Proposals to shore up what is thought to be Social Security's shaky finances necessarily fall into two categories:
- Increase revenues.
- Cut benefits.
The received wisdom among the chattering classes in Washington long has been that some combination of both is necessary to close the program's long-term actuarial deficit. Conservatives in particular argue that the nation "can't afford" to raise Social Security taxes enough to do so on its own.
A new paper by economist Thomas L. Hungerford, an associate commissioner at the Social Security Administration, gives the lie to that argument. Hungerford presents a range of options for broadening the Social Security tax base by restoring the payroll tax's historical share of income, and even bringing overlooked forms of income into the system.
"The current Social Security tax base" — which covers only wage and salary income up to $118,500 this year — "is a narrow tax base that has been shrinking relative to the economy … for the past 30 years," he writes.
Raising revenues by broadening the tax base is preferable to benefit cuts because, among other reasons, the latter can't have a short-term effect: Policymakers typically exempt current and near-retirees from any cuts and phase in the rest over years, even decades. "Consequently, increasing revenue is almost the only viable short- to medium-term policy option."
Hungerford has been around Washington long enough to know his prescription won't be a cakewalk. Increasing the system's revenue "would likely be difficult to sell, especially during a bitter presidential election and with a polarized Congress."
Before we get deeper into his views, a few words about Hungerford. He is known for having written, while at the Congressional Research Service in 2012, a sober, carefully reasoned paper that drove conservative Republicans so batty that they forced the CRS to take it out of circulation. Its sin was that it found that the level of marginal income tax rates had no effect on economic growth — thus exploding the GOP's core rationale for cutting top tax rates for the wealthy. He later served as senior economist at the progressive Economic Policy Institute.
Hungerford starts by clearly setting forth the fiscal issue facing Social Security. Most people focus on the supposed exhaustion date of the program's $2.8-trillion trust fund, or reserve, which will start being drawn down when all other revenues — the payroll tax, interest on the trust fund bonds and income tax on benefits – are no longer enough to cover all benefits, perhaps as soon as 2020. The fund would be depleted, according to rough current estimates, in 2034. But Social Security won't be "broke" then. It will still have enough money coming in to pay as much as 79% of all currently scheduled benefits.
That's the wrong figure to look at, Hungerford argues. The program's unfunded obligation — its long-term deficit – is the key, and that amounts to 1.3% of future gross domestic product. Is that a lot? Consider that total federal revenue today comes to 18.2% of GDP. Depending on where you stand, another 1.3% might not seem much of an increase.
In any event, the task is to fill that gap between revenue and expenditures. Two trends have contributed to it. One is that taxable earnings — the wages below that $118,500 cap — have been shrinking as a share of all wage and salary income in the country for 30 years. That's because income inequality has moved a larger proportion of national earnings beyond the reach of the payroll tax.
The second trend is that labor's share of income — wages, plus fringe benefits — has been falling as a percentage of GDP since the 1970s. "Between 1933 and 1975," Hungerford observes, "the ratio fluctuated around 67%." Now it's about 60%.
That suggests several options for broadening the tax base. The payroll tax is pegged at 12.4% of taxable payroll (divided equally between employer and employee). In 2013, that brought in about $733 billion, based on taxable payroll of $5.9 trillion. If you tax a broader category of income, you can bring in much more.
What if we wanted to raise the same amount by eliminating the payroll tax cap and taxing all covered earnings? Then the overall tax rate could be reduced to 10.2%. If we applied the tax to the entire labor share, including fringe benefits, a tax rate of 8.3% would do the trick. Apply it to all income, including capital gains, dividends and interest, and the rate would need to be only 5.1%.
Those indicate how much more money could be brought in simply by broadening the tax base. If the 12.4% rate remained fixed, applying it to all wage earnings would bring in 20% more; taxing all wages and benefits, 50% more; and taxing all wage and unearned income, 144% more. One could broaden the tax base and cut the tax rate, and still bring in more revenue.
Taking any of these steps would introduce "wrinkles," Hungerford acknowledges. To begin with, preserving the traditional linkage between the payroll tax and Social Security benefits would require raising benefits for higher-income people who would be paying a higher tax.
Eliminating the payroll tax cap wouldn't close the actuarial deficit entirely, especially if some of the additional revenue had to be returned in the form of higher benefits. But it would go a long way. Hungerford cites a finding by the Social Security chief actuary that eliminating the cap would eliminate as much as 71% of the long-term deficit.
One virtue of any of these changes is that the Social Security payroll tax would no longer be regressive (or as regressive as it is today). The biggest tax increases under any of these scenarios would be felt by the top 20%. Currently, the rate falls sharply as wage income rises above the cap; the effective rate for the top 5%, for instance, is 3%, not 12.4%.
The underlying importance of Hungerford's analysis is that it shows how broad the options for closing the long-term deficit really are. A sizable proportion of Americans' income remains untouched by the payroll tax, most of it collected by the wealthiest members of society.
Over the last three decades, their share of the Social Security financing burden has shrunk, because they collect a larger share of wage income and because more of their income arrives in forms other than wage income. Whether they should feel more of the pinch, and by how much, is a political issue, as Hungerford acknowledges. As an economic issue, however, there's no reason to place all of that income out of bounds.