Saturday, September 15, 2012

The Social Security Tax Cut Debate

This was the first of three articles I wrote about Social Security Tax and the "temporary" reduction in payroll taxes to solve the financial crisis. Will these reductions just be roots of additional financial failures? Only time will tell. I sounded the warning originally in an article on Facebook on Wednesday, December 21, 2011.

I was a debater in High School. As a member of the debate team, I traveled around Montana participating in competitions and arguing pro and con with students all around the state. I won some and lost some, but mostly I grew in appreciation of various points of view.

In debate there is a topic that is discussed for the entire year. Teams prepare both affirmative and negative evidence and arguments. You must be prepared to take either side of the discussion. This strengthens one’s appreciation for the other side. You realize that arguments are rarely one sided and this strong belief that most people seem to have that their idea is right and the other side of the discussion is not only wrong, but somehow less intelligent to think that way is patently ridiculous. As the saying goes, there is room for men (or women) of good conscience to disagree.

Much in the news these days is the current state of the economy and the joblessness and suffering of Americans. There have been a lot of suggestions of ways to fix this problem, most involving government action. Lots of talk about taxes: raising them, lowering them, simplifying them, flattening them, etc. Certainly our tax code has become an entanglement of rules so complex a noble prize winner could not explain them and the central argument in the “us” vs. “them” debate on who is responsible for this fine mess we find ourselves in. Fingers are pointed at the large tax cuts passed under the Bush administration, and many would like to see taxes raised, at least on the “other guy.”

To demonstrate the power of the debate ethic, I will now argue both the affirmative and the negative of the most current tax and economic stimulus debate: Resolved: The United States federal government should continue its current policy of reduced “payroll taxes” for another year in order to strengthen the economy and relieve the impact of the downturn on US citizens.

In formal debate you always define your terms. For honest and useful communications between opposing sides, you need to be sure you are both talking about the same thing. For the sake of this discussion, “payroll taxes” are defined as the amount of tax withheld from a paycheck for Social Security Insurance. This tax is called the Federal Insurance Contributions Act (FICA) tax. It does not include the amount withheld for Medicare nor does it refer to the amount withheld for federal, state, or local income tax.

The Social Security tax is made up of two parts, one paid for by the worker, and a second part paid for by the employer. Note that self-employed persons must pay both of these parts. In 2010 the social security tax was set at 6.2% for both employee and employer. In 2011 the employee tax was reduced to 4.2%, although there was no change in the employer rate. This reduction was designed to increase individual citizens’ net income, thereby increasing spending and improving the economy overall. This special tax cut expires on Dec. 31, 2011. (For now I will refer to it as a tax since it is money withheld from earnings that flows to the government, similar to all the other taxes.)

Currently there is a heated debate in congress to extend this cut into 2012. Some of the bills offered will increase the cut eliminating employee paid Social Security tax entirely and possibly even reducing the employer paid portion with the intent of further stimulating growth and hiring. In addition, many of the proposals also include extension of unemployment payments for those still out of work.

There are several special points to be made about the social security “tax.” First, it isn’t really a tax. Some have described Social Security as a ponsi scheme. That alludes to the fact that workers today are paying for current retirees. However, those retirees paid during their working years for the older retirees at that time with the expectation that younger workers would do the same for them when they retire. I don’t view FICA as a tax. You could consider it a contract between generations. I consider it “insurance.” That is, you pay into the insurance fund during your working lifetime, and then collect retirement based on the premiums you paid.

It is the job of the Social Security Trustees to keep the insurance fund solvent. That is, it must have enough funds in income and reserves to be able to pay out on its obligations. Further, since Social Security payouts include a cost of living clause, they are, to some extent, inflation proof.

But Social Security is not a retirement investment fund like an IRA or 401(k) nor a funded pension plan. In those types of funds your money is invested, and you collect the principle and any earnings when you retire. For one thing, Social Security is available to people before they retire under circumstances of disability or loss of a parent. No, FICA is most like insurance. In some cases you may collect a lot more than you paid in, and, in other cases, you may collect less. Those that die before starting Social Security payments get nothing, and no money is put into their estate for heirs. This is similar to automobile insurance. Some pay and pay, but never have an accident and collect, while others may collect several times what they pay into the insurance. Insurance is a spreading of risk and not everyone gets back all that they contributed.

Another difference between the Social Security “tax” and other taxes is that you only pay for the first portion of your income. Those that earn above a certain limit in a given year don’t pay any FICA tax on the amount about the limit. That is the opposite of most income tax rates where the percentage you pay increases with increased income.

