The American Interest
The Middle East & Beyond
Published on January 30, 2013
Why Your Taxes Just Went up after the Obama Administration Said They Wouldn’t

Last week I erred by identifying the now-rescinded FICA tax cut from 6.2 percent to 4.2 percent as part of the Bush-era tax cuts; it wasn’t. A reader pointed out that this was a 2010 Obama Administration decision, part of the broader stimulus program.  I had forgotten that. Everything else I said about it stands, but while we’re on the topic of this tax, we might as well use the opportunity to elucidate the matter.

The reduction of the FICA tax was always meant to be temporary, but then again so were the Bush-era cuts. Most people, I guess, are assuming that the Administration decided to end the 2 percent reduction because of concern over the balance in the Social Security trust fund. Not that any senior or semi-senior Administration spokesman has bothered to discuss the matter so that we little citizens out here can get an idea what they’re doing.  Since this decision has not been much discussed in public, let alone justified, this is why, after being promised in late December that their taxes would not go up if they were bellow the $450,000 family income ceiling, a lot of people felt they had been lied to when in fact their taxes did go up.

So we don’t know—I don’t know, anyway—why the Administration jerked up the FICA tax 2 percent, but it almost certainly was not over concern about the Social Security trust fun in any simple way. This is where things get interesting.

Some weeks ago an old acquaintance pointed out that there was something strange about the discussion over the deficit and the so-called fiscal cliff. Why, he asked, should politicians be making equilibrations between entitlements, again so-called, like Medicare, Medicaid and Social Security when these programs all have separate revenue streams apart from the general Federal budget that pays for discretionary spending?  If these programs have separate revenue streams from the general budget, then what sense is there in talking about the sequestration of social spending and military spending, because the discretionary revenue pool has nothing to do with paying for Medicare, Medicaid and Social Security, right?

I thought this was a good question. I, at least, did not have a ready and persuasive answer to it. So I asked around of people who have been in this business for their day job. What I learned was interesting enough to be worth sharing.

First of all, yes, there are separate revenue streams, and there are supposed to be separate revenue pots of money, to cover Medicare, Medicaid and Social Security. Technically, there are; in reality, it’s all one big pot. The taxes that are supposed to pay for Medicare and Medicaid collect only a fraction of what those programs cost, and that fraction has gotten ever smaller over the years as these programs have become more expensive for a variety of reasons, some of them demographic and others politico-bureaucratic.

Social Security is a little different, but not much. Of course there is supposed to be a special trust fund into which contributions go, and yes, as everyone knows, those who work and pay into the fund at any given time are really paying for those elders who are retired. These workers in turn will be paid back their contributions in retirement by subsequent generations of workers. If this sounds like a Ponzi scheme, that’s because it is. But there’s nothing wrong with a Ponzi scheme if everyone recognizes it as such, and if it is not voluntary, so that risk is shared completely. It’s okay, that is, as long as demographic realities support the scheme. Some observers have been pointing out now for more than twenty years that demographic change has put the Social Security trust fund balance in jeopardy. (I’m not exaggerating when I say that we have been warned now for at least twenty years about this—just look up Pete Peterson, who was briefly Secretary of Commerce during the Nixon Administration, and you’ll see.) This makes it all the more amazing that our political class has failed repeatedly to heed these warnings and do anything to avoid the train wreck. I am also told, by the way, that the train wreck is actually here now: The Social Security trust fund is technically now in deficit.

I never understood until recently why our political class was so blasé about dealing with this problem. Now I get it: In reality, as opposed to law, there is no Social Security trust fund. And there is a good reason for that.

After the end of the Depression and World War II, money began to pile up in the Social Security trust fund as the U.S. economy got back on its feet and began to thrive. As it was explained to me, this put U.S. Treasury officials in a bind. They could do two things with all this money. First, they could just let it sit there, but that would be a tremendous and irresponsible waste of capital, capital needed at a time when we were trying to build and broaden the American middle class through the G.I. Bill, the expansion of S&L activity, and a variety of other programs. Second, the Treasury could either invest the money in financial instruments or it could acquire real estate, corporate stocks and other forms of somewhat less liquid equity. A few people thought this was a good idea, but cooler heads prevailed. The prospect that the government might own significant parts of the economy, even if only in theoretical trust for its retired citizens, raised all sorts of philosophical and practical warning flags, in particular the potential for corruption and insider dealing of several kinds.

Since it made no good sense either to sit on this money or to buy things with it, a decision gradually sort of made itself to merge the money “in effect” with the general revenue pot. You have probably heard accusations that from time to time the Congress has “raided” the Social Security trust fund. It has, but it has more or less done so by mutual agreement. These “raiding” accusations tend to come from partisan quarters, or from those who do not like the purposes to which the money has been put. The “one big pot” approach has become common practice in both Republican and Democratic administrations over many years. And that, in turn, is mainly why our political class has not gotten all that exercised about the demographic-induced imbalance in the trust fund that is now upon us because of the aging of the Baby Boom generation. The basic idea is that, hey, if we, the Congress, took money out of the trust fund when that made sense, we can stick money back in it if we have to when that makes sense. The cash shovel works in both directions, so no big deal, really.

