1. Opinion

Column: 'Scrap the cap' puts Social Security at risk

Published May 17, 2013

Even though the Social Security system is not "broken," "raided," "bankrupt" or contributing to the national debt, both Democrats and Republicans stand ready to "fix" it instead of focusing on real problems like jobs and crumbling infrastructure.

Currently, the program is funded by a payroll tax of 6.2 percent on employee income up to a cap of $113,700, a tax that employers are required to match. Many would-be reformers, apparently unfamiliar with how government-provided insurance works, support scrapping the earnings cap. Were they to succeed, their efforts would seriously threaten the continuation of this most popular program.

The Payroll Tax Stabilizes the System.

Social Security is a government-mandated retirement insurance program. The premium for this insurance coverage is the payroll tax. Because this tax mimics an insurance premium, voters view the protections provided as "earned benefits" and not "welfare." The amount of payroll taxes paid is used to determine the size of the benefits earned.

President Franklin Roosevelt believed that the payroll tax would strengthen the longevity of the program. Anticipating the instability of alternative financing mechanisms, he said, "We put those payroll contributions there so as to give the contributors a legal, moral and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my Social Security program." To this day, any "damn politician" who proposes to curtail any aspect of Social Security can expect to encounter opposition from a huge majority of the electorate.

Attempts to Raise the Cap to Redistribute Income.

Among the many ideas to fix what isn't broken are proposals to raise or eliminate the payroll tax earnings cap. In fact, the National Academy of Social Insurance reports that 71 percent of those polled prefer such a "scrap-the-cap" option.

While apparently popular with the general public, this option to "scrap the cap" poses a potential danger to the program's continued existence. The benefits earned by retirees are calculated based on how much they contributed. An average monthly earnings number is calculated for each applicant for Social Security retirement benefits using earnings from each worker's top 35 earning years. These past earnings are then adjusted via a wage index to bring them to today's purchasing power.

In this calculation, each dollar of the first $711 of the average monthly earnings adds 90 cents to the benefit check; each dollar of the next $3,517 adds 32 cents; and each dollar above that adds a mere 15 cents. Note that while the benefit amount rises with earnings, the rate of increase drops very fast: Those who earn less in their life have a much higher "rate of return" on each dollar they earn compared to the return that the higher-income earners receive.

This progressivity must be taken into account when assessing the practicality of scrapping the cap. For example, if the current formula for calculating benefits were retained, then each dollar of earnings above the current cap would contribute only 15 cents to monthly benefits. Consequently, higher-income people would be taxed heavily while receiving a meager return, a confiscatory delinking of Social Security benefits from payments into the program, rendering it less of an insurance program and more of an income redistribution program.

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This would likely create the very divisiveness that Roosevelt adamantly tried to avoid. The negative reaction to "scrapping the cap" would be even more pronounced for the self-employed who are required to contribute as both employer and employee.

Using the Payroll Tax as Part of a Stimulus Strategy.

In 2010 and again in 2011, the Obama administration reduced the payroll tax rate to stimulate the economy, a purpose completely unrelated to Social Security. To achieve macroeconomic stimulus, the payroll tax rate was reduced to 4.2 percent, causing an immediate increase in take-home pay, much of which went to increased spending throughout the economy. There was no loss of revenue to the Social Security system; the Treasury used general funds to credit Social Security for lost revenues due to the payroll tax cut.

Unfortunately, this action was portrayed to the general public as a "payroll tax holiday," instilling in many the false belief that the Social Security system lost revenue. Perhaps a less misleading description could be found, such as "earned income tax rebate." It would be an unforced error to lose this highly efficient recession-fighting tool through poor communication.

William L. Holahan, far left, is emeritus professor of economics at the University of Wisconsin-Milwaukee. Charles O. Kroncke, retired dean of the College of Business at UW-M, also recently retired from USF. They are co-authors of "Economics for Voters." They wrote this exclusively for the Tampa Bay Times.


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