The maximum wage amount of FICA has been gradually raised over the years and currently has plateaued at $106,800, but it will increase in 2012 to $110,100. This is an important consideration making FICA tax somewhat “regressive” while the income tax system is “progressive.” This means that income tax rate increases for people who make more money, but the FICA overall rate compared to all income goes down for high earners above the maximum Social Security wage amount.

So, now with those definitions and basic economic theory stated, I will move on to the debate. First, I will take the side of the affirmative and argue for an extension of the social security deduction reduction.


The current situation in the US is a severe recession. Although economists calculate some amount of growth in the gross national product since 2008’s real estate bubble burst, unemployment remains at an historical high and people all across this great land are suffering. It is a key role of government to provide for the general welfare and that includes encouraging economic growth and job development. Economists have agreed that the current Social Security tax cut has had a positive impact on the economy, and it has the added benefit of providing assistance to those in most need for that help.

Congress deemed that the best way to get tax relief to the most citizens — especially those that really need help making ends meet — was to reduce the FICA deduction. Of course, a reduction in the FICA withholding won’t reach all of the citizens. Those that are not working will not benefit directly. That includes both those that are unemployed and looking for jobs in our depressed economy as well as those retired. However, the suggestion to continue the FICA reduction also includes extension of unemployment relief.

Why was a payroll tax reduction chosen by congress to stimulate the economy rather than some other form of tax change? There are several answers, but primarily it is because not everyone pays federal income tax. Many studies have shown that only about half of the earners in the US pay any federal income tax. That is due to various deductions and credits in the income tax code. Many people who earn low wages, have large families, or have other large deductions don’t have to pay any income tax at all. After subtracting deductions for children, child care, and various other exemptions including a deduction for home mortgage interest, state taxes, or large medical expenses to name just a few of the many deductions allowed in our complicate tax code, their total income tax bill is zero.

The economic motivation for this “tax cut” is to increase spending, thereby growing the economy and, hopefully, leading to more jobs. More jobs would be an improvement for the unemployed. To actually improve the economy, a tax cut must lead to increased spending. Note that a tax cut, by itself, does not improve the economy. It is the impact or effect of the cut that actually makes things better. More money in the pocket leads to more spending which is more income for business.

A second reason that this particular mechanism was chosen is something economists call the “marginal propensity to consume.” Let’s parse that little phrase in order to understand what it means. “Marginal” refers to an increase. For example, if I pay less FICA tax, then I have an increase in my net pay – more money in my pocket. Now what will I do with that increase? I might just stuff it in a mattress or put it in my savings account to have for future needs. That doesn’t improve the economy except indirectly by increasing the savings rate. I might use the money to pay off my credit card or other debts. That doesn’t improve the economy except to help lenders make more profit. Or I might spend the extra money on almost anything. Now it is this spending that will directly stimulate the economy.

So, think about this. If you knew someone who barely could put food on the table or pay their rent, and they got a little more money, what do you think they would do with it? What would be their “propensity” to consume. (Propensity is just a $20 word for probability.) I suspect it would be quite high. If they can barely put food on the table, then they are likely to buy more food – thereby stimulating the economy.

Now imagine some rich guy (or gal). They really have all they need. Do you think they would be likely to rush out and spend a small increase in their income. Probably not as likely as the poor person described earlier. That is why many economists prefer these tax cuts to the lower or middle class as a mechanism to stimulate the economy. Since the FICA tax is only paid on the first $110,000 (approximately) of income, it would have a greater proportional effect on lower income workers.

In addition, there are obvious social reasons to give more help to the poorer members of society that need the help, rather than give it to the rich who seem to be doing quite well without help.

The tax reduction in 2011 has been a success with a small reduction in unemployment just one indication of that success. Certainly no-one would deny the benefit of putting a little more money in the consumer’s pocket. Although some Republicans, including some presidential candidates, have criticized continuing the cut by claiming there is no evidence that it has improved the economy, that is an unusual argument from the political party that supports a continuation of the tax cuts for the highest earners in our society with the statement that the cut is good for the economy and creates jobs. Since there is no evidence that the Bush tax cuts of 2001 have improved the economy, and the cuts had ten years to perform that role, it is odd that this party now argues that there is no evidence that the payroll tax cut has improved things. Where is the evidence that the Bush tax cuts improved the economy?

It is obvious that people in the US are suffering. People are out of work. People have been forced to take jobs at reduced pay. Companies continue to lay-off workers and the rate of job creation doesn’t even match the number of new workers entering the job market. This recession has continued for several years and economists agree to the need for further stimulus.

