Friday, September 09, 2011

Social Security - Ending The Myth

The US Social Security system consists of a tax on employees and on employers. The main components are 1) Social Security 2) Medicare.

How Social Security Taxes are Calculated:

The social security tax rate on individuals is 6.2% up to $106,800 (this amount has been increasing annually, that is the 2011 "cap") and this rate was reduced to 4.2% in 2011.

The social security tax on employers is also 6.2% up to $106,800. The employer tax percentage was not reduced in the 2011 "payroll tax holiday" that was put in place as part of the grand budget compromise last year.

For medicare - it is 1.45% on employees with no limit, and for employers it is also 1.45% with no limit.

In total - if you are self employed, it is (6.2+6.2 less 2% tax holiday) or 10.4% FICA up to $106,800 and a medicare tax of 2.9% up to your total income.

The Social Security "Trust Fund"

The revenues from social security go into Federal government coffers. Then benefits are paid out of Federal funds. Technically the "surplus" of social security revenues over amounts paid out goes into a trust fund but there is essentially nothing "saved" in a real sense, just an "IOU" from the Federal government promising to use their taxing (and more likely, their borrowing) power in the future to meet this obligation.

While many people have been skeptical about social security's ability to pay out benefits in the past (including a recent candidate who called it a "Ponzi scheme"), there was at least a logical smidgen of truth to the fact that the US government attempts to tax in a clear fashion from workers that will someday benefit from social security and then pay out benefits in a consistent manner.

Recent Tax Proposals

Recent tax proposals, however, start to remove the last fabric of the lies that allowed social security to be seen as anything other than another government entitlement program, funded by a mix of taxes with a lot of borrowing thrown in (at an unsustainable rate). The new proposals cut the individual rate to 3.1% (and the employer percentage down to 3.1% for smaller payrolls), a reduction from the pre-holiday combined rate of 12.4% down to 6.2% (for smaller companies). There is a separate $50M holiday for companies increasing payroll that makes this calculation more complex, and the medicare portion stays the same at 1.45% for employer and employee to total 2.9%.

Since social security can barely cover its current obligations now out of tax revenues, likely these changes will move it into the red immediately, and eliminate the fiction that the surplus is "saved" in a trust fund anywhere at all. Now social security looks like any other tax program, subject to the whims of the government and changing policy preferences, rather than a pension plan which it is made out to be.

Taxes and Behavior

The current administration is curious. On the topic of raising rates, they don't think that it changes behavior. Specifically, they fought the prior administrations' tax reduction as "giveaways" to the rich who could afford to pay taxes, as if the rich would work just as hard in order to provide an ever increasing percentage of their income to the government.

But they DO believe that reducing rates can incent behavior other times, such as in "cash for clunkers" or the previous tax reduction holiday. More specifically, they take a myopic short-term view that putting a bit of extra cash into workers' pockets will help their constituents, but making a more competitive tax policy overall (that will spur investment and growth) isn't anything that is worth investing in or considering. I am frankly kind of surprised that it took the administration this long to consider a payroll tax holiday, since all they care about is the short term impact on their logical supporters, and this is the quickest way to reach them. I wouldn't be surprised if the government tried to turn hiring into a tax INCENTIVE, and then just raised taxes everywhere else, or just borrowed more money. If your only goal is to put money in your supporters' pocket in the short term, this is a (sad) way to do it.

At least these policy proposals put a lie to the myth that social security is anything other than an entitlement program supported by government tax revenues. If nothing else positive comes out of the debate, a little bit of more obvious truth is a small benefit.

Cross posted at Chicago Boyz

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