National Debt Part III: Radical Reform of Social Security

Radical Reform of Social Security requires starting at the root, and that root is its real purpose and goals today, in 2010.  What are we really trying to accomplish with this program?  What are the basic problems for which we should supply social safety nets, and how do we best supply and sustain them?

2010 is more like the 1935 of Social Security’s birth during the Great Depression than any other time in American history so far.  It is a time of Great Recession, when macroeconomic events have created new poverty and exacerbated old.  Unemployment has destroyed wage income, and plummeting stock markets have devastated savings from earlier and other incomes.  Nonetheless, asking this root question of purpose yields distinctly different appropriate approaches from those we’ve been following, only slightly tweaked, for almost 75 years.

In 1935, FDR was responding to the ruination of nest eggs through collapse of the stock market.  He was particularly interested in the suffering of people who were too old to replace these losses through years of extra work and saving.  They had become poor too late to help themselves, and Society stepped in to provide this help.

Today, even as FDR’s Social Security system approaches bankruptcy, it does only a mediocre job providing financial ease in old age.  Even worse, the very structure of social security causes harmful effects to the economy in general and the working poor in particular.

According to the Social Security Administration, Social Security checks only provide 39% of a retiree’s income.  American workers must not only pay their Social Security taxes, but put money away at the same time if they want to avoid poverty in old age.  Needless to say, there is not much “security” in such a system.  Most people will not be able to survive on $1100 or  $1200 per month.  The current Social Security System does not successfully protect against poverty in old age.

Furthermore, Social Security has a number of negative indirect effects. The program may actually make a substantial number of people poorer in many of the years before retirement. “Contributory financing” is attractive to Americans who like to think that other people have paid for what they’re getting from the government.  But in the case of Social Security, this translates into the practice of early forced “saving” through payroll taxes to replace earned income for the elderly after retirement.  The result is more poverty, less employment, and higher underemployment in hopes of less poverty tomorrow — a tomorrow far, far away for many and never reached for those who die early.

Payroll taxes are a noxious form of taxation at all times, but particularly when high rates of unemployment are a national concern, as they are today.  These taxes discourage employment by creating a wedge between what businesses have to pay to hire or keep workers and what workers get to keep.  From 1937 to 1948, this difference was relatively small.  To finance Social Security benefits, employers and employees were each taxed 1.0% of the wages they paid out or took home. Medicare had yet to be invented, so its payroll taxes didn’t add to the total.  Social Security now taxes all workers at a rate of 6.2% of all their earned income up to $106,800, and employers have to match withholding with another 6.2% of their own. (Medicare adds another 1.45% to each side, for a total burden of 15.3%.)

The poor, it is often said, don’t pay income taxes.  The Earned Income Tax Credit has certainly made this true for some.  But the income ceilings for eligibility are pretty low, and everyone with a job paying above that level sends at least 7.65% of his or her earned income to the government.  “At least” because “writing the check” is different from “paying in a true economic sense.”  If businesses can get away with lowering wages in response to payroll taxes, they will.  Their total costs (wages plus their share of taxes) then go up by less than the taxes, and labor’s income (wages minus their share of taxes) go down by more. Business has then shifted some of the tax burden to Labor.  For workers earning minimum wage, the results can be even more draconian.  Employers can’t shift any of the burden to these employees, but they may lower their wage to zero, firing or never hiring people whose productivity is regarded as less than the total of minimum wages plus payroll taxes.

The situation gets even more deplorable.  Social Security may be part of what traps the poor in an even deeper sense.  The payroll tax not only causes poor people to lose income today by reducing employment and after-tax income.  It also causes losses in future income.  Entry-level jobs don’t just provide current income. Part of their rewards are hidden and deferred — on-the-job training, investment in human capital that can lead to better jobs and entry into the middle class.  Investing in human capital doesn’t just occur through formal education.  And it’s every bit as important a source of economic growth and prosperity as investing in machinery.

Growing the economy requires getting out of this Great Recession and increasing investment in equipment as well as in people.  Investment in extra capital tends to increase labor productivity even when the new equipment is just like the old.  The effect is even more positive when new capital embodies new technology.  Unfortunately, Social Security is probably holding back recovery and holding back growth.

To hire new workers, employers have to be very optimistic about economic recovery and not too concerned about future tax increases and other changes in the rules.  Reverse Keynesianism may actually be taking hold today. Deficit spending may actually be holding back private spending. Businesses may be cutting back as all that “job creation spending” previously known as “stimulus spending” raises anxiety about exploding deficits and debt and how they’ll be financed. Social Security plays a negative role here, too. Not only does it require current taxes that discourage employment, it has future unfounded liabilities that reduce entrepreneurial confidence and optimism as we all anticipate future tax hikes.

Few, if any, of these negatives are offset by the salutary effect of all the forced “saving” driven by payroll taxes. More saving, absent recession, means more investment, and more investment means more growth.  But none of that payroll revenue has actually been saved.   Our government is saving nothing for the elderly. It has never saved anything for the elderly.

What we have is a pay-as-we-go program, with a pledge to support today’s and tomorrow’s elderly by imposing payroll taxes on today’s and tomorrow’s workers.  Demographic change has put us on a frightening trajectory of massive and accelerating unfounded liabilities.  In 1950, 16.5 workers supported each retiree. Because of the baby-boomer bulge and increased life expectancy, this number has fallen to 3.1 today, and within 20 years it’s expected to drop to a mere 2.1.

The horror story of unfunded promises has received a lot of publicity of late. Less acknowledged is what has happened to earlier surpluses in the system: they were diverted to the payment of other government programs.  In 2008 alone, the Social Security surplus was $180 million, with a cumulative total of $2.4 trillion.  No wonder Mark Brandly urges us to “[t]hink of it as an exponentially larger version of Bernie Madoff’s Ponzi scheme.”  (See  “The Social Security Scam”.)Trillions of dollars of regressive payroll taxes can’t even be justified as “contributory financing”.  This is shameful diversion and warrants more exposure from the press.

While Social Security has done nothing directly to increase savings, the program has at least two indirect consequences for private savings.  On the one hand, people with jobs and therefore mandatory contributions to Social Security are likely to save less because this program “guarantees” defined benefits for their retirement years.  On the other hand, they may not believe this guarantee and increase savings not just because Social Security is insolvent but also because most efforts to improve its balance sheet are likely to include increased income taxes.  Small solace, this, because the extra savings will go ultimately to debt and deficit reduction, not to new ideas and the equipment that embodies them.

Poverty at all ages is our real problem, and the Social Security program as it exists today should accordingly itself be retired.   It’s certainly old enough, it’s not properly structured, and its goals are insufficiently wide.  Created in a crisis, it’s worsening today’s crisis.  Even in times of prosperity, it has created  poverty in efforts to avoid poverty.  Well intentioned, Social Security deserves a proper memorial service, but buried it definitely should be.

The next column will discuss alternatives to the current social security system.