We can't tax our way out of the Social Security crisis

The long-simmering debate over the future of Social Security has become front-page news over the past few months as President Bush has moved it to the top of his domestic agenda.

Over the next year, the American people will have an opportunity to debate a number of different approaches to grapple with the demographic changes that are driving the most popular government program in American history toward insolvency.

Thick books and complex policy papers have been written on the social and economic impact of Social Security reform, but to really understand the challenge — some say crisis — ahead, one need only remember a handful of numbers, which are acknowledged by all sides of the debate. Set aside the fact that the basic model of Social Security was designed 70 years ago for a primarily industrial economy in which few women were employed outside the home, and is, thus, profoundly outdated for today's workforce.

The more pressing problem is that, when the program was founded, there were about 42 workers paying taxes into the system for every one retiree drawing benefits. With life expectancy increasing and fewer babies being born, today that ratio has declined to about 3-to-1. Within a decade each retiree will be supported by only two workers.

Those who say no changes are needed are presumably comfortable with the fact that existing law will automatically cut scheduled benefits in the range of 20-30 percent by mid-century.

The debate over exactly what form changes should take will be complex. For now I'd like to focus on one misguided proposal — to increase payroll (also known as FICA) taxes.

At 12.4 percent of income (up to $90,000 a year), FICA is already the biggest deduction from most Americans' paychecks. The proposal is to increase the taxable wage base from the current $90,000 to $150,000, or even eliminate the inflation-indexed "wage cap" entirely. That means FICA taxes could be slapped on all income, at the same rate — 12.4 percent — that it is currently levied on the first $90,000.

The problem here is that the benefits that workers receive upon retirement are linked (albeit not precisely) to what they've paid into the system, and limited by the wage cap. In other words, under current law, even if you earn $150,000 a year, you will not receive a larger benefit than someone earning $90,000; however, neither will you pay more taxes.

Social Security was deliberately designed this way to make it a social insurance program in which all Americans have a relatively commensurate stake, rather than a form of welfare that simply redistributes wealth and discourages saving. Thus, increasing or eliminating the wage cap forces a painful follow-up choice: either eliminate the wage cap but pay wealthy retirees significantly more in benefits (which leaves us back where we started), or turn Social Security into welfare for senior citizens.

Wealthy Americans don't need the government to force them to save for a comfortable retirement. And there is a great fear that going the welfare route would inevitably undermine public support for the program.

Moreover, increasing or eliminating the wage cap would stunt the growth of the entire national economy. Economist and 2004 Nobel laureate Dr. Edward Prescott of Arizona State University has found that workers are very sensitive to tax increases on labor income, and tend to change their behavior, by literally working less, as their taxes increase. The continued sluggishness of western European economies, compared to America's solid recovery and high productivity, can largely be explained by their considerably higher labor tax rates.

Increasing or eliminating the wage cap also makes it more expensive to hire workers who will earn above the cap. That means fewer of the good-paying jobs that everyone wants to encourage, because it will be more expensive to create those jobs, with a ripple effect down the wage scale. Since Social Security is funded by a lot of workers making good wages, this is hardly likely to save the program for future generations.

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