Therefore I ask that you agree with the affirmative and resolve that the payroll tax cut should be extended into 2012. Thank you.


The negative team agrees that the US is in a serious recession and that changes in policy are called for. However, any solution must be considered for both its short-term and long-term effects. As you are all aware, one of the financial crises facing this country is the long-term viability of our Social Security system. The facts are well known. Due to the large demographic called the “baby boomers” we are just entering a time when there will be much increased demand on the Social Security system for payouts at a time when the number of workers paying in will be decreasing.

It was in anticipation of this bubble of retirees that Congress set the current Social Security tax rate at an amount that created a surplus over the last several years. Just how long that surplus will provide for the increased demand is debatable, but one thing is certain: reducing the income to the Social Security Insurance system will hasten that point where the system goes broke. Already the cash flow of Social Security has turned negative forcing the government to tap the surplus. And just where is that surplus? Why it is in government treasury bills. And how will the government redeem those notes and convert them to cash to pay off retirees? Since the government is running in deficit, it will have to issue more t-bills.

In other words, the surplus doesn’t really exist. It has already been borrowed against by the government. I don’t see how additional government spending and borrowing is going to improve the economy. Any positive impact will be more than offset by the negative impact of additional borrowing.

Let’s talk about this economy. One trend we have observed over the last 90 years is a steady increase in the percentage of the gross national product consumed by the federal government. That percentage has risen from 10% in 1910 to 50% today. One way to interpret that statement is that the US government basically employs half of the people in the US. That is either directly as government employees, or indirectly as employees of government contractors.

So how will it help our economy to further cash starve the very government that is providing, directly and indirectly, half of the jobs in the US? Further, how much is this large government worker base retarding growth in the other industries throughout America. Certainly recent events would argue for careful regulation of certain industries, but there is also evidence of over regulation and costly limitations on business the result of too much government. The tax code itself, and these frequent, last-minute changes in that code, cost American businesses with each change and each paragraph of legalese in the regulations.

Let’s also consider social justice. It is worthwhile to craft a program that benefits the lower income people in this country, but at whose expense? Current retirees will not save since they are not paying Social Security tax because they don’t work. Further, reducing FICA income may end up requiring a cut in Social Security benefits. Unemployed won’t benefit since they don’t receive a paycheck either. Most people are having a hard time, but the ones who are affected most are the unemployed. Why give tax breaks to those who already have jobs?

The question you have to ask is, will this continuation of the payroll tax cut, or even a possible increase in the size of this cut actually stimulate the economy enough to pay for the negative effects on the Social Security trust fund, older Americans, and even the unemployed? Would a better way to improve our economy and create jobs be to reduce government debt and encourage investment rather than spending? What are the real trends causing the current loss of jobs in America and how can those trends be reversed, not a short-term boost in spending that will likely only result in more purchases of imported goods, but a real change in the way America does business. Consider needed investment in infrastructure, education, and all the other long-terms needs of our society.

Tax cuts in the FICA contribution rates, such as was done for 2011, without corresponding benefit reductions simply worsens the current under funding of Social Security. This either will require larger benefit reductions in the future, higher taxes, or a break in the linkage that underpins the program. Extension of the SSN tax reduction is pandering to the electorate in its worst form by both parties. Whatever side one comes down on as to taxation, deficits, stimulus, etc., we must not cut contributions to the already troubled Social Security system.

For these reasons we request you reject this temporary band-aid in favor of more permanent solutions.

1 comment:

  1. It is important to note that the cut in SSN tax does not reduce income to the Social Security Trust Fund. The shortfall is made up by transfer from the General Fund.

    To prevent Social Security from losing tax revenue, Congress mandated that revenues be transferred from the general fund to the Social Security trust funds to make up for the tax reduction.

    This is provided for in section 601 of the Tax Relief Act, which reads in part, "There are hereby appropriated to the Federal Old-Age and Survivors Trust Fund and the Federal Disability Insurance Trust Fund established under section 201 of the Social Security Act (42 U.S.C. 401) amounts equal to the reduction in revenues to the Treasury by reason of the application of subsection (a).

    Amounts appropriated by the preceding sentence shall be transferred from the general fund at such times and in such manner as to replicate to the extent possible the transfers which would have occurred to such Trust Fund had such amendments not been enacted."

    Of course, one can argue that it is more borrowed money promised to the trust fund from the entity that already borrowed the entire surplus, but at least the math is maintained.