Friday, September 28, 2007

Social Security in the Democratic Candidates' Debate

There was a portion of the debate on Wednesday night focused on Social Security, and, in particular, raising the maximum taxable earnings as a way to collect more revenue and improve projected solvency. You can watch the segment here. The issue at hand is whether solvency can be restored by removing the cap on taxable earnings, so that all earnings are subject to the 12.4% combined (employer plus employee) tax for Social Security. This is currently the case for the 2.9% combined payroll tax for Medicare Part A.

There are two ways in which this might be done. In the first, workers who pay this additional tax would have the earnings on which they were taxed included in the calculation of their subsequent benefits. In the second, workers who pay this additional tax would not have these incremental earnings included in the calculation of their benefits. The Office of the Chief Actuary at the Social Security Administration has made it very easy to assess the effect of changes of this sort on projected solvency. The first case is shown here, and the second case is shown here.

In the first case, the system can pay full benefits for almost all of the 75-year projection period. You can see this in two ways. First, the second to last column is -0.10, meaning that over the 75-year period, full benefits could be paid entirely if this provision were enacted and the combined payroll tax rate were increased (on the old base) from 12.4 to 12.5 percent. Second, you can see that the new path of the trust fund crosses zero just at the end of the projection period.

In the second case, the system can pay full benefits for the full 75-year projection period. The second to last column is now +0.28, and the trust fund has a balance of about 3.5 years worth of benefits at the end of the period. Is this enough to say that the system is solvent? I don't think so. Even in this case, the balance in the trust fund is declining and will cross zero at some point after the 75-year projection period ends. The last column of numbers shows that annual deficits are equal to almost 3 percent of (the old base) taxable payroll. More would need to be done here to ensure that the trust fund is never projected to cross zero.

It is not clear which provision the candidates meant, but I am going to assert that it was the second one. If the problem is that there is not enough money to pay currently projected benefits, then it seems odd to now increase the claims that will be made on the system by the very wealthiest recipients. (Very roughly, if I pay these taxes on another million dollars of earnings each year over the course of a career, my benefits will go up by $150,000 per year during retirement.)

This is a large increase in top marginal tax rates on incomes where the supply-side response could be relevant. When Jeff, Maya, and I were developing the LMS plan, we decided that we didn't want to do this all on the revenue side and didn't want to get all of our revenue via increases in the cap. Instead, we borrowed the idea from the Diamond-Orszag plan to lift the cap to a point where 90% of all earnings were taxed (with no incremental benefits for the additional earnings subject to taxation). This was roughly the amount subject to the tax at the time of the last big reform in 1983. (Since a lot of the increase in average earnings has been at the high end, over time, a lower share of total earnings have been below the cap.) We also added an increase in the payroll tax rate for 1.5 percent of (the old base) taxable payroll, and made up the rest of the financial shortfall with changes on the benefit side.

More importantly, we required that all new revenues go into a system of personal accounts. This was my deal-breaker. If we were to raise this much additional revenue, without channeling it to personal accounts, we would simply be compounding a budget problem that is already severe. When the government runs a Social Security surplus, it treats those monies as available to spend on things other than Social Security. We know this because it targets the unified budget deficit, and has done so pretty routinely over the last several decades. (See here and here.) If these government inflows are matched by offsetting outflows (into the personal accounts), then there is no danger that they will be used to finance current expenditures, and the additional revenues will actually raise saving rates to help prefund future obligations.

6 comments:

TStockmann said...

Instead, we borrowed the idea from the Diamond-Orszag plan to lift the cap to a point where 90% of all earnings were taxed (with no incremental benefits for the additional earnings subject to taxation).

More importantly, we required that all new revenues go into a system of personal accounts.

I'm confused. If all new revenue, including that coming from the higher cap, were to go to private accounts, then wouldn't the individuals paying under the higher cap receive 100% of the incrmental benefit of their higher contributions, since they would appear in their personal accounts? Or is it only the revenue from the 1.5% across-the-board increase that would be placed in the private accounts?

eightnine2718281828mu5 said...

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If these government inflows are matched by offsetting outflows (into the personal accounts)
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Of course nothing says we couldn't take the additional money and split it equally among all personal accounts, right?

Anonymous said...

TStockmann,

In the LMS plan, only higher earners would pay the extra taxes from the tax max increase, but everyone would get a personal account. In other words, the tax increase on some would be used to finance personal accounts not only for themselves but for everyone else, so the effect is actually quite progressive.

Specifically, everyone would get a 3% account. 1.5% would come from added contributions. The other 1.5% would be paid from projected payroll taxes, but these in turn would be larger than under previous law because of the tax max increase. So that 1.5% is financed by higher earners for everyone else.

I think I've got that right; going from memory. If it's wrong, Dr. Samwick can correct.

Andrew Samwick said...

You've got it right. You could think of it as a 1.5% personal contribution from the account holder, with a dollar-for-dollar match funded by the revenue from the higher cap and reductions in outflows elsewhere in the system.

Anonymous said...

Social Security is not insolvent, except under scenarios which would be pretty rough on everybody.

Somebody coined the term 'Samuelson', like a Friedman Unit. It's the number of years from the present until Social Security is predicted to be insolvent, and floats around 40.
Year after year.

-Barry

Lord said...

The more appropriate marginal tax rate would be the 15% capital gains rate.