Commentary

Kerry’s Social Security Plan

This article originally appeared in the Washington Times, September 24, 2004.

The biggest economic challenge of the not-so-distant future will undoubtedly be the rapid aging of the population. The number of seniors will double in just 30 years, making it literally impossible to pretend the status quo for Social Security is a viable option.

Yet Sens. John Kerry and John Edwards appear to define their solution to the looming Social Security deficits as doing literally nothing. “Kerry and Edwards… will not raise Social Security taxes… and they will not cut benefits for people who rely on Social Security.”

Critics quickly called this a “do nothing” plan, but that just showed they couldn’t translate political doubletalk. While Mr. Kerry may not want to cut benefits for those who “rely on” or “need” Social Security, he has flirted with cutting benefits for everyone else — namely, prudent seniors who plan to rely primarily on other pensions, individual retirement accounts, 401(k) plans and personal savings, as well as industrious seniors who keep working and paying the Social Security tax.

And when Mr. Kerry and Edwards say they “will not raise Social Security taxes,” they mean they won’t raise them on those with incomes below $88,000. They would, however, raise the cap on the amount of income subject to the 12.4 percent Social Security tax by 36 percent — from $88,000 to $120,000. For those with incomes in that range, marginal tax rates would jump by 10 percentage points (less than 12.4 percent because the employer’s half is tax deductible).

Many taxpayers now in a 28 percent tax bracket would suddenly face a marginal tax of 38 percent on any extra earnings from overtime, raises or promotions. Many in the 25 percent bracket would likewise face a marginal tax of 35 percent.

Although it can be argued the Social Security tax is partly a prepayment for an annuity, that would not be true in this case. The victims of this cash grab would be expected to pay up to $4,000 more in Social Security tax, year after year, without a dime in increased benefits. This something-for-nothing tax offer would create an unusually potent disincentive. It would make more attractive income in forms not so easily confiscated by the IRS, such as perks, retirement benefits and leisure.

Martin Feldstein, president of the National Bureau of Economic Research, estimates this would cut income reported by about 7 percent, due to reduced effort and increased tax avoidance. Mr. Feldstein estimated the tax would therefore raise only about $5 billion a year. But the total burden on the private economy would be much larger.

On the benefits side, Mr. Feldstein noted Mr. Kerry said he would consider “making sure that high-income beneficiaries don’t get more out than they pay in.” Such means-testing involves cutting Social Security benefits 80 percent for those who paid the most in Social Security taxes, by Mr. Feldstein’s calculations. Moreover, by emphasizing that “current law revenues would be sufficient to pay 73 percent of scheduled benefits after trust-fund exhaustion in 2042,” the Kerry campaign is actually conceding total benefits may be cut 27 percent. Reneging on Social Security’s promises to high-income seniors would make an imperceptible contribution to such a huge cut — so most benefits would have to be cut by 20 percent or so.

President Clinton already set a dangerous precedent for means-testing Social Security benefits in 1993 by taxing 85 percent of Social Security benefits for seniors whose other income (from pensions, saving and work) exceeds the “high income” of $44,000 per couple. Those with lower retirement incomes pay tax on none of their benefits, or on only half. The 1993 surtax on Social Security benefits was just a devious way of cutting benefits substantially, but only for those who were prudent (and therefore saved for retirement) or industrious (and therefore kept working after age 62-65).

President Clinton set a far more dangerous precedent in 1993 when it comes to the tax side of the Kerry-Edwards agenda. The cap on income subject to the 2.9 percent Medicare tax was not just raised by a large amount, as Mr. Kerry and Mr. Edwards propose for Social Security, but eliminated completely. The sky is now the limit when it comes to the taxes some must now pay for Medicare’s mediocre yet mandatory health insurance.

It doesn’t take much imagination to view the Kerry-Edwards Social Security tax proposal as a Trojan Horse — a first step toward eliminating the income cap altogether, as the Clinton administration did with the Medicare tax. This has long been the dream of income-leveling Democrats such as Robert Kuttner and of socialist Michael Harrington, who promoted the idea in “Dissent” in 1988.

If Congress were ever so foolish as to eliminate any income ceiling on the Social Security tax, the United States would face the highest marginal tax rates in the civilized world. With the Kerry-Edwards income tax increase, stepping over this year’s $178,650 income threshold on a joint return would cause a very sharp jump in the tax rate from 28 to 36 percent. Above $319,101, the tax rate would be 39.6 percent.

The top two marginal rates are higher than they look because itemized deductions begin to be phased out if income tops $142,700 and personal exemptions are phased out above $214,050. Add 2 or 3 percentage points to roughly account for that, and the top two tax rates would be about 38 percent and 42 percent.

That doesn’t count state income taxes, highest where many high-income people live — 7.7 percent in New York, 9.3 percent in California and 9.5 percent in D.C. Because state taxes are deductible, add another 5 percentage points for them. And add another 3 points for the Medicare tax. That puts the top Kerry-Edwards income tax rates at about 46 percent and 50 percent, respectively.

Eliminating the cap on Social Security taxes, as was done with Medicare taxes, would add another 10 percentage points for everyone now in the 28-35 percent income tax brackets. The top two tax rates on labor income would then be about 56 percent and 60 percent. Even the most brutally overtaxed, stagnant European economies do not impose marginal tax rates that high. The United States would have a higher marginal tax rate than Germany (47 percent) and even Sweden (56 percent). Nearly all major countries still cap annual income subject to Social Security tax (such as 54,000 euros in Germany). And Social Security taxes are generally deductible in Europe and Japan, to avoid double taxation of labor.

Meanwhile, the Reagan-Thatcher revolution has continued pushing marginal tax rates down in all the most vibrant economies of the world. Since 1980, the highest tax on individual income has fallen from 55 percent to 36 percent in South Korea, from 60 percent to 30 percent in India, and from 55 percent to 22 percent in Singapore. Some countries emphasize individual income taxes more, such as Russia’s 13 percent flat tax. Others cut deeper on the corporate side, such as Ireland’s 12.5 percent corporate tax. Regardless of these details, all economies that sharply reduced marginal tax rates on labor and capital have experienced economic growth of at least 6 percent a year for many years.

In countries with punitive marginal tax rates of the sort favored by Messrs. Kerry and Edwards, by contrast, long-term economic growth has long averaged 2 percent or less. To see why, download Ed Prescott’s awesome study of why Americans work more than Europeans, at minneapolisfed.org.

When economies don’t grow, neither does the government’s tax revenue. So, if you really want to see how quickly we can drive Social Security over the cliff, try the Kerry formula of means-tested benefits and brutal marginal tax rates. But if you want to consider a Social Security reform that would really work, for real people not the bureaucracy, look into Mike Tanner’s thoughtful studies at cato.org.

Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.