12/20/2010 10:39 am ET | Updated May 25, 2011

Reality Check: Why Truth Will Protect Social Security

It is clear from the comments on our last piece that we might have raised more questions than we answered. Above all, we want to make clear that when we discuss the funding aspects of the Social Security program, we are doing so in a way that is designed to safeguard it, not eliminate it. We believe that fictions are not necessary, because the truth will protect the program better than distortions, however well-intended. Enemies have lied enough; supporters do not need to battle fictions with more fictions. Here we will deal with a dozen issues surrounding the proposed payroll tax holiday, and illustrate why we do not believe that the holiday is a danger to the program -- as long as we understand the facts.

1. Social Security Has Deep Support. Social Security is consistently counted as America's most popular program. It lifts millions of seniors out of poverty. It provides benefits to widows, dependents and persons with disabilities. It has never missed a payment due. It is a federal government program, and as such has the full faith and credit of our government standing behind it. There is absolutely no reason to believe that it would ever default on its commitments. Its promises are as secure as any promises made anywhere in the world. One of the things that makes it so popular, and hence safe from political interference, is that it is essentially a universal program -- Congress determines eligibility requirements. It has no means tests, so unlike "welfare" programs it is available for poor and rich alike. So it commands political legitimacy in a way that welfare programs do not.

2. Social Security is a Generational Promise. In real terms, Social Security is an assurance program, maintained by a promise by Americans of working age to provide material support for seniors and other beneficiaries (those widows, dependents, and people with disabilities). It is an assurance that is renewed every generation: those of working age produce the goods and services needed by Americans of all ages, secure in the knowledge that when they become aged or infirm, the next generation will work hard to support them.

3. There is No Viable Alternative. What would be the alternative to this social assurance program? Previous to the creation of Social Security, most elderly people lived in (or near) poverty, relying largely on handouts coming from their own children or, in many cases, from charities. Few Americans had adequately provided for their own retirement. All studies today demonstrate that the average American still has not adequately prepared for retirement. For most Americans, the Social Security "leg" of the retirement stool is absolutely essential for a dignified retirement. There is no reason to believe things will ever be different. There is no alternative to public support for retirement. If we also add in widows, dependents, and people with disabilities (who now account for a quarter of all beneficiaries of Social Security) it becomes even more obvious that Social Security is necessary and is here to stay.

4. The Payroll Tax is Unpopular. In spite of the defense by well-intentioned, albeit misguided, liberals, no one really loves the payroll tax. It is the most burdensome federal tax for 70% of all Americans. It adds to the cost of employing American workers -- making it hard to compete in a global economy in which many of our competitors have no equivalent business cost. In most nations, a public pension for retirees, as well as social protection for dependent youths and people with disabilities, is not a cost imposed on business. Rather, it is a cost born by society as a whole. In America we impose a cost on employment -- both employee and employer -- that is not typically born by our competitors. Just as in the case of imposing health care costs on employers, the US almost uniquely puts barriers in the way of employment. Social Security alone adds 12.4% (half each on employer and employee) to employment costs.

Further, the tax is poorly designed because it is regressive, with much lower tax rates on high income earners. It also taxes only employment income. This is extremely problematic in a nation in which the share of wages in national income has been declining on trend and is projected to continue to decline in coming decades. While we do not endorse such projections, we wish to point out that these have a lot to do with the projections of future financial "shortfalls". In addition, as income becomes more unequally distributed, more employment income at the top becomes exempt from the tax -- another reason for projected shortfalls. Again, we do not endorse the projection, but it provides fuel to the fire of neocons who point to projected shortfalls in their argument that the program is financially unsustainable.

Our point is that a payroll tax cut reduces employment costs, will restore 'spending power' and, by helping households to make their mortgage payments, will help to fix banks from the bottom up. Maximizing employment and output in each period is a necessary condition for long-term growth. A payroll tax reduction helps to mitigate the impact of rising unemployment. So even on the conventional accounting grounds that today's Social Security Trust Fund will have "shortfall" (to reiterate, a position which we do not endorse), full employment provides greater tax revenue to the government, which will shut down these discussions about Social Security's "affordability".

5. Tying Social Security to the Payroll Tax is Problematic. Even if we strictly stick to conventional understanding of government finance, it makes little sense to tie the program's fortunes to the payroll tax for the reasons enumerated above. The tax base has been falling. The tax is regressive. The tax helps to make America uncompetitive. More importantly, the tax is almost unique among federal taxes -- it is "dedicated" to a single program. That allows both "money's worth" (comparing taxes paid to individual benefits received) calculations as well as calculations of "Armageddon day" (when revenues fall short of benefit payments). It also has led to completely unnecessary tax hikes over the years, from a tax of about 2% of wages on the parents of baby-boomers to the current 6.2%. These current tax rates have nothing to do with current benefit payments -- Greenspan pushed them up far beyond what was necessary on the argument that we needed "advanced funding" for benefits that would be paid 50 or 75 years into the future.

