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Please, Not Another Payroll Tax Hike

by Timothy Penny

This article appeared on cato.org on February 20, 1998.

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Social Security is one reason why politicians have earned the reputation that the only thing they know how to do is raise taxes and spend money.

The history of Social Security is a vicious cycle of overextension followed by raised taxes. For decades, expansions were financed with temporary surplus funds, setting the stage for later tax increases.

The situation has worsened as Social Security fund surpluses have been spent to cover the federal deficit. This year alone, nearly $l00 billion intended for Social Security will he used to cover overspending in other areas.

At its start in 1935, the Old Age and Survivors Insurance tax had a rate of 2% on only the first $3,500 of income -- with 1% paid by the employer and a 1% payroll deduction. That gave rise to the term "payroll tax."

The payroll tax was increased 13 times in the course of 60 years. And the amount of income subject to the tax, often called the earnings base, has notched up 26 times.

Right now, payroll taxes -- which today include Social Security, disability and Medicare -- total 15.3% on the first $65,400 of income, with the 2.9% Medicare tax applied to all income with no cap. Fully 71% of American workers pay more in payroll taxes than in income taxes.

The pattern for 40 years, from the program's inception until the late '70s, had been for Congress to expand benefits and, almost as often, to boost the tax burden to keep the system solvent.

There were five workers for each retiree in '65. Currently, there are three workers for each retiree. When baby boomers are fully retired in 2030, there will be only two workers for every retiree.

But this setup changed in 1977. All of the changes since have raised the tax burden while muzzling benefits. In essence, the program went from tax-and-spend to tax-and cut.

Here's what happened:

• In '77, the "notch" -- a revised benefit formula for Social Security payments -- was created to fix an inadvertent and overly generous provision in the formula begun just a few years earlier.

Around the same time, both the payroll tax rate and the earnings base were increased. Taxes were slated to rise to 7.65% in '90, or 15.3% combined (rather than a previously scheduled 7.45%. and the earnings base was raised to $22,900 in '79, 525,900 in '80 and 529,900 in 1981. Also, the earnings base was tied to the inflation rate so as to rise automatically each year.

Social Security benefits exceeded available payroll taxes in 1982. To keep the system solvent, Congress borrowed from the Medicare trust fund.

In '83, Congress passed major reforms designed to secure the system for 75 years.

• The retirement age would gradually be raised from 65 to 66 by 2009, and eventually to 67 by 2027. Also, cost-of-living adjustments were delayed for six months. And half of Social Security income was taxed for wealthier seniors.

Finally, the payroll tax increases -- up to 7.65%, or 15.3% for the employer and employee shares combined, by 1990 -- were changed to kick in earlier.

• In '93, as part of President Clinton's first budget, wealthier seniors were subjected to income taxes on 85% of their Social Security income.

That's the sad history of a well-conceived program and its ill-conceived consequences.

ln future years, a crisis looms as baby boomers will double the ranks of the U.S. retired population. With no surplus to draw on, pressure will mount to raise payroll taxes once again. There were five workers for each retiree in '65. Currently, there are three workers for each retiree. When baby boomers are fully retired in 2030, there will be only two workers for every retiree.

Simple math suggests a sizable payroll tax hike is inevitable, unless the Social Security system is dramatically altered and soon. Clearly, serious reform is needed before the baby boom crisis hits. But this time around, payroll taxes must be taken off the table -- tax increases are too easy, and they don't get to the heart of the problem.

To avoid an ever-higher tax burden, taxpayers must forcefully say to the president and Congress, "Enough is enough! No more payroll tax hikes!" And we must begin sending that message now.