(Part III of our series Cracking the Internal Revenue Code: How the tax system rewards the rich)
Most American workers who do not work for a state or local government are subject to Social Security and Medicare taxes. Social security and medicare taxes make up a large percentage of total receipts by the IRS. In 1996, they represented 35 percent of all internal revenue; in 2000, that figure declined slightly to just under 33 percent. Oddly enough, Social Security taxes have a built-in limit that protects not the poorest Americans but the richest ones instead.
Despite the flaw in their system of taxation, for its recipients, Social Security and Medicare can be godsends. Social Security provides guaranteed benefits, not only to retired workers, but also to disabled workers and to the spouses and children of deceased workers. Medicare provides guaranteed hospital and medical benefits to all retired Americans and may disabled Americans, regardless of their physical needs. But when conservatives talk of "reforming" Social Security, they do not talk of making Social Security taxes less onerous on the poor. They talk instead of making these guaranteed benefits subject to the vagaries of the stock market. They would jeopardize the most successful anti- poverty measure in American history.
The largest source of tax receipts to the federal government, individual income taxes, has tax rates that generally increase with income. (One giant exception to this general rule is that capital gains, which accrue disproportionately to the richest taxpayers, enjoy favorable treatment (see my article on this topic from two weeks ago). All in all, IRS statistics show that income tax as a percentage of income increases as income itself increases. In 1999, the 27.4 million taxpayers with adjusted gross income under $10,000 paid an average of 3 percent in federal income taxes. The percentage increased monotonically until the 553,000 taxpayers with adjusted gross income above $500,000 paid an average of just over 28 percent in federal income taxes. Despite the progressive nature of the income tax system, for the poorest taxpayers, any income taxes at all can be an extreme burden. For the richest taxpayers, income taxes are an annoying governor on disposable income.
The next largest source of tax receipts to the federal government is the combination of Social Security and Medicare taxes. These taxes are probably the most regressive taxes imposed by the federal government, because their effective tax rate goes down once income is high enough. Unlike income taxes, these have fixed rates: 6.2% for Social Security tax and 1.45% for Medicare tax. Employers and employees pay equal amounts, based on those percentages, to the federal government. The richest Americans get a huge break on these taxes, however. The Social Security wage base of $84,900 limits the Social Security tax for any worker to $5,263.80, regardless of his or her salary; the Medicare tax has no such limit. The effect of the wage base is that a corporate executive earning $1,000,000 per year pays 1.45% in medicare taxes and 0.53% in social security taxes for a total tax rate of 1.98%. Meanwhile, most American workers pay the full 7.65% rate.
|Type||FY 1996||FY 2000|
|Corporate income tax||$171 B||10.8%||$205B||12.5%|
|Individual income tax||$656B||47.7%||$978B||51.5%|
|Social Security and Medicare taxes||$481B||35.0%||$623B||32.8%|
|Railroad retirement tax||$4B||0.3%||$5B||0.2%|
Source: IRS Statistics of Income, http://www.irs.gov/pub/irs-soi/00db01co.xls
Social Security taxes are high for a reason. In calendar year 2000, the Social Security Trust Fund ran a surplus of $153.3 billion. It took in money from payroll taxes, from interest on Treasury bonds that it holds, and on income taxes on social security benefits received from affluent recipients. The Social Security Trust Fund attempts to secure the social security benefits of future generations by investing current social security surpluses in Treasury bonds. Over time, as birth rates decrease and life expectancy increases, analysts expect that the number of workers per retiree will decrease. Eventually, the annual payroll taxes will be less than the annual outlays,the the trust fund will use its maturing bonds to pay its current obligations.
At different points in the 2000 presidential campaign, both Al Gore and George Bush promised to balance the federal budget without considering the Social Security surplus. Both described a "lockbox" for social security. In reality, the Social Security surplus is automatically put into a sort of lockbox through investment in Treasury securities. Balancing the budget without using the Social Security surplus would mean that the rest of the federal government would not need to borrow money to make inflows match or exceed outflows.
The huge surpluses envisioned by both parties in 2000 have come to an end. The combination of the 2001-2 recession and the 2001 tax cut have postponed for years any overall balance of the federal budget, never mind balancing the budget without Social Security. The problem with the Bush budget is not that it promised a short-term deficit in order to spur on the economy. Deficit spending in the face of recession is an old and valuable concept. What is galling about the Bush budget is that the deficits continue through much of the current decade. These deficits do not come from one-time tax breaks or targeted government spending, but from perennial cuts in taxes on the wealthiest of Americans. And unless Congress fails to renews these tax cuts in 2010, the deficits would continue for the foreseeable future.
In the next several years, the Social Security Trust Fund will continue to take in more money than in sends out in benefits. For several years after that, the Trust Fund can spend its principal to supplement current revenue. As the Center for Budget and Policy Priorities has noted, the long-term outlook for Social Security is bright if the federal government uses the Social Security surplus to pay down its other debt. The Bush administration's tax cut has eliminated that possibility for the next few years, and threatens to eliminate it for several years more.
Conservative pundits have talked for years about privatizing part or all of Social Security. They finally have a kindred spirit in the White House. The arguments for privatization are twofold. First, the federal government cannot afford, in the long run, the current program. Second, private accounts would do better for Social Security recipients.
The first argument is a nebulous one, given the factors involved. If social security taxes go up or are no longer capped, then the Social Security Trust Fund would take in more income. If the statutory retirement age goes up, then the trust Fund would pay out less. If the federal government reduces its public debt in the next two decades or so, then it would have more resources in the long run to keep the program afloat. In any case, the day of reckoning Social Security is a long way off.
The second argument misses a more important point. Social Security is a guaranteed program. To divert even part of the stream of social security taxes to private investments would necessarily cut the current guarantees that it provides. (The Bush administration has proposed cuts in guaranteed benefits of about 50 percent in exchange for private investment of some Social Security taxes.) Investing in the stock market might prove better in the long run that investing in the federal system, but the stock market has no guarantees.
There is a guarantee about who would benefit from Social Security privatization: the sponsors of the targeted investment funds on Wall Street, who would certainly charge handsomely for handling millions of generally small accounts. The Social Security Administration has administrative costs of just under 1.0% of annual receipts. Most mutual funds charge more than 1% of plan assets, not just new investments.
The Social Security system is not just a retirement program, but also an insurance program. It provide disability insurance for workers. It provides survivorship benefits for the spouses and children of deceased workers. These are vital programs for millions of Americans.
Affluent Americans do not need Social Security to retire. Many managers and professional workers have 401(k) and similar retirement plans. The $11,000 that a manager can contribute to a 401(k) plan makes her $5,263 contribution and her employer's $5,263 contribution to Social Security less vital. Affluent Americans can afford to gamble with the Social Security taxes, because their continued affluence does not depend on Social Security at all. Most lower-income Americans, however, depend on Social Security to avoid retiring into abject poverty. They do not have 401(k) plans at work. They do not have the disposable income to contribute $3,000 per year to an IRA. They certainly lack the money to invest in variable annuities that would pay off at retirement. They need the guarantees that only Social Security can provide. If we are to reform Social Security, we should reform it in ways that benefit those who need it, not those who don't.
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