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WebMemo #747 on Social Security

May 17, 2005

Courageous Folly: The Democrats' First Plan To Fix Social Security

By

On Monday, Representative Robert Wexler (D-FL) courageously broke ranks with Democratic Party leadership to offer his plan to improve the troubled Social Security system's solvency. Rep. Wexler deserves praise for acknowledging Social Security's problems and offering a solution. 

 

However, his plan is a step in the wrong direction. Wexler would increase taxes on all wages above $90,000 by six percent. This tax increase would impact millions of Americans, slow the economy, and cost jobs. Specifically, the Wexler tax increase would:

 

  • Directly raise taxes on 9.8 million American workers;
  • Raise taxes for 3.6 million workers over the age of 50-just when they're trying to steer towards retirement;
  • Raise taxes for 3 million small-business owners;
  • Slow the growth of the economy, shaving an average of $33 billion per year off of the Gross Domestic Product over the fist ten years of the tax increase;
  • Reduce total employment by an average of 340,000 jobs per year over the first ten-year period; and
  • Make Social Security a worse deal for millions of Americans.

And for all the pain that Wexler's plan would entail, it would not even permanently fix Social Security.

 

The Wexler Plan

Workers and employers now pay Social Security payroll taxes on the first $90,000 of a worker's annual income. That "wage cap" is indexed to the growth of real wages in the economy and increases every year. Workers and employers split the tax, each paying 6.2 percent apiece on earnings under the cap.[1]

 

Rep. Wexler would maintain the cap but add on a new three percent tax that workers and employers would pay on earnings above it.[2] This amounts to a new six-percent tax on wages that would be paid, just like the rest of the Social Security payroll tax, by workers, in terms of its economic impact.

 

Economic Effects

The most obvious shortcomings of Rep. Wexler's plan are that it would slow the economy, cost jobs, and actually weaken other retirement savings. Wexler's plan would raise high-earner's marginal tax rate by 6 percent, bringing the marginal rate for most of them to well over 40 percent on all taxable income. A tax increase of this magnitude would have several economic repercussions. Economic growth and job creation would be slowed as workers react to this tax increase. According to the Center for Data Analysis's macroeconomic estimates, Wexler's plan would reduce GDP by $33 billion per year, on average, over its first ten years. In addition, it would reduce total employment by an average of 340,000 jobs per year over that period.

 

Proponents of extending Social Security taxes above the wage cap point out that most workers would not face a tax increase, but that is not to say that raising taxes on others would not affect them. When people pay higher taxes, they have less to spend on goods and services, which translates into fewer jobs and lower wages across the economy. These indirect effects are especially apparent when those paying higher taxes own businesses and employ workers.

 

Eliminating the Social Security wage cap would directly raise taxes on 3 million small-business owners by billions of dollars.[3] These small-business owners make up about one-third of the nearly 10 million workers who earn more than Social Security's wage cap. It is easy to see this direct effect-more of small-business owners' wages would be exposed to the payroll tax. However, what is not so obvious is that their businesses would have billions less to spend on wages, to invest in new buildings, to purchase new computers, and to expand and grow in general.

 

Many of these 3 million small-business owners do not file as single taxpayers. Accounting for their families, these business owners are collectively responsible for more than 4.5 million people, including spouses and children. Altogether, this means that almost 8 million small business people would be directly affected by Wexler's proposal-and that does not even include small businesses' employees and customers.[4]

 

The 3 million small-business owners who would be affected by Wexler's proposal account for almost one-third ($129 billion) of the wages paid out by all small businesses.[5]

 

Interestingly, Wexler's plan would disproportionately target workers in their maximum earnings years who are near retirement. Nearly 10 million workers exceeded the wage cap in 2003, according to data from the U.S. Census Bureau's March Current Population Survey. Of these workers, over 3.6 million are over 50 and over 600,000 are 62 years or older.[6] Many workers over 50 are in their peak earning years and would be hit hard by a tax increase on earnings above the payroll cap. Workers over 62 may simply chose to retire early and avoid altogether the sting of Wexler's Social Security plan.

 

In short, Wexler's proposal would slow economic and job growth, especially in the vital small-business sector. His proposal would reduce workers' disposable incomes and, in turn, their personal savings. Ironically, this decline in savings would make worse the very problem that Social Security is intended to fix-workers retiring without enough money for a decent retirement.

