Social Security Could Be Made Solvent through Payroll Tax Increase, but Not Without Consequences

January 30, 2013

To deal with Social Security's insolvency, some congressional Democrats favor increasing the payroll tax, a move that could be effective if implemented properly, says Andrew Biggs of the American Enterprise Institute.

  • Negotiations will undoubtedly continue as Congress struggles to fix America's long-term fiscal gap and spending crisis.
  • Of the entitlement programs on the menu for budget cuts is Social Security, which will likely be targeted as part of the agreement reached during the fiscal deal that promised spending cuts in exchange for tax increase.
  • Social Security currently levies a 12.4 percent tax on earnings below $110,000.

While raising the payroll tax rate would fix Social Security's financial woes, it would stifle new growth and pit the young, who pay for today's retirees, against the old, who rely on current workers to fund the benefits they have earned previously.  Raising taxes would discourage employment, saving and working for the elderly, which would lower the net income of the average American.

  • Middle- and higher-income households, not just lower-income households, derive a significant portion of their income from Social Security benefits.
  • Biggs notes that many middle- and high-income earners view Social Security as a substitute for personal saving and reduce their personal saving in accordance with the Social Security benefits they accrue.
  • When this money is not channeled into personal investment vehicles, it cannot raise the amount of resources available to act as collateral for capital investments, which drive economic growth.

Some policymakers have called to eliminate the $110,000 cap on payroll taxes, which would fund the program for almost 75 years. Biggs cites several economists who conclude that eliminating the cap would not raise revenues enough to make Social Security solvent.

The most logical manner to reform Social Security is to do what has always been done: raise the payroll tax rate. The tax rate would have to immediately jump from 12.3 percent to 16.3 percent in order to make Social Security sustainable. Tax increases of this magnitude bring significant economic impact. If the rate increase is necessary, Biggs says it should be levied equally across all income levels.

Biggs suggests that in order to make the Social Security system once again viable, the Social Security Administration could reduce benefits, which would encourage middle- and high-income households to save more. This would allow the system to support more retirees with fewer workers.

Source: Andrew Biggs, "Don't Raise Social Security Taxes: But If It's Necessary, Here's How," American Enterprise Institute, January 22, 2013.

 

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