’s necessary, here’s how.”

The basic take is this: Social Security is the entitlement where it makes most sense to reduce benefits rather than raise taxes. Unlike Medicare or Medicaid, cuts to future Social Security benefits can (by middle and high earners, at least) easily be replaced through higher retirement saving.

However, political compromise may mean that revenues will have to be on the table as part of any package deal to fix Social Security. If so, it would be preferable to raises taxes the old fashioned way – by increasing the payroll tax rate – than by raising the payroll tax ceiling.


Larry said...


Social Security levies a flat 12.4 percent payroll tax on earnings below $110,100. The tax is higher, then, for workers with low and moderate earnings than it is for high-income employees. A worker earning a meager $11,010 a year pays a 12.4% of this in payroll taxes, the same as a worker earning ten times this amount, but an employee earning $220,200 a year pays only a 6.2% tax.

Eliminating the $110,000 cap on which payroll taxes are levied, without any increase in the tax rate, would keep the scheme "funded for almost 75 years". Yet your preferred reform, on the revenue side, is "an immediate increase in the payroll tax rate from 12.4 to 16.3 percent" to "make Social Security permanently sustainable"? High-income employees would continue to benefit from low rates of taxation.

Why? Don't conservatives favour flat taxes? Here is an opportunity to transform Social Security taxes from a regressive tax on earnings into a flat tax, payable on all wage income, from the very first dollar of income. Why not seize the opportunity?

Or, better yet, why not fund Social Security from a broad national sales tax, or a tax on all income, rather than just wage income below a cap? By broadening the tax base in this way, the programme could be made permanently sustainable with low tax rates.

Just wondering. As you know, my preferred solution is to eliminate state earnings-related pensions ("Social Security"), and replace them with a flat universal pension, financed from general government revenue on a pay-as-you-go basis.

Andrew G. Biggs said...


IF we fixed Social Security entirely through taxes (which isn't my preferred option), my preferred option would be an increase in the payroll tax rate.

You're right that the payroll tax rate is regressive, but since OASDI is a contributory system you need to consider benefits as well. Since the benefit structure is progressive, the net tax rate -- taxes net of the benefits they bring -- remains progressive. Assuming people have a (more or less) accurate understanding of how the program works, it's the net tax rate that matters for incentives.

If you don't want a contributory program, which I have some doubts about myself (at least for a lower tier), then obviously you have a lot more options on the revenue side. I don't see that the US tax code, which is already among the most progressive in the OECD, needs to get more progressive. If financing from general revenues, I would merely think in terms of what approach -- a VAT, etc. -- might be the most efficient means of generating whatever revenues we need.