Social Security: a class-warfare bonanza for Democrats

I caught an excerpt of Hillary's speech in Ohio; she was voicing disgust about the middle class's higher tax rates compared with the average rates Wall Street zillionaires pay.  It's a cornerstone of Robert Reich's elevator speech, too, so I assume (but can't confirm) that Obama agrees.  That's not all: it's the same rhetoric John Edwards had been using in his campaign -- and it's closely related to Warren Buffett's puzzling complaint about his own tax rate compared with his secretary's (...puzzling because he is in a position to fix that pseudo-problem quickly).  It's class warfare slick-talk, with everyone adhering to the fundmental principle revealed at the end of this article.

Here's what Hillary said in Ohio on Friday, Feb. 15:

It is OUTRAGEOUS that a teacher, a nurse, an assembly line worker, or a truck driver here in Ohio making fifty thousand a year pays a higher tax rate than some Wall Street investment manager making fifty million a year. 

What is causing this outrageous injustice?  Hillary didn't say, but it's none other than Franklin Delano Roosevelt's famous New Deal program: Social Security.  (My guess: That's probably why Hillary didn't say.)  Would FDR be surprised to learn that his own party has turned his famous program into a class warfare bonanza?  Here's a diagram of how it works:

What would FDR have to say about the assertion that the social security system is unfair?  [I haven't heard of any Republicans complaining about it, but if you know of any, let me know and I'll add them to the list.]

Everybody pays 6.2% of income, up to a limit, where it stops.  That's by design; social security was meant to be a contributory system, not a welfare system.  The maximum contribution of $6,045 is a different percentage of gross income, depending on one's income (big duh).  The nonrich people Hillary mentioned typically pay more social security tax than income tax, so they end up paying a higher overall percentage of their gross income than the rich.  That's the so-called OUTRAGE, and guess what: it's FDR's fault.  (Why didn't Hillary mention that part, I wonder?)   

But let's play along; let's assume for a minute that the mechanics of FDR's social security system is, as Hillary says, an OUTRAGE.  Okay, how could we remedy it?

I could think of the following four ways to end the OUTRAGE, any one of which would start forcing the rich to pay a higher overall percentage than the nonrich:

1. Change social security into a welfare system: the rich pay more taxes into the system, but their retirement benefits do not increase.

2. Change social security into a retirement windfall for the rich (relative to the nonrich): the rich pay a lot more into the system, and collect a lot more in retirement.

3. Eliminate the revenue side of FDR's contributory system altogether, and increase progressive income tax rates accordingly. 

Note that all three of those "solutions" would decimate FDR's purpose for social security: it was to be a system whereby each worker contributed to the retirement safety net; it was NOT to be a welfare system, or a progressive system that benefitted the rich more in retirement.

Here's the fourth possibility, the one I personally favor:

4. Change the income tax system into a dual-rate tax similar to the one described in this article, so that the more you make, the higher overall percentage you pay. 

Which solution do the Democrats prefer?  When will they start getting more specific about solutions to the OUTRAGE? 

Class warfare: the fundamental principle
I've decoded the important underlying principle of class warfare rhetoric and sloganeering:

When you have a choice, always pick the scarier of two numbers, to incite the maximum possible resentment in the voters you are addressing. 

Specifically:

1. To incite resentment about the regressive social security tax, be sure to talk about tax percentages, not tax dollars;

BUT...

2. To incite resentment about income tax cuts, do the opposite: talk about tax dollars, not tax percentages. 

=================
End note:

The sophistry in political campaigns is a hot button for me, if that isn't apparent yet.  Both sides employ it, but this particular topic seems to be the exclusive domain of the Democrats.

-----------------

UPDATE: Was Hillary talking about the social security payroll tax?  Here's a clue: an excerpt from the Democratic debate at Howard University, June 28, 2007 (seven months ago); emphasis mine: [ link ]

SEN. CLINTON: Well, I clearly think that our economy was working a lot better in the 1990s. We had the creation of 22 million new jobs, a balanced budget and a surplus. And certainly when the Bush administration came in, they were determined to tilt the balance back toward the privileged.

We are paying a very big price for this, because middle-class and working families are paying a much higher percentage of their income. That was Warren Buffett’s position, that he pays about 17 percent, because don’t forget, it’s the payroll tax plus the income tax. And when you cut off the contribution at $90,000, $95,000, that’s a lot of money between 95,000 (dollars) and the 46 million (dollars) that Warren Buffett made last year. And he’s honest enough to say, look, tax me, because I’m a patriotic American and I want to make sure our country stays strong and is fair.

