The Heritage Foundation

Executive Memorandum #12 on Social Security

January 18, 1983

January 18, 1983 | Executive Memorandum on Social Security

Wrong Rx for Social Security


(Archived document, may contain errors)

1/18/83 12

.WRONG RX FOR SOCIAL SECURITY

The National Commission on Social Security Reform seems to be convinced that the treatment for anemia is-blood-letting. Instead of finding.a way to revitalize the Social Security 6ystem, the Commission is prescribing a bigger dose of what has afflicted and weakened the system for d ecades. The Commission's $169 billi6n bail-out plan fails to address Social Security's underlying st.kuctural problem--Cong .ressis attempt to make it function as both insurance and welfare. This unnatural and unworkable hybrid is unfair to retirees, work e rs, and especially to the young, who are forced to participate in a program that is inferior to private sector alternatives. Ignoring the root ills of the system, the Commission instead is trying to solve the prbblem by raising taxes, cutting benefits, fo r cing those now outside the :System to climb aboard the Titanic as it heads for the 'iceberg. The $40 billion payroll tax hike would raise employment costs. The result: longer unemployment lines, lower capital investment, and-slower economic recovery. Rath e r than easing Social Security's financing problems, the Commission's proposals could merely cause the economy to deteriorate--weakening social security revenues and 'forcing more extreme corrective action in the future. Raising payroll taxes was supposed' t o solve Social Security's problems in 1977, when Co'ngress passed one of the largest tax increases in the U.S. history. it didn't then, and it won't now, because payroll tax increases do not attack the system's basic problems and perpetuate the structure t hat:has brought the system to the edge of bankruptcy. Most of today's younge;r workers will receive a pitiful return on their tax contributions. Anolther increase in taxes now simply will reduce their'return still furthek. The Commission also recommends i n creasing th;e tax on self-employed persons to the tune of $18 billion by raising the base from three-fourths of the combined employer-employee rate to the full employer-employee rate. In return, they would be allowed to deduct half of the payroll tax from taxable income. This is little more thAn a backdoor method of financing Social Security from general revenue; 'it would redistribute, not reduce, the tax burden. Slowing the growth 6f benefits or allowing workers to opt out of the program are the only mea n s of lowering this tax burden. Indirect general revenue financing just robs Peter to pay Paul--and increases the burgepning non-Soci-al Security budget deficit. Under the Commission's'plan, Social Securit@ coverage would be extended to newly hired federal employees and to::nonprofit groups now outside the system, and it would end the right of state and local govern- ments to withdraw from Social Security. By forcing new participants into the system, this measure would only postpon6 the day of reckoning; it wo'uld undermine sound private pension plans and torpedo the Civil Service Retirement System. Moreover, it is clear that many Americans want: to withdraw from Social Security. In 1982, for example, 172,000 employees;

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f rom various organizations withdre w from the system primarily because of soaring payroll taxes and the system's suspect solvency. If Americans believe Social Security is not a good insurance @rogram, they should not be compelled to join it. Instead, the government;should allow them to sel e ct private sector alternatives for Social Security's insurance functions. Forcing more people into the system will merely increase dissatisfaction with the program and increase the' scale of the underlying problem. The Commission is simply suggesting th@t more people should be made to join the chain letter ruse that is Sociai Security. The Commission would also reduce benefits by permanently delaying the annual cost-of-living adjustment (COLA) by six months. Although benefit increases in the last fifteen y e ars have been excessive, rising much faster than prices and the average wage, a benefit cut is not the solution. Because millions of people have baseditheir retirement plans on the expectation of receiving inflation adjust6d benefits, delaying the annual C OLA for those now retired would amoun:t to changing the rules in the middle of the game, and it would impose uAfair hardship on the group least able to adjust to sudden changes. Cutting benefits by $40 -billion would partially shift costs to general reven u es by increasing spending on poverty programs. Half of their Social Security benefits, recommends the Commission, should be included in taxable income for some miadle to upper income retirees. The rationale for this change is that:the employer's share of t he payroll tax has escaped taxation because it is a business expense. By including half of all Social Security benefits' in taxable income, the tax treatment of the system would resemble that of private pensions and other government programs. While this p r oposal has some merit, taxing benefits would mean, in effect, a reduction in benefits for about three million eople, and it would penalize most those:who have taken the p precaution of saving for their retirement. The change should only be phased in after a reasonable grace period--it is:not a short-term option. True reform of Social Security cannot begin'until Americans and their Congress recognize the program for what it,really is: part insurance and part welfare. Once this is understood, the :roblem can be dealt p with in a manner fair to both the beneficiaries and taxpayers. The commission's recommendations are unfair to both 4roups'and would impose substantial costs on the economy. A successful approach to rebuilding -social Security will require divis i on of responsibilities between the government and the private sector, with the government maintaining the welfare aspects of the program (albeit in a more-efficient manner) and increased private sector participation fulfilling the program's insurance func tion. only in that way can the fears of curtent beneficiaries be reduced and the younger workers of today anticipate secure retirement years.

Peter Germanis -Schultz Fellow

F or further reading: Peter J. Ferrara, Social Se curity Reform: The Family Plan.(Washington, D.C.: The Heritage Foundation, 1982). Rebuilding Social Security, Heritage Lectures 18 (Washington, D.C.: The Heritage Foundation, 1982). Peter Germanis, "Rx for Social Security: The First Steps," Heritage Found ation Backgrounder No. 159, December 14, 1981.

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