The Truth About Social Security (That Was Ignored in the Debate)

Last night, both presidential candidates touched on Social Security and Medicare. I literally mean the word “touched” because there was not enough discussion of entitlements for me to conclude that either candidate “grasped” the subject. First, let’s look at Social Security. The annual Trust Fund report was quietly released in June of this year with little fanfare. It is no wonder the Obama administration tried to hide it because it looks bleak. Social Security (including retirement benefits, Disability and Supplemental Security Income) is facing a $11.4 trillion shortfall over the next 75 years, or an equivalent of 2.5 percent of payroll from 2016 to 2090. If this were to extend into the infinite horizon, the unfunded liability increases to $32 trillion, or 4 percent of payroll through the infinite horizon. People may shrug their shoulders at the infinite horizon, but the 75-year number should be of concern. After all, no candidate is proposing to cut off Social Security benefits in the year 2090, so this money has to come from somewhere, through benefit cuts or tax increases. The $2+ trillion trust fund (which is being spent on other programs) will be depleted by 2034. This is probably an understatement. Why? Because all the current Trustees are government officials (Secretary of the Treasury, Secretary of Labor, Secretary of Health and Human Services and Social Security Commissioners) and the two positions for “public” Trustees (those independent of government) are vacant, so there are no outside Trustees to balance the administration’s likely bias in favor of underestimating the unfunded liability.

Liqun Liu, Andrew Rettenmaier and Thomas Saving at the Texas A&M University Private Enterprise Research Center produced an NCPA study two years ago on the effect of popular minor entitlement reforms.  One of them — raising the amount of worker’s salary subject to the Social Security tax — has been proposed by Hillary Clinton. However, according to Liu et al.,

“…the existence of a taxable maximum means that, for workers whose earnings exceed the maximum, Social Security taxes are like lump-sum taxes in that the amount they pay is fixed. The additional Social Security taxes for workers who earn above the maximum are zero and, thus, importantly, Social Security taxes do not distort the decision of the biggest contributors to the nation’s output to work more. In contrast, eliminating the taxable maximum suddenly imposes a 10.6 percent (the OASI portion) marginal tax rate on high-income earners. Although the effective marginal OASI tax rate is below the statutory level due to the formula linking OASI taxes and future benefits, it would still be substantial, especially for high-income workers. Thus, it generates additional welfare costs.”

Simply put, tax increases matter even for high-income earners.  But they matter even more if lifting the taxable maximum on earned income is not tied to future benefits.  Social Security will become less of an “entitlement” program and more of a welfare program.

Next year, the taxable maximum salary cap will increase to $127,200.  If all Social Security earnings become taxed, the worker earning above that will expect to pay a marginal tax rate of over 34 percent (over 35 percent when factoring in the Medicare tax of which there is no cap).  If one assumes that the employer portion of the payroll taxed is passed on to the worker in the form of reduced wages, the marginal tax rate becomes 40 percent.  Several reports have addressed the expected revenue from lifting the cap will completely close the 75-year unfunded liability, but according to Social Security estimates, the additional tax will, at best, extend the trust fund through 2082.  This is contingent upon paying no additional benefits to correspond with the additional payroll tax contributions.  Furthermore, the trust fund could not be spent on other programs as it is now.  This may be too much to ask of our politicians.

Next week I will discuss the Medicare side of entitlements.

 

 

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