Government Takeover of Retirement Assets

President Barack Obama signed into law a huge, holiday-season tax bill extending cuts for all Americans on Friday, saluting a new spirit of political compromise as Republicans applauded and liberals seethed. At a cost of $858 billion over two years, the deal contains provisions dear to both Democrats and Republicans. Obama conceded that the White House and Congress face a difficult challenge when it comes to controlling the deficit and tackling the nation's debt. Friday's bill signing marked a remarkably swift conclusion to a bargain struck 11 days ago between the White House and Senate Republican leader Mitch McConnell of Kentucky. To complete the deal, Obama set aside his vow to extend tax cuts only for the middle class and lower wage earners. Social Security taxes would be cut by nearly a third, from 6.2 percent to 4.2 percent, for this coming year. A worker making $50,000 would save $1,000; one making $100,000 would save $2,000. But the payroll tax cut also means that workers will face an increase in 2012 if the full 6.2 percent rate is restored. - Obama Salutes Spirit of Compromise, Signs Tax Bill, Associated Press, December 17, 2010

Will the Tax Deal Kill Social Security?

December 16, 2010

The Curious Capitalist - Last week, when the tax deal emerged, some commentators said we would be better off if the proposal contained a smaller income tax break (notably less for the upper class), and a larger cut in the payroll tax. That structure, some said, would produce 500,000 more jobs for the same price. Well, it turns there could be a huge potential downside to cutting payroll taxes: It could kill Social Security.

Payroll taxes at least in name provide the funding for Social Security and Medicare. So cutting the tax that is associated with Social Security could put the program already thought to have money problems in worse shape, and potentially lead to its demise. Here's why:

For many the idea that the tax plan could put Social Security in jeopardy may seem a little silly. It's like telling someone with a few days left to live it's time to cut back on the sweets. The truth is Social Security is not nearly as deep in the red as many people think. The federal program used to fund itself and then some through the payroll tax. That mostly ended this year when it had to dip into its trust fund for $40 billion to help pay benefits. But even on its current course it will still be another 27 years before Social Security exhausts its current reserves and will actually be in financial trouble. At least that was the situation before the tax deal.

How significantly does the drop in the payroll tax change Social Security math? Pretty significantly. The deal on the table is to cut what employees pay in payroll tax by two percentage points, to 4.2% from 6.2%. According to Dean Baker, who is the co-director of the liberal think tank the Center for Economic and Policy Research and opposes the tax deal, that 2% drop if made permanent, as some fear it will be, be would mean that Social Security could drain its trust fund and go on life support as early as 2020. That means Washington which usually looks a decade out when devising the budget would have to start dealing with the problem of what to do with Social Security pretty much immediately.

Still, some are unconvinced the threat to Social Security from the tax deal is real. First of all, the tax deal right now only cuts the payroll tax for 2011. And Social Security itself won't lose any money for now. Treasury Department will pick up the tab for the payroll cut. What's more, Felix Salmon the Reuters blogger had this to say earlier in the week:

It's been uncontroversial for decades to use the Social Security surplus to help pay for non-Social Security programs. Why should it be more controversial to do things the other way around?

But Salmon misses a big fact. It will be more controversial because it's illegal. Social Security, by law, is not normally allowed to borrow money from the Treasury. So not only would it be more controversial, it would be impossible without Congress passing a new law. And Baker says it's not likely that Republicans would willingly do so. What's more, anyone trying to kill Social Security will have a stronger argument to make in 2011 that the program is a drain on the Treasury and boosts the deficit. Afterall, the Treasury Department will be forwarding the program around $120 billion. That's the first time that has ever happened. That it is doing so is because of the payroll cut will be lost in the shuffle.

In fact, the biggest problem for Social Security is that no one really likes the payroll tax--not even Democrats. And so while the tax deal is being called a compromise, it's really a gang up. John McCain proposed cutting the payroll tax back in 2008. Senator Daniel Patrick Moynihan proposed the same thing 10 years before that. The tax is regressive. You pay 6.2% on only the first $100,000 or so of your income. If, like most of us, that's all you make, your tax rate is 6.2%. But if you make $10 million your effective payroll tax rate is close to zero.

The good news is that it is probably time, as my colleague Michael Crowley pointed out a few weeks ago, that we tackle these sacred cows. There are better ways to tax people. And there are probably better ways to distribute federal dollars to the elderly than our current system. Alicia Munnell, who runs the Boston College Center for Retirement Research and regularly defends the need for Social Security, says the fact that we are using the federal retirement safety program to produce stimulus "muddies the water" of the debate. But even supporters of the system like Munnell say it is time to sit down and try to fix Social Security. Another benefit of the tax deal may force us to do just that much sooner than we had thought.