Ever since Ronald Reagan’s successful run for the White House in 1980, the Republican Party has branded itself as the pro-growth, tax-cutting party. The strategy worked. Benefits of lower tax rates were well documented, Republicans regained control of Congress in 1994 after being out of power for decades and two more Republicans were elected president after Mr. Reagan left office.
More recently, the party has also promoted a flat tax. Steve Forbes, in his run for the White House, was a strong proponent of this reform. The flat tax has the dual benefit of capping the marginal tax rate to a single number for all taxpayers — no marginal punishment for success — and of significantly reducing the costs of complying with today’s virtually unintelligible tax code. Today’s Republican presidential candidates continue to promote the brand as they campaign on cutting tax rates further, and in some cases fighting for the flat tax.
As beneficial as these initiatives are, by themselves they miss the bigger picture by a very wide margin. Left unchallenged, the federal government will consume an ever greater share of the economy, and reduce further our personal freedoms. This is so because politicians from both parties have passed legislation that promises entitlements — largely from Social Security and Medicare — that are only affordable if taxes are increased to oppressive levels. As Baby Boomers make retirement plans based on these promises, politicians will have to eventually concede that either their word cannot be honored or that we must embrace a much larger government — sort of a call to arms, a shared sacrifice by all for the greater good. That moment is quickly approaching.
According to the 2006 Social Security trustees report, costs will exceed tax income starting in 2017. In addition, over the next 75 years this mismatch totals $6.5 trillion. Adding Medicare’s mismatch swells the number to $17.8 trillion.
Looking beyond 75 years, the so-called infinite horizon, the total jumps to $42.7 trillion, equivalent to a little more than three years of GDP. This means that to afford the benefits that politicians have already promised, each worker needs to pay the government all his future payroll taxes and an additional $268,000 today, or some greater amount tomorrow. Cutting tax rates does not change this. Neither does a flat tax. The party of Reagan needs to rethink its brand, and expand its agenda.
Social Security is a tax-financed system. With life expectancy increasing and birthrates falling, the number of taxpayers shrinks relative to beneficiaries. In 1950, there were 16 workers per beneficiary, today there are 3.3 and in 2040 there will be 2. As long as benefits are provided from taxes, and demographics continue as they have, either benefits must be cut or taxes must be increased, and by a lot.
But by changing the financing to a saving and investing model, eventually all benefits would be provided by one’s accumulated wealth, and most of the payroll tax would end: a very big tax cut. Yet, many Republican politicians don’t see this; they seem caught in some kind of warp wherein Social Security reform is not tax reform.
This is a lost opportunity, and for many reasons:
- All wage earners pay Social Security taxes but not all pay income taxes. The Tax Foundation estimates 43 million Americans who recently filed a tax return had no income tax liability. So a cut in income tax rates holds little interest for them.
- About 80 percent of all wage earners pay more in Social Security taxes than in income taxes. Any politician who promotes big tax cuts for all workers needs to target the payroll tax.
- Fundamental Social Security reform would be the biggest tax cut in history.
- Finally, it would significantly reduce, as opposed to limit, the size of government.
According to the fiscal 2008 budget, payroll taxes for retirement benefits were $520 billion in 2006, and individual income taxes were $1,044 billion. Reforming Social Security by allowing 5 percent of the 10.6 percent tax allocated for retirement to be saved and invested would reduce the payroll tax by $245 billion. This is equal to 23 percent of individual income taxes collected in 2006, and 17.2 percent of fiscal-year 2006 federal outlays. This would reduce taxes and the size of government more than any tax reform now proposed by Republican candidates. But they don’t seem to see it.
And herein lies the opportunity. Just as Ronald Reagan defied conventional wisdom on many issues, and with abounding success, a candidate may emerge who tells us he is campaigning on lower tax rates, a simpler tax code, smaller — in contrast to limited — government, and fundamental Social Security reform. And, importantly, he or she also tells us all these pieces fit together; they are integral to each other.
If this catches hold, the Republican Party will build on its established brand, and expand its agenda. Now out of power in Congress, and perhaps the White House in 2008, it needs no less.