So, yes, we have to change the tax system, and we’ve got to get back to having those with the most contribute to this country. (Applause.)

Comments

[Steverino]

Thanks for this post.

One thing that's always bugged me about the Social Security screaming match is that those complaining about the cap on contributions never mention that there is a cap on the benefits. Or that if you contribute the maximum for most of your earning years, you won't get back anywhere near what you contributed to the system.

Social Security is called an insurance scheme. If so, it's the most perverse form of insurance I've ever seen: those least at risk (the more you earn, the less likely you are to need a safety net) pay the highest premiums.

[William]

Also notable is that the Social Security contribution scheme favors paying one worker more to work more hours, rather than hiring more workers to work fewer hours. The effect on employment, the number of hours worked per week, and wealth distribution in a society? Social Security may just be a notable component of the increase in the Gini.

[Ironman]

First, here's a tool you can use to approximate what your "investment" return is from Social Security:

http://tinyurl.com/23ckqs

Second, what you'll find using the tool is that those with the lowest lifetime incomes come out way ahead of those at the top end of the income spectrum.

Third, there's a reason why the program was designed with a cap on the amount of income that could be taxed to support it.

Having gone through the Great Depression, which demonstrated that income taxes could be an extremely volatile source of tax revenue, the program's developers needed to ensure that the amount of income coming into the program would be rock solid. Otherwise, the program would be perpetually at risk of having dangerous deficits when the people at the top of the income earning scale had a bad year. Kind of like what was very common in the great depression. Kind of like what just happened between 2000 and 2005:

http://tinyurl.com/2gvk9v

Since the program was set up to provide benefits to Social Security recipients on a "pay as you go" basis, any potential deficit meant that people who solely relied on upon them would be much, much worse off.

So, the people who designed the taxes for Social Security made a trade-off. They exchanged taxing all income in favor of having a very stable flow of tax income for the program. They achieved this by setting the maximum amount of income that could be taxed for the program well below the volatility range of the country's top income earners.

And that's why the income cap exists that way.

By the way, did Hillary miss the whole part of the income tax code where people actually pay higher rates at higher levels of income?

[Jason]

"That's by design; social security was meant to be a contributory system, not a welfare system." That's the problem. It's a welfare system masquerading as a contributory system in order to protect its own existence. It was a shrewd political move, but a poor financial move.

Steve,
I didn't listen to the speech, but I believe Hillary and Buffett's complaint is with capital gains rates versus income tax rates. The marginal tax rate on earned income can be as high as 35% while capital gains are taxed at 15%. BTW, wouldn't raising taxes, aka ending "the Bush tax cuts" make this problem worse? It seems this is a good argument for some sort of flat tax rather than any of her proposals.

[Grodge (aka, Tony)]

From NYT:
http://tinyurl.com/yt5wk4

"At the heart of the newest proposal is an attempt to bar private equity and hedge fund operators from a longstanding, but little understood, practice that has allowed them to pay a lower capital gains rate of 15 percent instead of the ordinary top income tax rate of 35 percent on their performance fees, which typically represent most of their annual income."

The argument has nothing to do with Social Security, Steve; but your graphs were still educational.

[Syphax]

I agree with Hillary... Social Security SHOULD be a welfare program, but it should cover only the elderly who really need aid rather than EVERYONE. Why does a retiree with plenty of savings need Social Security? He/she would be much better off if he/she could have invested the money privately. On the other hand, those in need would be just as well off(Actually more private investment would probably make the economy better for everyone, but lets ignore that). Why most Americans support a program that hurts them and doesn't really give an advantage to the poor is beyond me.

We should...
-Compensate those who already paid in based on age(ie 40 yrs old=50% benefits, 30=25%, 20=0% etc)
-Eliminate SS benefits for those who don't need them from today forward
-Stop the 6.2% nonsense... its 12.4% and we all know it.
-Lower the SS tax significantly

[Steve]

Jason and Grodge:
Thanks; that's a possibility. Robert Reich is usually talking about FICA regressivity and how to fix it whenever this subject comes up; I've asked him to comment on this article if he has a minute. Maybe Hillary will clarify which one she was talking about; if it was the cap gains tax, it's a moot issue in this economy, with all the capital losses in equities -- although I doubt we'll be hearing any mourning over how much the Wall Streeters have lost, and how much less tax revenue the feds will get as a result.

[Steve]

Follow-up: I think she was talking about the payroll tax, based on this, from the debate at Howard University Jun 28, 2007:

Q: Do you agree that the rich aren't paying their fair share of taxes?

