Friday, March 2, 2012

Stealth Income Redistribution

In her recent New York Times column, Gail Collins makes make the following unoriginal, lazy and Robin Hoodinan proposal for Social Security reform:
“The basic answer to fixing the long-term Social Security imbalance is just to eliminate the payroll tax cap, which currently exempts all income over $110,100 a year. Do that, and you have solved the problem. Politically speaking, you would probably have to agree to mix a limited tax increase with one of the fixes desired by fiscal conservatives, like reducing benefits for the wealthy, or changing the cost-of-living adjustment or, yeah, raising the retirement age a little. But the main answer is that cap, and anybody who refuses to even discuss the payroll tax cap is not serious about fixing Social Security.”
Ms. Collins is no doubt pandering to the New York Times reader, and judging by the comments, successfully so, but the piece grossly misdiagnoses the problems of Social Security (perhaps intentionally), and prescribes the wrong medicine.

Let’s step back a bit to understand the original intentions of Social Security – straight from a passage on the U.S. Social Security Administration’s (USSSA) website describing the 1935 Social Security Act:
“The significance of the new social insurance program was that it sought to address the long-range problem of economic security for the aged through a contributory system in which the workers themselves contributed to their own future retirement benefit by making regular payments into a joint fund. It was thus distinct from the welfare benefits provided under Title I of the Act and from the various state ‘old-age pensions.’"
At its essence, Social Security is a government mandated and administered (herein lies the problem) defined benefit retirement plan for every American worker. Workers pay in 6.2% of their lifetime earnings for the promise of a return of that money, plus interest (i.e. the cost of living adjustment), in monthly increments upon retirement.

Ms. Collins correctly points out that workers contribution are capped at $110,100, but she conveniently fails to mention that Social Security benefits are also capped at $110,100. Anyone who makes more than $110,100 only accrues future benefits on the first $110,100 of income each year.

The intention of Social Security was to provide for a social insurance program, not a welfare program.

The problem is that the USSSA is both actuarially challenged and politically malleable - resulting in a Ponzi scheme that makes Bernie Madoff look like a child who stole a pack of Skittles from the grocery store.

The Social Security obligations have substantially grown, in large part due to American’s ever increasing life expectancy and the generous cost of living adjustments baked into the benefits formula, yet the amounts paid into the system have not grown fast enough to fund these obligations, and in some cases, most recently as part of the payroll tax “holiday” legislation, contributions have actually shrunk. Uncle Sam now needs the payroll taxes of three current workers to pay for the Social Security checks of one retiree. 

Social Security is a ticking fiscal timebomb, and without reform, the only question will be which generation gets soaked with reduced benefits and/or substantially increased taxes.

So what’s the solution?

Ms. Collins is right that fixing Social Security will require multiple actions, including an increase in the retirement age and a decrease in the cost of living adjustments. However, those actions really just tinker with the benefits formula, which is important, but its not a solution.

The only real solution is to turn the program into an economically sound retirement savings program. Americans should only be entitled to receive benefits that have been fully funded by their payroll tax contributions. Private businesses realized long ago that defined benefit plans are dangerous and can be prohibitively expensive, and have since replaced them with defined contribution plans, for example, 401(k) plans. It’s time our government did the same.

Ms. Collins idea of eliminating the payroll tax cap, while hinting at lower benefits for those now forced to pay more into the program, flies directly in the face of the original purpose of Social Security.

We should be reforming Social Security to bring it back to its original insurance mandate, not to create yet another vehicle for welfare programs funded by income redistribution. If we believe there is a population of Americans who deserve more than they put into the system, and there absolutely will be, those funds should be appropriated through Congress, along with all other welfare programs, and not obfuscated within the Social Security and payroll tax debate.

If you want to argue for an even more progressive tax code, by all means make that argument, but don’t cower behind the guise of Social Security and payroll tax “reform” to get there. You might be able to fool your core audience, but you can’t fool all the people all the time.


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