The Trend In Social Security Reform

The trend in Social Security reform should be a concern of every small business in America.  The trend is to make the system bigger, with a wider revenue base by pushing the cost of the system from the covered worker to the general taxpayer.  It is an enormous increase in the revenue reach of the system.     

It is important to understand how this change in funding increases the revenue base of the system.  Payroll taxes which fund Social Security can draw up to 15.3% of wages, up to a cap.  So the sole funding source for Social Security is capped-wages.  When funding for Social Security comes from the general fund, it can draw on all of the taxpayer’s income, including interest, dividends, capital gains, rents, royalties, casino winnings and the like. 

This trend was first predicted by A. J. Altmeyer who was the Chairman of the Social Security Board in 1944.  He warned Congress at that time; “It is a mathematical certainty that the longer the present pay-roll tax rate remains in effect, the higher the future pay-roll tax must be if the insurance system continues to be financed wholly by payroll taxes. “  He continued to say that “Retaining the present rate creates a moral obligation on the part of Congress to provide a Government subsidy later on to the extent necessary to avoid levying inequitably high pay-roll tax rates in the future.”  In short, if you do not raise these taxes, the payroll taxes will rise to levels that cannot be sustained.

We reached that point in the mid-1970s.  Congress developed the Earned Income Tax Credit as a way to reimburse low-wage workers for contributing to Social Security.   According to Bill Clinton: “The EITC, which dates back to 1975, was originally designed to offset the burden of the Social Security payroll tax for low-wage workers with children.”[1] 

That subsidy is now being expanded to all workers with the payroll tax-holiday.  This is not a tax-cut.  It is a tax-shift where the burden of Social Security is passed from the covered worker to the general taxpayer.  In 2011, the taxpayer paid Social Security roughly $105 billion dollars to subsidize the system.  Why? The reason is that payroll taxes are killing jobs here – we are at the point where the government has to subsidize the system in order to avoid levying inequitably high payroll taxes.

These subsidies are dollar for dollar increases in deficit spending. Deficit spending drives up the total debt, which drives interest costs higher.  Higher interest costs can only have two results higher taxes or less government services.  In the net you are seeing the shift predicted back in 1944.

This is not a cost neutral shift because not all taxpayers contribute equally to the general fund, and not all Americans benefit equally from Social Security.  The biggest losers in this game are those people who do not participate in Social Security.  There are millions of workers, like those for work for Galveston County, who do not contribute to Social Security nor benefit from Social Security.  They are however general taxpayers.  So they will be asked to subsidize a system from which they cannot benefit.

The next biggest loser will be high-wage workers who pay a higher percentage of their income in the form of income taxes.  The high-end worker gets back as little as $0.25 on the dollar after taxes according to the Social Security Administration.  Because they will not get any credit for the pass-through contribution, these workers will get substantially less than $0.25 back on every dollar contributed.

The next biggest loser will be small business owners who have accumulated a lifetime of wealth that will now be exposed to the system through capital gains taxes.  Anyone who gets interest, dividends or other income can expect to see their tax dollars go to support the system – but they will not get any credit for the passthrough. 

There is a much larger negative in this transition.  Funding from the general taxpayer distributes the cost of the system away from the worker.  As the cost comes down, more people will participate.  And more people will participate to a fuller rate.   If costs come down enough, Galveston County will ask to get back in.  If its workers have to pay for Social Security, these businesses will decide that it is in their best interest to participate.

If you think that Social Security has problems now.  Just wait until it is free.