Hillary Clinton: Middle-class and working families are paying a much higher percentage of their income. [Billionaires like] Warren Buffett pay about 17%, because don't forget, it's the payroll tax plus the income tax. And when you cut off the contribution at $95,000, that's a lot of money between $95,000 and the $46 million that Warren Buffett made last year. We've got to get back to having those with the most contribute to this country.

[Tim]

I think the common understanding of Hillary's statement goes to the difference between the income tax rates on ordinary income (paid on wages) and capital gain rates (paid by hedge fund managers on income from carried interests). I think the Social Security reference is off point.

[Steve]

Tim:
Do you think Hillary misspoke in the June 28 '07 debate?

[Bob]

Regarding Buffet it's all about the effective rate on income.

If Buffet's income is through capital gains and investments as opposed to a salary or hourly wage then he will pay a lower tax rate than his secretary, or his auto mechanic, etc. He'll pay a heck of a lot more in real tax but that's not the talking point.

Steve, I love ya' but this is getting old. I think we all know pols like Hillary are addicted to this bellocose hot air.

Can't we move on?

[Jason]

Payroll taxes are likely a part of Hillary's argument, but I think it would be helpful to examine the other side of the Buffett tax example. Perhaps an article on why his average rate seems so low and another reminder about the difference between tax rates and absolute amounts. Also, most people tend to forget about the inflation component of capital gains.

As for Social Security, my take is that the Federal government has plenty of superior retirement savings alternatives already in place. Instead of trying to push for new "private/personal accounts," use 401ks and IRAs to help phase out Social Security. End payroll taxes and pay current SS recipients out of general tax revenue (essentially what happens now without the Trust Fund semantics). There's an easy tax cut for the middle class.

[PseudoNoise]

I don't want to see SS phased out. It's minimal retirement/insurance for all people. Privatizing it means that we go back to pre-FDR times of old people starving in the streets. Sorry, not in my America.

[Jim Glass]

If the richer paying lower tax rates than the poorer is bad, then it's gotta be *much worse* for the poorer to pay such high taxes to finance cash transferes *to* the rich.

E.g., Warren Buffett's employees at Dairy Queen pay 15.3% payroll tax to pay for his Social Security and Medicare benefits. (Labor economists are unanimous that employees pay both the employer and employee halves of payroll taxes.)

Warren for some reaason seems a lot less concerned about the injustice of him receiving cash transfers from those so much poorer than himself.

SS may be a winning issue for the Dems and the "progressives" today -- but this is going to come back to whomp them in the head in about 10 years, when taxes to pay for these programs have to start going up in a *big* way.

When that happens, means testing of SS and Medicare is going to become major and overt (it's already started in small and hidden ways). There's no way it will be avoided -- how can "progressives" of all people raise taxes on the poor to keep paying the rich?? -- but overtly means testing these programs and turning so them into "welfare" has always been anathema to them. They're going to have a big problem.

[Bob]

Update:

What Hillary really meant on June 28 at Howard:

"Well, you see when my husband was in the White House times were really good. I mean, look at the cheap gas prices and all the capital gains taxes we took in from the raging stock market. Honestly, I don't know how he did all that but the fact is that times were much better.

So, I think it has something to do with having a Clinton running things. I'll restore the world as you knew it. Happy days will be here again.

I promise."

[Neocon Spin Master]

Great post! Totally in agreement. Also, I liked the quote from Mises.

[gunthestops]

Up until 1983 SS was a pay as you go program, that all changed when Mrs. Greenspan’s little boy Alan worked up a plan to pre-fund the program though higher SS taxes. What a plan it was too, it started to fill the coffers to the brim with hard working Americans money. Had the surpluses been in invested properly it would have over 4 trillion in assets, instead of the 2 trillion in IOUs from the government. Over the years there has been many attempts to sequester the funds from the government so they could not spend it as part of the unified budget process. But in the end, there is no way they could keep their hands off all that free money.

Side note: lots of people and politicians like to blow hot air about privatizing SS. The time that should have been done is in 1983, before the government looted the SS surpluses of over 2 trillion dollars. The reason they can’t privatize it now is they have spent the surpluses and put into the SS fund, Intargovernmental Securities that are really IOUs that have about the same value as monopoly money.

