The Economic Cost of the Social Security Payroll Tax

Studies | Social Security

No. 252
Friday, June 28, 2002
by Liqun Liu and Andrew J. Rettenmaier


Net Additions to the Nation's Means of Production

Figure V - Taxes on Incremental Capital

While reducing the size of the welfare cost associated with labor supply distortions, prepaying Social Security also increases the size of the nation's means of production, what economists call the capital stock. Because promised Social Security benefits funded by pay-as-you-go financing displace savings, the nation's capital stock is smaller than it would be in the absence of the system. The $12 trillion to $14 trillion of accumulated benefits owed to current retirees and current workers based on their participation in the program as of 2001 is a rough estimate of the degree to which the capital stock is currently diminished by the presence of Social Security.

"Funds in personal accounts would also add to the nation's capital stock."

With partial prepayment similar to that we just discussed, the capital stock will rise by the amount by which future government debts are reduced. Both wage price indexation and benefit offsets reduce the debt. As a result, the accumulated balance in PRAs can be thought of as additions to the capital stock, with the amount in the offset accounts reflecting a conservative estimate of the additions to the capital stock.

As the capital stock rises, it produces earnings, or returns on capital. These returns, adjusted for inflation, recently have been estimated at 8.5 percent of the underlying capital. The 8.5 percent reflects pretax returns, before corporate taxes at the federal, state and local levels. Some earnings on the incremental capital due to the reform are taxed away before they show up in individual PRA accounts. Since after-tax returns are used to estimate the effects of PRAs on the system's financing, the corporate taxes can be redirected to Social Security. Figure V indicates the taxes that can be recaptured, measured as a percent of taxable payroll. By 2050 these taxes are between 1.5 percent an 2.4 percent of payroll.


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