Commentary

The Death Tax for the Other 98 Percent of Us

This article originally appeared on Foxnews.com on February 11, 2003.
A new study from the Federal Reserve says that the wealth gap between rich and poor grew wider as the stock market boomed in the late 1990s.

The most obvious reason is that more than half of all American families now own stocks either directly or indirectly — but almost half don’t. That means that when the stock market rises, the gap between the stock-owning half and the non-investing half rises.

How to close the wealth gap? Bring more Americans into the investor class and let them pass their hard-earned money onto their children.

President Bush’s plan to let younger workers invest their Social Security taxes in stocks, bonds, or other private assets would do that. Social Security modernization would not just help all working Americans become investors, it would help end the Social Security death tax.

Pollsters are often mystified by the unpopularity of the estate tax — lately renamed the “death tax.” How, they ask, can so many people object to a tax that falls on only a few rich people? They have a point.

What everyone seems to have missed, though, is that there is a death tax that affects every working American. It’s called Social Security.

Every year, every American worker pays 12.4 percent of his income to the Social Security system. Workers may not realize this because the money is taken out of their paychecks in advance. (That’s what FICA means on your paycheck.) And half the tax is concealed by pretending that the employer pays it. But economists agree that a tax on wages ultimately comes out of the worker’s pocket.

When a worker retires after paying 12.4 percent of wages for years, he gets a monthly Social Security check. The return isn’t very good, but at least there’s a check (so far). But look what happens when the worker dies: After paying in for all those years, the worker owns nothing. He can’t leave anything to his children.

In short, Social Security imposes a 100 percent death tax on every working American. The money he “saved” all those years disappears.

And there’s considerable money involved. Take a thirty-something couple earning $54,000 a year. Social Security promises to pay them about $27,000 a year (in today’s dollars) when they retire — if Social Security still has any money. But when they die, that income stops, and there’s no estate to leave to their children. (Of course they may have saved other assets, but the Social Security assets would not survive them.) On the other hand, if they had been putting those Social Security taxes into a retirement fund divided between stocks and bonds, they could expect to have nearly $1 million in their personal retirement account at retirement. That fund would pay them an annual income more than double what Social Security promises, and they would still have $1 million to leave to their children — or their church or favorite charity — at their deaths.

If that couple invested solely in stocks, though exposed to greater short-term risk, they could expect to have even more money — $1.6 million. That’s what the Social Security death tax costs a working couple. If they were allowed to put 12.4 percent of their income into real investments, they could accumulate as much as $1 million or more — and the Social Security death tax takes it all.

Reform that would allow younger workers to put their Social Security taxes into personal retirement accounts would end the Social Security death tax — the tax that hits every working American — and dramatically narrow the wealth gap.

David Boaz is executive vice president of the Cato Institute.