By contrast, there is no dedicated military tax. Imagine tax policy that would try to increase taxes today on the argument that we will need to increase military spending in 2075. It would be rejected as nonsense. In fact, no one wastes time trying to calculate the defense spending "shortfall" through the next 75 years, let alone "infinite horizon" shortfalls (as is done by inter-generational warriors in the case of Social Security). Too silly to imagine. Without a "dedicated" payroll tax, such calculations would never be done because they could not be done. A "hypothecated tax" supposedly designed to safeguard Social Security's long-term viability, then, actually provides the political means to destroy it.

6. Ignoring "Financing", There is no Social Security Crisis. As we explained in our first piece, aging raises the real "burden" in the sense that eventually we will have only two workers per beneficiary versus three today. But all reasonable projections of rising worker productivity easily takes care of that. If we stick to "real" arguments Social Security, proponents can defeat neocon critics hands-down. The burden rises very slowly, and by less than it has risen over the past half century -- we have already dealt with a rising number of seniors as great as what will occur in the future.

In truth, we have already completed most of the transition to an aged society. And it ain't that bad. Yes, we need more old folks' homes; but we need fewer day care centers. We need more hip replacements but we need fewer neonatal units. It is almost a wash -- that transition from baby-boomer young to baby-boomer old. And they'll all soon enough be gone, anyway. In truth, the baby-boomers were a blip on the historical radar screen and we are almost done with them. Yes, they were a burden -- from birth to death -- but they gave us one heck of a lot of excitement, from war protests to sexual revolutions, and from drug experimentation to the best music the country ever produced.

7. Sustainability Calculations Are Distorted. Only in financial terms can the program look unsustainable -- but that is entirely due to the myth that the payroll tax must pay for the program. The shortfall is due to several factors, most of which are based on the assumption that recent trends will continue. As discussed above, it is partially due to projections that the distribution of income will continue to shift away from wages and toward rentier income and high income earners. It is also due to projections of low wage growth and to other projections about "real" variables: low immigration of workers to the US, low economic and productivity growth, low birthrates, falling retirement ages, and low labor force participation rates. Most of these are arguable, and some are policy variables (if desired, there is a nearly infinite supply of potential immigrants).

But the bigger point is the one we have made above: these sustainability calculations rely on projections of faster growth of benefit payments relative to the growth of payroll tax revenue. If there were no dedicated tax, there could be no "financial" calculation of sustainability. Instead, we would have to focus on the much more relevant "real" variables: will we have enough workers of sufficient productivity to produce all the goods and services we will need to support elders, dependents, people with disabilities, and workers? The answer is a resounding "Yes". There is no controversy about that, even taking the pessimistic assumptions used by program critics. The "financing" diverts us from the real issue.

8. The Holiday is Good for the Economy. Eliminating the payroll tax ends the irrelevant "money's worth" and "sustainability" calculations. It also relaxes the fiscal stance by an amount that is probably sufficient to remove the fiscal drag that prevents the economy from operating at full employment. The "holiday" is a move in the right direction with regard to loosening the fiscal stance and tax relief is well-targeted to workers and firms. We can begin with the 2 percentage point reduction and move forward to greater reductions. It is possible that our calculations are wrong. If so, it will be necessary to increase taxes or reduce spending when -- and if -- our economy finally recovers. When that becomes necessary, there are better taxes than a payroll tax that punishes employers and especially lower and middle class workers.

9. Payroll Taxes Do Not "Pay for" Social Security. Let us first look at this from a conventional viewpoint of government finance. Benefit payments are made by Treasury, just like any other federal government spending. Payroll taxes are paid to Treasury, just like any other federal taxes. If total spending, including Social Security, exceeds total tax revenue, including payroll taxes, the government records a budget deficit. It does not matter whether one part of the budget -- say Social Security -- receives dedicated taxes greater than spending. We can just as easily imagine that fuel taxes "pay for" transportation, and that income taxes "pay for" military adventures. If Social Security runs a surplus but the rest of the budget runs an equal deficit, the government has a balanced budget. It can say that the rest of the budget "owes" Social Security -- but that is just internal record keeping. Later, if the rest of the budget continues to run deficits and then Social Security also runs a deficit, the sum of those two equals the budget deficit -- an external deficit. The internal records that show Social Security has run years' worth of surpluses do not change that fact at all. From the perspective of the budget as a whole, this internal accounting makes no more sense than when a household allocates the husband's income to the house payment and the wife's income to the auto loan with careful record keeping to track the husband's debt to the wife when he comes up short. If total income is less than spending, there is an external budget deficit and the wife cannot collect from the husband on all the internal debts he may owe her from previous years.