Also, all the surpluses that flow into the trust fund side of the national debt each year can be borrowed and spent in the CBO Unified budget process and you don’t have to record it as deficit spending, now isn’t that cool!!! Here is what looks like at the end of 2007:

Total Public Debt: 9.0 trillion dollars (debt all Americans are on the hook for)

Publicly Held Debt: 5.1 trillion dollars (Treasury securities held by the world)

Trust Fund Debt: 3.9 trillion dollars ( Intargovernmental Securities, basically IOUs that have no legal public claim)

Now this is why people who like to obscure the truth about the true size of debt and deficits like to use the CBOs Unified budget process, it only accounts for part of the spending. That 3.9 trillion of trust fund money was spent in the general budget and not a penny was counted as deficit spending, how cool is that! No wonder no one knows the truth about the debt and deficits.

The current government “Trust Fund concept would bring an evil smile to Niccolò Machiavelli face. What a diabolical concept; take in hard cash from working people, spend it as you please, write an IOU that is non binbding on the government and pay it back at depreicated currency. Now to make the concept look legit, they pay interest on the Trust Fund IOUs. Now this is such a cool concept, for FY 2007 the Trust Funds earned about 180 billion in interest, so what do these benevolent government officials do, they tack it on to the end of the trust fund debt and write another IOU for it--lol. In most business transactions that would be fruad. So in the Unified Budget you will see a line item for net interest paid, it means interest paid on publicly held debt, they don’t even count interest paid on the trust fund accounts because they can just tack it on to the end of the loan and not considered real spending.

Final thought for the evening; our currency is backed by nothing but faith, a faith based currency—the neo-cons must love it—lol. Faith that we will not default on our debts, faith that we will not give back worthless currency, faith that we will not destroy our economy in a tsunami of debt.

As our government piles on debt year after year and refuses to make any efforts to pay it down, as our country runs larger and lager trade deficits, municipalities fiscal conditions continue to deteriorate, citizens continue to pile on credit card and mortgage debt, and then top it off with the coming unfunded liabilities. Hmmmmmm HOW MUCH FAITH DO YOU HAVE????

Thanks, Les

[Big Daddy Matty]

While it seems that Hillary was pushing the payroll tax part of the tax "inequity," it should be noted that there is absolutely no way Warren Buffett or a Wall Street hedge fund manager would pay a lower overall tax rate than a regular working stiff if not for the difference between capital gains and wage income taxes. If a wage earner (e.g. a superstar athlete) earned $50 million in a year, he would pay the maximum federal tax rate, 35%, on nearly all of his income. The fact that he would pay roughly 0% in payroll taxes wouldn't change the fact that his effective tax rate would still be much higher than the $50K/year factory worker.

In fact, to illustrate, let's assume that our average joe is single, has no dependents, and does not itemize any deductions. In other words, he pays the maximum federal income tax burden allowable at his income level. His total income tax for 2007 would be $5,399 and his total Social Security tax (including the employer component) would be $6,200. The total, $11,599, would be 23.2% of his total income (it's actually 21.8%, since the employer portion of the SS tax should be considered additional income, but I'm not trying to split hairs), much lower than the 35% that the A-Rod type pays. Even at $97,500, the effective total tax rate is 30.3% (28.5%).

The problem with the Warren Buffett argument, one which he is fully aware of and which makes the argument infuriatingly disingenuous, is that tax rates on investment income aren't really lower than those on wage income. Theoretically, capital gains and dividend income ought to be entirely tax-free. The corporate profits, on which the stock price gain or dividend is based, have ALREADY BEEN TAXED at the corporate level, and generally at a rate higher than the maximum individual rate.

And therein lies the solution. If we want a real apples-to-apples comparison to make sure that the rich are really paying their "fair share," eliminate all taxation at the corporate level and eliminate the distinction between capital gains and regular income. Then Warren Buffett and the fatcats at Goldman would pay their 35%. Of course, it would mean that the total of tax receipts would go down, since regular folks with investment accounts would pay on the same corporate income at much lower rates than those companies now do, but it's a small price to pay for transparency, right?

[gilleland]

Les / gunthestops,
Don't worry, global financial markets, even our very own on Wall Street, won't let the government or aggregate irresponsible households get away with financial idiocy for too much longer once it reaches a tipping point.

Moody's has already warned of the likelihood of downgrading the U.S. government's credit rating in the coming years and obviously the declining dollar value isn't being helped by our anticipated fiscal challenges.

God bless the free flow capital in the global financial markets that will help force corrective action in Washington -- because the populace isn't up to the task.

[brucest]

A similar but smaller issue: Medicare: Everyone puts in the same percentage uncapped, but benefits are capped to the same level. So "the rich" pay a lot more and get the same. Clearly a subsidy, and the liberals can be outraged because the middle class pays "the same" as the rich.

