Jewish World Review March 7, 2005 / 26 Adar I, 5765

Robert Robb

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Lifting the Social Security cap isn't a solution but a short-term patch | To keep the prospects of Social Security reform alive, President Bush recently indicated that, while he wouldn't accept an increase in the payroll tax rate, he would consider increasing the wage limit on its application.

Although I'm a staunch supporter of personal retirement accounts, establishing them at the expense of lifting the wage cap is a bad bargain. The payroll tax of 12.4 percent currently applies to the first $90,000 in wage income. The limit increases each year, at the same rate as average wages.

As a result of the cap, the Social Security payroll tax does not apply to about 15 percent of wage income. Obviously, the income of relatively affluent individuals.

So, lifting the cap has an instinctive and superficial appeal. Why shouldn't all the wages of the rich be subject to the payroll tax, as is the case for the working poor and middle-class?

To the extent Social Security is a pension plan, and not primarily an income-transfer program, the equity argument actually works the other way. The wage cap not only limits taxes but also the wages on which benefits are calculated. Social Security benefits are already progressive: low-income workers get a larger percentage of their previous wage base in retirement income than do high-income workers. Lifting the wage cap would accentuate this redistributionist feature.

Moreover, lifting the wage cap doesn't do that much to make the Social Security system more solvent. According to Social Security actuaries, lifting the wage cap only delays the date at which current taxes are insufficient to pay current benefits, now projected at 2018, by six or seven years.

It would do more to delay the point at which trust fund reserves are exhausted, currently projected to be 2042. But that's in large part because it would increase Social Security surpluses in the short run. That would increase the trust's reserves, held in the form of special treasury notes. But that exacerbates the already considerable problem of financing the redemption of those notes as they are needed to pay benefits. The trust is already projected to rack up over $5 trillion in such IOUs through 2018.

Although the don't-worry crowd simply assumes these debts get paid, figuring out how to do so is part of the Social Security financing problem. Lifting the wage cap extends the long-term solvency of the system, but in part by making this intermediate financing hurdle even higher. The major reason lifting the wage cap is a bad bargain, however, is the effect it will have on the economy.

If the country had a flat income tax, the argument for lifting the wage cap would be much stronger. But the increased payroll taxes would come on top of what is, despite the Bush tax cut, a sharply progressive federal income tax.

The added payroll tax would hit incomes that are now subject to marginal tax rates ranging from 25 percent to 35 percent. Just the individual part of the payroll tax would increase these marginal rates to 31.2 percent to 41.2 percent.

And then there is the employer portion. Where the incidence of corporate taxes actually falls is a mystery. I once read a book on the subject (yes, I know, I do need to get a life) and the answer, as best I could discern it, was: No one knows.

But it falls in some proportion on consumers, in the form of higher prices; on shareholders, in the form of reduced returns; and on employees, in the form of lower wages.

So, the tax effect of lifting the wage cap may approach increasing these marginal rates to as high as 37.4 percent to 47.4 percent — levels the country hasn't seen for over two decades.

This would hit hard at the heart of the investor class. The top 20 percent of income earners are responsible for around three-quarters of all private savings and investment.

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Lifting the wage cap would raise about $70 billion a year. But this is $70 billion currently going somewhere else, in significant part toward providing investment capital. And at present, the only effect would be to increase what the general treasury ultimately owes the Social Security trust fund.

Eating the economy's seed corn just to accumulate future debt makes no sense.

It's quite obvious the momentum for Social Security reform is dissipating. That's in significant part because Bush ran on just the concept of personal retirement accounts, while ignoring the knotty issues and costs of truly adjusting Social Security to the demographic realities of the future.

The sooner personal retirement accounts get established, the sooner they will accumulate sufficient resources to provide alternative retirement income, easing the bite of what will be necessary to bring the pay-as-you-go part of the program into balance.

Chances are, however, that the consequences of inaction will have to become more obvious and acute before the political will can be developed to do what ultimately has to happen.

Lifting the wage cap is an unacceptable price for accelerating this process.

JWR contributor Robert Robb is a columnist for The Arizona Republic. Comment by clicking here.


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