 

Wexler's Plan Would Not Fix Social Security

For all of its economic harm, Rep. Wexler's proposal would not even fix Social Security's long-term financial problems.[7] A recent report from the Social Security Administration (SSA) examined the effects of eliminating the wage tax cap while maintaining the cap for the purposes of benefits.[8] This resembles a beefed-up version of Wexler's plan, applying a 12.4-percent tax to earnings above $90,000 instead of a 6-percent tax. This larger tax hike would bring even more revenues into Social Security than Wexler's proposal, but still it is not enough to fix Social Security. SSA's actuarial study showed that eliminating the wage cap on payroll taxes while paying benefits on only earnings below the wage cap would delay the start of Social Security's annual deficits from 2018 to 2025-just seven years.

 

Raising the wage cap in this way would delay the onset of massive deficits by only a few years. As Social Security now stands, annual deficits will first reach $100 billion a year (in 2003 dollars) in 2022, according to the 2003 Social Security trustees report.[9] Subjecting all earnings to payroll taxes but only paying benefits on income up to the current wage cap only delays the start of those $100-billion deficits until 2031.

 

If raising taxes on earnings above the wage cap by 12.4 percent while holding benefits steady only delays deficits by seven years, and $100-billion deficits by 9 years, then raising taxes on those earnings by just 6 percent would not even delay the crisis by that long.

 

Wexler's Plan Would Make Social Security a Worse Deal

A worker's savings, pension (if any), and Social Security benefits make up the bulk of his or her total retirement security. Not only would raising Social Security taxes reduce workers' savings, but it would also make Social Security a worse deal than it is today.

 

Social Security is a poor investment and a bad deal for the vast majority of workers who pay into it. It offers most workers a rate of return on their contributions that is several times lower than what they could get from the most conservative investments, even assuming that retirees live long lives.[10] For example, single men and women who die before retirement receive nothing for their Social Security taxes. For this reason, black men as a group have an especially low rate of return. On average, black men paying into Social Security receive back less than their payroll taxes-a negative rate of return. Younger workers who are just now entering the workforce also face the likelihood of a negative rate of return.

 

Rep. Wexler's plan would force workers to pay more money into Social Security in return for the same benefits. This would make Social Security an even worse deal for them than it already is. Even more workers would receive a negative rate of return, and all workers would receive a lower rate of return for their payments into the system.

 

Conclusion

Rep. Wexler is right to admit that we should take action to fix Social Security sooner rather than later. Delaying Social Security reform is costly and only makes reform more painful down the road. However, Rep. Wexler's approach is misguided: it would hurt the economy and cost jobs, make Social Security a worse deal for millions of workers, and, for all that sacrifice, wouldn't even bring the system to permanent solvency.

 

Rea S. Hederman, Jr., is Manager of Operations and a Senior Policy Analyst in the Center for Data Analysis at The Heritage Foundation.



[1] See David C. John, "How Today's Social Security Works," Heritage Foundation Backgrounder No. 1827, March 2, 2005, at http://www.heritage.org/Research/SocialSecurity/bg1827.cfm.

[2] " Wexler offers details on Social Security plan," Associated Press, May 17, 2005.

[3] See Norbert J. Michel, Ph.D., J. Scott Moody, and Ralph A. Rector, Ph.D., "Raising the Social Security Wage Cap Would Hurt Small Businesses," Heritage Foundation Backgrounder No. 1845, April 19, 2005, at http://www.heritage.org/Research/SocialSecurity/bg1845.cfm.

[4] Ibid.

[5] Ibid.

[6] Rea Hederman, Jr., and Tracy Foertsch, "AARP's Social Security Plan Would Raise Taxes for AARP Members Without Fixing Social Security," Heritage Foundation WebMemo No. 678, March 7, 2005, at http://www.heritage.org/Research/SocialSecurity/wm678.cfm.

[7] See, generally, David C. John, "Raising the Social Security Payroll Tax Cap Does Not Fix Social Security," Heritage Foundation WebMemo No. 667. February 16, 2005, at http://www.heritage.org/Research/SocialSecurity/wm667.cfm.

[8] Chris Chaplain, Actuary, and Alice H. Wade, Deputy Chief Actuary, Social Security Administration, "Estimated Long-Range OASDI Financial Effects of Eliminating the OASDI contribution and Benefit Base."

[9] Social Security Administration, 2003 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (Washington, D.C.: U.S. Government Printing Office, 2003), at www.ssa.gov/OACT/TR/TR03.

[10] See, generally, William W. Beach and Gareth G. Davis, "Social Security's Rate of Return," Heritage Foundation Center for Data Analysis Report No. 98-01, January 15, 1998, at http://www.heritage.org/Research/SocialSecurity/CDA98-01.cfm.

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