[mark]

FDR created the system while the U.S. operated under a gold standard. Greenspan changed the system under the assumption of a gold standard. Under a gold standard, a federal deficit can drain the gold reserves. Forward funding (a surplus in the trust fund) made sense under a gold standard. Today we live in a world of floating rate currencies. It is unfortunate that most people will not take the time to understand the difference between a gold standard and a floating rate currency. The 15% SS and Medicare tax combined with the 25% marginal tax is draining too much money from the middle class. Economic growth (driven by consumer spending) will be lackluster until this situation changes. That might not be until SS runs an annual deficit - returning more money to the middle class consumer (in the aggregate) than it is draining through the FICA tax.

[Stephen Reed]

A big piece of information missing from talking about low capital gains tax rates is that corporations pay tax on their income. If Warren Buffet's Berkshire Hathaway did not have to pay any corporate income taxes, the value of his shares would be higher. He is thus in effect paying a portion of the taxes that his company pays and this should be taken into account when calculating his effective tax rate.

[JBL]

The solution to Social Security is simple: eliminate the wage cap, phase out benefits for the relatively wealthy, and use the resulting surplus to lower the tax rate. Everybody wins. Add a default 401(k) program and in 30 years the need for the safety net will be even smaller.

Increasing the dividend tax and eliminating the corporate tax, for all its merits, runs into the old Personal Holding Company problem. It's probably more effective to close the loopholes in the corporate tax code and drop the dividend and capital gains rates to zero.

I expect a lot of empty rhetoric from politicians, but I can't figure out Buffett; his position on taxes is uncharacteristically dishonest.

[Big Daddy Matty]

Are you kidding, JBL? How does everyone win under that scenario? It seems to me as if only people earning at or below the current SS wage cap would win. For those earning more, they would pay more taxes (a LOT more, by the way, as in $12,800 extra per $106,400 of income) and stop receiving benefits altogether.

I suppose you're considering the resulting tax rate reduction from the surplus as a "win," but there are two problems with that line of thinking. First, there is no way in the political world that such a move would end up being revenue neutral. A significant portion of this new-found revenue would be kept in Washington. Second, even if the entire amount was returned in the form of lower income taxes, it wouldn't all go back to the people from whom it was taken. Liberals would demand that much of the cut go to the poor and middle class, making it yet another redistribution of wealth.

Such a plan, which is exactly what many Democrats have been floating for years as the "solution" to Social Security solvency issues, does nothing more than turn what is, at least for the most part, a contributory system into one more welfare entitlement. In my opinion, that's precisely the opposite of what we ought to be doing.

[Jeremy Falk]

Whenever I come across this argument, that "rich" people pay less taxes than others (for whatever reason). I usually point them to the CBO Effective Federal Tax Rate.
http://www.cbo.gov/ftpdocs/88xx/doc8885/Appendix_wtoc.pdf

Top 1% sits at 31.2%
Top quintile sits at 25.5%
Fourth quintile sits at 17.4%

and it goes down sharply from there.

I recall (perhaps incorrectly) that Steve linked to the CBO data when it was released. I'm curious why this hasn't been mentioned, is there a flaw I'm not seeing in using this data as a rebutal?

J

[em butler]

the avg Joe is being screwed since the SS surplus is being spent on armament and Soros is getting a free ride..

[JBL]

Nope. Not kidding at all. The wealthy currently close to retirement would not get reduced benefits. The cuts could easily be phased in over 30 years. And anyone with more than 30 years to invest should wind up better off investing at market rates.

I would be better off paying 6% in taxes and 6% into a 401(k) or IRA and receiving no benefits than I will be paying 12% in taxes and getting the piddly returns SS mandates. I'd take that trade any day.

Not everybody wins in the short term, but that's true of any proposal. Initially, if you eliminate the cap and cut the rate in half, people making over $180,000 or so will have higher taxes. The proposal also works if you roll the cap back rather than eliminate it so you don't hit those making over $500,000 too hard, but the more income you include the more you can cut the rate so just getting rid of the cap altogether may be the way to go.

Over time, as 401(k) and other savings build value, the pool of people qualifying for government subsidies will shrink and the tax rate can be lowered even further.

I will admit the whole idea does depend on using the surplus to lower the tax rate (and lower it evenly), which is why I am not optimistic about its political prospects. There are a lot of dumb ideas that are more likely to pass congress. But the numbers work.

[Dave]

"Specifically:

1. To incite resentment about the regressive social security tax, be sure to talk about tax percentages, not tax dollars;

BUT...

2. To incite resentment about income tax cuts, do the opposite: talk about tax dollars, not tax percentages. "

this is 100% true - and I dont get why either side lets the other get away with it in debates.