Hold That Tax

Social Security does not face an urgent crisis, and its problems do not need to be addressed now by a tax increase.

By Paul Starr
The American Prospect, December 2007

It seems so reasonable, particularly to many Democrats. To solve the long-term shortfall in Social Security, why not tax all earnings instead of just the first $97,500? Wouldn't taxing pay above that level be the economically progressive and fiscally responsible way to solve Social Security's problems?

Prodded by Tim Russert at two Democratic presidential debates this fall, Joe Biden, Barack Obama, and John Edwards agreed that it was indeed the thing to do. None of them challenged Russert's premise that Social Security faces so dire a prognosis that only a big tax increase or cut in benefits can solve the problem.

Let's think carefully about this. Do Social Security's problems need to be addressed now by a tax increase? How many tax increases can the next president expect to get through Congress? And what would be the impact of taxing all earnings on the long-term political viability of Social Security?

Social Security does not face an urgent crisis. It will be solvent through 2041 even under the dismal 1.8 percent economic growth rate assumed by the Social Security actuaries under the most-cited "intermediate" projection for the program. According to that scenario, Social Security will have a deficit equal to 2 percent of payroll (or .7 percent of gross national product) over the full 75-year period that the actuaries attempt to forecast.

These forecasts are not facts in the usual sense of the word. They depend on guesses not just about economic growth but about inflation, birth and death rates, immigration, and many other unknowns -- all the way out to the year 2082. We're not certain what most of these variables will be next year. But a lot of people have become persuaded that the very height of responsibility is to promise to raise taxes next year on the basis of speculative projections of what will happen decades from now.

Let us suppose that we do nothing, the forecasts come true, and Social Security starts to run short in the 2040s. During the following decades, the federal government would have to dedicate 13 percent of its general revenue to pay Social Security benefits. This is not our most pressing worry.

Given the political resistance to any proposals for increasing taxes, a new president will have to consider carefully whether the first priority for new revenue in 2009 ought to be solving the speculative budgetary problems of the 2040s. A new administration might want to do something instead about the 47 million Americans who don't have any health insurance now. Or it might want to make productive investments in education, research, and infrastructure that could help keep the economy growing more than 1.8 percent a year.

And consider this: Eliminating the cap on taxable earnings in Social Security will change the relationship to the program of people making more than $97,500, not all of whom are plutocrats. Social Security remains a good deal for most of them because it provides income in old age that, unlike private pensions, is indexed for inflation. But take off the cap on taxable earnings and more upper-income people may start agitating for privatization.

I'm not suggesting there couldn't be some tinkering with the cap, but we already have a method for annually adjusting it. In fact, the cap went up from $94,200 to $97,500 in the past year under a formula established in the 1980s that sets the limit on taxable earnings on the basis of changes in average wages. When the formula was adopted, the aim was to ensure that the payroll tax would apply to 90 percent of total earnings. But because pay has become increasingly concentrated at the top, the share subject to Social Security taxes has fallen to 83 percent.

In other words, one way to solve Social Security's long-term problems is not only to grow the economy faster than 1.8 percent but to adopt policies that ensure more of the growth goes to people who aren't already rich. Even assuming low growth and high inequality, we could close two-thirds of the projected shortfall by earmarking a reduced estate tax for Social Security and investing a portion of the Social Security trust funds in equities rather than U.S. Treasury bonds. If there is any need for increasing the wage base -- and I'm not sure there is -- the proposal should come from a bipartisan commission and have both parties' fingerprints on it.

A new Democratic administration is sure to get into trouble if it starts raising taxes for purposes that show no benefit to the voters. It's not brave for the Democrats to put themselves on record for a payroll tax increase -- it's just plain dumb.

Copyright 2007 by The American Prospect, Inc.
Preferred Citation: Paul Starr, "Hold That Tax," The American Prospect, December 2007. This article may not be resold, reprinted, or redistributed without prior written permission from the author. Direct questions about permissions to permissions@prospect.org.