So the other day there was a diary about the rich paying more in taxes and how bad that was, during the discussion I pointed out that although the rich do pay more in income taxes the working class make up for the difference in payroll taxes. This of course led to a small discussion of payroll taxes and the effect payroll taxes have on effective overall tax rates and actual contributions to the US Government revenue stream. As I thought about payroll taxes and income taxes I began to think we should spend some time talking about Social Security and how it should be reformed in order to be more progressive and stable.
The first thing that should be done is already being considered by this administration, removing the cap on income. This cap stops the collection of the 6.2% employee and the 6.2% employer contributions to Social Security at $106,800 for 2009. By removing the cap it would increase the collection of FICA taxes by $124 billion per year in 2007 dollars. In fiscal year 2007 $705 billion was collected in Social Security taxes, Medicare accounts for the other $165 billion in payroll taxes collected (these numbers come from the CBO and are not separated so I estimated the separate Medicare and Social Security revenues for this diary). The additional income from removing the cap would in itself resolve the long term deficits that are expected to begin in 2017. The issue with this of course is the Federal budget runs annual deficits which suck up all the Social Security surpluses. So by removing the cap we get to borrow $124 billion less from the public or overseas, but the money still disappears down the black hole of government budget deficits. The argument for the removal of the cap is to equalize the income stream across all wage earners. The argument against the removal of the cap is, well, the Heritage Foundation says it would be bad but they say anytime you take money from the rich it is bad so who wants to listen to them.
The second thing that could be done is to redefine the word income and include all income received from any outside source. This would remove the exemption of income derived from non wage earner activities such as rental, partnership and capital gains income. The upside to the redefinition is on the benefits side. During the discussion the other day means testing came up and I was asked if I had a specific proposal, here it is. If the definition of income is all income received from any outside source if your gross income is more than $100,000 your Social Security benefit would be reduce by 10 cents for every dollar over $100,000. This would phase out most income from Social Security by the time your gross income reaches $200,000. My thought process behind this is Social Security was originally envisioned by FDR as a way of reducing poverty for the old folks, in the 1930’s 50% of all people over the age of 65 were living below the poverty line, in 2005 that number had been reduce to 9%. If benefits are reduced for people who are making more than 90% of the working population I don’t think we need to help them out of poverty. This of course would fundamentally change the current view of social security from a retirement fund to a retirement supplement for the working class. This is what it should be anyway.
The third possible change would be to go back to the pay as you go system. The changes made in 1983 by Reagan and Tip envisioned creating a trust fund that would create a surplus that could pay off the national debt putting the Federal Government in the position to borrow money as the Boomers began to retire and require benefits. This of course never happened. The money has been spent and used to make the deficit look smaller than it really is for the last 24 years. Under the pay as you go plan taxes are adjusted as needed. This would reduce our current tax rate but as expenditures increase so would the tax rates.
The fourth option is to completely do away with payroll and income taxes and go to the "Fair Tax" which is basically a consumption/sales tax. There are some benefits to the "Fair Tax" proposal if you are interested here is a link to read the complete explanation. I would love to get some feedback on the "Fair Tax" proposal from DKers. fairtax.org