Topic: Social Security

The Answer Is a New Government Program. What’s the Question?

The Sunday Washington Post had a long, hagiographic article about Senator Mark Warner’s critique about how capitalism “isn’t working” for the masses and his heroic attempts to fix it that left me thinking I’m in an alternate reality.

The problem he sees is that the growing tendency of people to change jobs throughout their career has left people unprepared for retirement, and that we need to do more to make sure that workers have some sort of safety net to provide them with health care and income in their golden years.

That this was largely addressed decades ago with the introduction of Social Security and Medicare was completely missing from the article. Social Security is an incredibly progressive retirement program that provides everyone with a work history of at least ten years with a decent-sized benefit that doesn’t go up all that much for wealthier people who contributed much more. And Medicare is the largest government program there is, covering hospitalization costs, basic health costs and drug benefits for tens of millions of senior citizens. The government spends about $1.5 trillion each year on these two programs, and they make up the majority of our federal budget. There’s also plenty of evidence that they prevent seniors from indigence: the poverty rate for seniors is well below that of other age groups. 

The current Administration also added an expensive entitlement that makes it much easier for people under age 65 who do not receive health insurance to obtain it, along with a healthy subsidy. For a family of four in Washington DC there is still a subsidy for an income of $80,000, which is well above the mean household income, and Medicaid completely covers those who don’t make enough money to buy their own health insurance. What more can we possibly do to make health insurance more affordable for the working poor?

The Attack on Chile’s Private Pension System

Last month, a scandal erupted in Chile. The media discovered that the former director of the Chilean gendarmerie, the country’s penitentiary service, was receiving a pension of about $8,000 per month. Chile privatized its pension system in 1980. Instead of sending retirement money to the government, workers there put their money in private accounts that invest and accumulate savings to be used in old age. When Chile approved the reform, the military and some law enforcement agencies (such as the gendarmerie) remained in the old public system.

Although the abuse occurred within the old public pension system, which benefits a minority of Chileans, and the beneficiary in this case was a socialist political activist and ex-wife of the head of the lower house of Congress (also a socialist), the episode was used to attack the private system to which almost every Chilean worker belongs. The left declared that the private accounts managed by the private pension fund companies (known by their Spanish acronym AFP) provide low pensions, something that incensed many Chileans who saw that the AFPs do not pay the same level of pension evident in this particular case.

Before long, protests involving hundreds of thousands of people took place throughout the country under the slogan “No + AFP,” and demanded a return to the old pension system. Last week, President Michelle Bachelet announced a series of reforms that would give the state a larger role in peoples’ retirement.

Much Higher Tax Rates in 2013 Left Top 1% Taxes About the Same

Top Tax Rate and Taxes Paid

A timely new blog post from the Tax Foundation points out that, “taxes on the rich are much higher than they’ve been in recent years. Between 2008 and 2012, the top 1 percent of households paid an average tax rate of 28.8 percent. However, in 2013, this figure spiked to 34.0 percent, as a result of tax increases in the “fiscal cliff” deal and the Affordable Care Act”.

“Readers should check out the new CBO report,” the authors suggest, “and reflect for themselves about whether or not high-income Americans are now paying their fair share of taxes.”

The trouble is that the tax rate alone can’t tell us how much the Top 1% paid in taxes: To know how much taxes were paid by the Top 1% requires knowing how much income they reported to the IRS.  The reason this matters is that there is ample evidence that the “elasticity of taxable income” is very high among top taxpayers, which simply means they find ways to report less income if marginal tax rates go up.  This doesn’t require lawyers or loopholes: Avoid capital gains tax by not selling assets and/or shifting into exempt assets (housing up to $500k); avoid the dividend tax by holding tax-exempt bonds; defer personal tax on business income by retaining earnings within a C-corporation; avoid punitive tax rates on second earners by becoming a one-earner household; retire early, etc.

Looking at the same thing from a different angle, the graph shows that average taxes actually paid by the Top 1% grew rapidly after the tax rate on capital gains was cut from 28 percent to 20 percent in 1997. Taxes paid by the Top 1% grew even more rapidly after 2003 when the tax rate on capital gains and dividends was further reduced to 15 percent and the top tax on salaries and unincorporated businesses was cut from 39.6 percent to 35 percent.  If you want the rich to pay more taxes, cut their tax rates.  

As it turns out, 2013 showed that we can’t just assume higher tax rates mean docile taxpayers will simply write bigger checks to the U.S. Treasury. On the contrary, when the average tax rate on the Top 1% increased by 18.4 percent in 2013, the amount of income reported by the Top 1% fell by 15.4 percent – from $1,856,000 in 2012 to $1,571,600. The net effect was almost a wash, in terms of taxes actually paid. According to the CBO, average federal taxes paid by the Top 1% were $530,128 in 2013 –virtually unchanged from $529,056 in 2012. 

Presidential candidates Bernie Sanders and Hillary Clinton propose even more increases in top tax rates on income and capital gains (to 54.2 percent with Sanders, 43.6 percent with Clinton), ostensibly to finance their lavish government spending plans.  But even a relatively small dose of this same poison failed to raise significant revenue from the Top 1% in 2013, partly because of the drag on the overall economy from reduced incomes and incentives. 