But in reality, the government is not like a household and we cannot use conventional views about government finance. While we treat tax revenues as "income," it is not the same as a household's income and does not really finance government spending in the way that a household's income finances its spending. The government actually receives back its own IOUs when taxes are paid; it issues its own IOUs when it spends. Deficits mean it issues more IOUs than it receives back. It cannot run out of its own IOUs. This is not a policy proposal, but rather a description of government spending.

We do not imply that the government can never issue "too many" IOUs. The government can spend too much, causing inflation and, possibly, causing currency depreciation. But when the government promises to make Social Security benefit payments, it is promising to credit bank accounts with its own IOUs. It cannot run out; it will never reach a point at which it cannot fulfill its promise. "Finance" is not constrained in this case. This is not a controversial point; it is accepted by all mainstream economists from Paul Samuelson (who wrote the textbooks most students used) and Milton Friedman to Ben Bernanke. There are many other issues associated with government spending -- it can be of the wrong type, it can be so large that it causes inflation, it can reward friends and punish enemies, and so on. But it cannot be financially constrained.

10. Political Reality Check. Our support for a tax holiday has been labeled "politically naïve." You want political reality? Retaining the fiction that payroll taxes "pay for" Social Security only gives ammunition to the enemies for the reasons we discussed above -- it makes it possible to calculate the program's shortfall. Amazingly, Social Security's "friends" (like President Clinton and Candidate Gore) accept those calculations! And just what do many "progressives" advocate to resolve the program's projected financial shortfall? Raising the cap so that taxes can be increased on higher income people. That is supposed to be politically popular -- a way to influence friends and convert enemies? Social Security is already a bad "money's worth" deal for high income people, who would much rather pull out and invest their savings in Wall Street.

Others want to means test the program -- again, targeting the high income to reduce their benefits. To generate more support among high income employees and the self-employed? Talk about political naiveté. In case no one has been noticing over the past half century, high income people have influence in Washington and do not need Social Security. They would love to pull out or gut the program.

By tying Social Security's fate to the payroll tax, progressives commit themselves to battling over financial "sustainability" and to difficult political choices that come down to raising payroll taxes or cutting benefits.

11. Defending the Payroll Tax Plays Into the Hands of Social Security's Foes. There is nothing more ironic and destructive than "progressives" refusing to give a payroll tax holiday to beleaguered workers. It plays right into neocons' hands. Keeping payroll taxes far higher than necessary to match benefit payments was precisely Greenspan's 1983 scheme to reduce popularity for the program. To some degree, it has been successful.

Imagine a truly progressive strategy that promised to eliminate the payroll tax to help workers and their employers. How much goodwill would that produce for the progressive cause? And how much fiscal stimulus would that add?

We would then move the focus to real issues: preparing our economy for a growing elderly population and for fewer workers per beneficiary. Education and training could increase future productivity. Policies that maintain high employment and minimize unemployment (both officially measured unemployment, as well as those counted as out of the labor force) are critical to maintaining a higher worker-to-retiree ratio. Policies can also encourage seniors of today and tomorrow to continue to participate in the labor force. The private sector will play a role in all of this, but there is also an important role to be played by the government.

The broader point is that any reform that seeks to address growth in the context of Social Security's "sustainability" ought to be made with a focus on increasing the economy's capacity to produce real goods and services today and in the future, rather than on ensuring positive actuarial balances between payroll tax receipts and benefit payments through eternity. Unlike the case with individuals, social policy can provision for the future in real terms -- by increasing productive capacity in the intervening years. For example, policies that might encourage long-lived public and private infrastructure investment could ease the future burden of providing for growing numbers of retirees by putting into place the infrastructure that will be needed in an aging society: nursing homes and other long-term care facilities, independent living communities, aged-friendly public transportation systems, and senior citizen centers.

12. Americans Want a Better Life for Future Generations. Throughout our history, Americans have always been willing to sacrifice to make our nation stronger over the long haul. That's America's promise: to give our children and grandchildren a better life. And if we succumb to the maniacal protests of the deficit reduction fetishists and cut back net public spending now and drive millions more workers out of jobs, then we will be guilty of crimes against our children and grandchildren. That's the real "inter-generational theft" that ought to concern us, not a reduction in the payroll tax.

Cross-posted from New Deal 2.0.