Well, the quiet confidence that has reposed in this surety has not worked out so hot, because when it comes time to stick a substantial amount of money back in—and that will be necessary—it’s not at all clear where that money will come from. There are only four places it can come from. That money can be created anew, “printed”, as we still say, even though “quantitative easing” uses electrons instead of ink these days. It can be borrowed.  It can be acquired through higher taxes. Or it can be acquired at the same or lower tax rates if the economy grows robustly. Those four options, or some combination of them, are the only ways to do this.

Obviously, the fourth option is the best one, and in the end it may be our salvation––as, in the past, with little to no thanks due the government for private-sector vivacity. The first option risks inflation. The second option risks deeper and more dangerous deficits, and by disproportionately rewarding those who make money off money it exacerbates rising inequality. The third option risks recession, and is politically very difficult at the present. So this is the dilemma.

As far as Social Security is concerned, this is very frustrating because there are at least three sensible ways to rebalance the system if we really felt like it, which is another way of saying, “had the political will to do it.”

We could go back to the original concept of Social Security as insurance for old age, which means that we would means-test payments. Right now those retired people who have skezads of money still get their full benefits, even though they don’t really need them. My father-in-law happens to be one such retiree, and he has said to me many times that it’s ridiculous to pay rich people insurance money they don’t need when so many other needs go unfulfilled. He’s right. But we have distorted the original understanding of the program from an insurance pool to a kind of untouchable phantom bank account that people have. I don’t know how or when this happened, but it was a mistake to let it happen.

Alternatively, and easier to do politically, we could simply raise the cap on the Social Security tax. As things stand now, there’s a maximum amount that any individual has to pay into the pot. I see the effect every year when in November and December my take-home pay goes up because I’ve hit the ceiling. We could either eliminate the ceiling altogether, and tax all income, or we could raise the ceiling enough to make the program solvent over time. Either way the increase would be a progressive one. The latter option, though the less progressive of the two, would be probably easier to do politically. And it would solve the problem because numbers, as opposed to statisticians and accountants, don’t lie.

Yet another alternative, often discussed, is raising the retirement age. When Social Security was initiated, life expectancies were much lower. No one in 1933 or 1935 could have imagined so many people living so many years past age 65. In many policy wonk circles this seems to be the most popular option, but there are at least two problems with it.

The first problem is how do you do this without reneging on de facto if not explicit promises made—in other words, how many age cohorts get grandfathered under the present system and how many younger cohorts don’t? How do you explain to people just on the wrong side of the new phased-in threshold that they’re shit out of luck? And what politicians want to be the ones doing the explaining?

The other reason this may not be such a great idea is that if we extend the retirement age, lots more older people working longer will clog up the entry channels for younger workers. Ordinarily that would not be such a big deal, but we live in a time when globalization and automation are making job generation problematical, especially jobs that sustain a middle-class living standard.

In any event, some combination of these three ways to ensure the solvency other Social Security trust would definitely work. Everyone in Congress who has looked at the problem over the past twenty years understands this, and so do their staffs; so do the thousands of academics and serious journalists who have studied the problem. And because we’ve done nothing to address this problem, not to speak of so many others, everyone’s taxes went up (at least) 2 percent in 2013 after being told they wouldn’t. Go figure.

  • Jim.

    Cutting FICA without trimming Social Security benefits was always a bad idea, frankly.

    “I don’t know how or when this happened, but it was a mistake to let it happen.”

    It happened because it makes Social Security an act of national egalitarian solidarity — “No matter who you are, if you pay in, you get the same thing out, just like everyone else.” It might not have passed, otherwise, as a straight income redistribution program.

    That was an easy one. Ask us a tough one.

    By the way, if your father-in-law thinks it’s not fair that he’s paid Social Security, there’s absolutely nothing stopping him from giving that money to whatever charity he deems the most worthy.

    “how many age cohorts get grandfathered under the present system and how many younger cohorts don’t?”

    The only fair way to go? Don’t grandfather anyone in. People have known this was going to happen for decades, as you said — I defy you to come up with a definition of the word “fair” that covers Boomers keeping their own retirements sacred while the rest of us get screwed.

    We younger folks have time to prepare, you say? So we get to make cuts to our family budgets, perhaps even cut kids out of the picture (a bit of irony there, no?) while the Boomers could spend it on themselves (with Roe v. Wade becoming policy, my own birth cohort is well under 2.1). Then after we cut back, we have a smaller portion to look forward to when we retire?

    I’m waiting to hear how this is “fair”. I suspect I’ll be waiting long after the Boomers and all their good intentions have turned to dust and ash.

    “How do you explain to people just on the wrong side of the new phased-in threshold that they’re shit out of luck? And what politicians want to be the ones doing the explaining?”

    Actually, this is what Paul Ryan did when he said, “Anyone who’s 55 or older you can stop listening right now.” Ryan is the bravest person who understands budget math, and even he’s too much of a coward to take on the self-indulgent Boomers.

    —–

    All in all, good work with this one — now that you’ve prepared the ground, do an analysis of Medicare.

    • Adam Garfinkle

      You are mistaken that the Social Security program started out as a egalitarian redistribution program, and that it would not have passed otherwise. In the first FDR Administration the President could have done anything the Supreme Court did not find unconstitutional. The American social contract as understood at the time did not include egalitarian redistribution as a principle. The (mis)understanding of the program that exists today developed later, along with a great wash of mostly mindless, undifferentiated egalitarianism in other realms of American social life. Not to see that is to misunderstand the past half century and more of American social history.