Obama’s Misguided Reversal On Social Security Expansion

In a speech this week, President Obama called for an expansion of Social Security, saying “it’s time we finally made Social Security more generous, and increased its benefits.” Obama was undoubtedly influenced  to some degree by the developments in the Democratic primary, where both Bernie Sanders and Hillary Clinton have expressed support for some form of expansion.  This represents a reversal in part for Obama. While he had always supported increasing payroll taxes on higher-earning Americans, he had also previously supported a change in the way benefits were adjusted each year that would have reduced the growth rate of benefits over a long timeframe in the interest of improving the program’s fiscal trajectory. Social Security’s long-term oultook has only gotten worse in the intervening years, but in his speech he signalled that he no longer believed “all options were on the table” to address solvency concerns  and instead supports further expansion. This reversal is misguided. If his favored reforms are implemented it will increase the economic distortions introduced by Social Security and do nothing to address its serious fiscal problems.  The more likely result is that with this retrenchment, policymakers will continue to make promises but fail to actually do anything. Younger workers will bear the brunt of the cost resulting from failures to put forward constructive reform.

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We’ll Never Improve the Tax System by Clinging to Partisan Folklore

top marginal tax rates over time

A stubborn myth of the pro-tax left (exemplified by Bernie Sanders) is that the Reagan tax cuts merely benefitted the rich (aka Top 1%), so it would be both harmless and fair to roll back the top tax rates to 70% or 91%.

Nothing could be further from the truth. Between the cyclical peaks of 1979 and 2007, average individual income tax rates fell most dramatically for the bottom 80%  of taxpayers, with the bottom 40 percent receiving more in refundable tax credits than paid in taxes.  By 2008 (with the 2003 tax cuts in place), the OECD found the U.S. had the most progressive tax system among OECD countries while taxes in Sweden and France were among the least progressive.

What is commonly forgotten is that before two across-the-board tax rate reductions of 30% in 1964 and 23% in 1983, families with very modest incomes faced astonishingly high marginal tax rates on every increase in income from extra work or saving (there were no tax-favored saving plans for retirement or college).

From 1954 to 1963 there were 24 tax brackets and 19 of those brackets were higher than 35%.  The lowest rate was 20% -double what it is now.  The highest was 91%.

High and steeply progressive marginal tax rates were terrible for the economy but terrific for tax avoidance. Revenues from the individual income tax were only 7.5% from 1954 to 1963 when the highest tax rate was 91%, which compares poorly with revenues of 7.9% of GDP from 1988 to 1990 when the highest tax rate was 28%. 

The Fundamental Fallacy of Redistribution

The idea that government could redistribute income willy-nilly with impunity did not originate with Senator Bernie Sanders. On the contrary, it may have begun with two of the most famous 19th Century economists, David Ricardo and John Stuart Mill.   Karl Marx, on the other side, found the idea preposterous, calling it “vulgar socialism.”

Mill wrote, “The laws and conditions of the production of wealth partake of the character of physical truths.  There is nothing optional or arbitrary about them… . It is not so with the Distribution of Wealth.  That is a matter of human institution only.  The things once there, mankind, individually, can do with them as they like.”[1]

Mill’s distinction between production and distribution appears to encourage the view that any sort of government intervention in distribution is utterly harmless – a free lunch.  But redistribution aims to take money from people who earned it and give it to those who did not.  And that, of course, has adverse effects on the incentives of those who receive the government’s benefits and on taxpayers who finance those benefits.

David Ricardo had earlier made the identical mistake. In his 1936 book The Good Society (p. 196), Walter Lippmann criticized Ricardo as being “not concerned with the increase of wealth, for wealth was increasing and the economists did not need to worry about that.” But Ricardo saw income distribution as an interesting issue of political economy and “set out to ascertain ‘the laws which determine the division of the produce of industry among the classes who concur in its formation.’

Lippmann wisely argued that, “separating the production of wealth from the distribution of wealth” was “almost certainly an error. For the amount of wealth which is available for distribution cannot in fact be separated from the proportions in which it is distributed… . Moreover, the proportion in which wealth is distributed must have an effect on the amount produced.” 

The third classical economist to address this issue was Karl Marx.  There were many fatal flaws in Marxism, including the whole notion that a society is divided into two armies – workers and capitalists.[2]  Late in his career, however, Marx wrote a fascinating 1875 letter to his allies in the German Social Democratic movement criticizing a redistributionist scheme he found unworkable.  In this famous “Critique of the Gotha Program,” Marx was highly critical of “vulgar socialism” and considered the whole notion of “fair distribution” to be “obsolete verbal rubbish.”  In response to the Gotha’s program claim that society’s production should be equally distributed to all, Marx asked, “To those who do not work as well? … But one man is superior to another physically or mentally and so supplies more labor in the same time, or can labor for a longer time… . This equal right is an unequal right for unequal labor… It is, therefore, a right to inequality…”  

Finland to Break New Ground with Basic Income Experiment

Despite some of the breathless headlines, Finland is not adopting a national universal basic income. That is, Finland is not scrapping the existing welfare system and distributing the same cash benefit to every adult citizen without additional strings or eligibility criteria. Finland is moving forward with one of the most extensive and rigorous basic income experiments in decades, which could help answer some of the lingering questions surrounding the basic income. The failures of the current system are well documented, but there are concerns about costs and potential work disincentives with a basic income. Finland’s experiment could prove invaluable in trying to find an answer some of these questions, and whether it is possible some kind of basic income or negative income tax would be a preferable alternative to the tangled web of programs in place now.

The Finnish Social Insurance Institution (Kela) will lead a consortium of think tanks, universities, and businesses in surveying the existing literature, analyzing past experiments, and designing different models to test in Finland. They will present an interim report next March, where the government will decide which models to develop further. The consortium will present a final report in November, after which the government will choose which models to actually test. The experiment will begin in 2017 and last for two years, after which the consortium will begin to evaluate the results.

One of the most important issues with any basic income proposal is deciding whether it would replace the current system or be added on to the existing structure. (The latter, of course, does not have much appeal from a limited-government perspective.) The consortium is considering multiple models, as Kela’s presentation shows: 

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