January 2017, No. 17-02
The Effects of Collecting Income Taxes on Social Security Benefits
John Bailey Jones and Yue Li, Federal Reserve Bank of Richmond
Since 1983, Social Security benefits have been subject to income taxation, a provision that can significantly increase the marginal income tax rate for older individuals. To assess the impact of this tax, we construct and calibrate a detailed life-cycle model of labor supply, saving, and Social Security claiming. We find that in a long-run stationary environment, replacing the taxation of Social Security benefits with a revenue-equivalent increase in the payroll tax would significantly increase labor supply, consumption and welfare. From an ex-ante perspective an even more desirable reform would be to make the portion of benefits subject to income taxes completely independent of other income.
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" From an ex-ante perspective an even more desirable reform would be to make the portion of benefits subject to income taxes completely independent of other income."
I thought that the reason that the tax was created was because then-seniors were collecting massive economic returns that were flowing to people who were very rich. The thresholds were set to affect about 3% of the retiree base.
As it is, the threshold starts close to poverty level, and pretty much stops at $45,000. I think that people making 50,000 pay taxes on something like 84.9% of their income.
So how will this reform change anything. Are we going to start taxing people in poverty?
The idea of replacing lost revenue with more payroll tax may increase the supply of labor, but increasing a wage tax is apt to hurt the number of jobs that employers offer.
The taxing of SS benefits was the result of the Greenspan Patch. As Joe the Economist correctly points out, it was applied to those who were in 1983 thought to have high retirement income. When this was passed I discussed with my father that over time this would affect every single retiree on SS. The simple and obvious reason was the income that was excluded from taxation was not indexed to inflation. Even had the excluded amount been subject to increasing with inflation, it would over a longer period of time creep into all income levels due to Wage growth leaving the excluded amount equal to that of 1983, but taxing the increase in standard of living from then on.
The alternative of increasing the payroll tax instead makes a terrible program just that much worse. The current benefit is worth if full scheduled benefits with COLA can be paid worth 7-8% of payroll. The current OASI tax is 10.03% (was 10.6% but was reduced to increase the DI's tax portion). In simple workers the workers as a group are paying a minimum of 2 percentage points more or roughly 25% more for a product than could be done on their own.
This in itself might not be too bad, but even the CBO and SSA both calculate that neither projection of current taxes and expenses will ever be positive again and worse, the divergent between revenues and expenses will continue.
Currently the 75 year solvency period has a 4.86% divergence. So increasing the tax from 10.03% to 14%+ would make the cost premium of retaining SS-OASI for workers equal nearly to 100% - For every one dollar used to get a benefit, the worker would contribute $1 for the sole purpose of allowing congress to continue the Social Security Program. If this were cell phone plan or an underwater mortgage, 100% of the people would change providers.
The SS Titanic is sinking, there is no way to keep it afloat. Why would we? Why not safely disembark from this wreck? The only reason I can think of is that politicians have made promises to over 210 million workers without knowing any math, economics or having an ounce of courage.
I am listening to Ken Follett's book "Fall of Giants" and in it talks about peace talks to end WWI in 1917, but no one wants to loose face, no one can remember what the war was about and more. Are we continuing a Social Security program because we have forgotten the reason and now 80 years later we are doing it out of duty?
Will there then need to be a higher EIT for those low wage workers are forever disenfranchised from being able to save? Will low wage positions be eliminated even faster as we employ robots that need not pay FICA taxes? Will we move more jogs overseas to escape a potential 18% SS-OASI tax?
For every tax created, there is an equal an opposite reaction to it. The tax never accomplishes its intended purpose.
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