Friday, August 07, 2009

To save Social Security, how much will taxes have to go up? 

"Saving" Social Security is a subject that blows very hot and then cold in politics. It's cold at the moment, eclipsed by all the argument over Obama's national health care plan. But you can bet it will blow hot again soon enough. When it does, you may want to have this data in your clipping file for reference.

How much will taxes have to go up to save Social Security? Andrew Biggs, former Deputy Commissioner for Policy at the Social Security Administration, writing at AEI tells us...
Social Security’s trustees say that to make the system “sustainably solvent” — which means, to put it on a path such that we won’t have to come back and reform the system again in the future — would require tax increases or benefit reductions equal to around 3.4 percent of taxable payroll. Raising the payroll tax by 3.4 percentage points —from 12.4 percent to 15.8 percent — would put Social Security back on a sustainable track....
True enough, but I find this figure "3.4 percent of taxable payroll" unsatisfying for a couple of reasons.

* First, the average voters I know have no idea what it means.

* Second, it counts the bonds in the Social Security trust fund as assets that help make Social Security "solvent." But whatever you think of the Trust Fund, there is no question at all that when those bonds in it are redeemed to help pay benefits, income taxes will have to go up to get the cash to redeem the bonds. That's in addition to the "3.4% of taxable payroll". So...

How much will taxes have to go up, including the cost of redeeming the bonds in the Trust Fund, to fund Social Security?

Happily, the Trustees of the Social Security Administration give us the ready answer in their Annual Report. This data chart shows by how many points of GDP promised Social Security benefits will exceed the 12.4% payroll tax that finances them in future years. This is the "financing gap" that has to be made up.

Between today and 2030, just 21 years from now, the cost of Social Security rises by 1.43 percentage points of GDP. (From payroll tax exceeding benefits by 0.13% of GDP this year to benefits exceeding payroll tax by 1.3% in 2030).

To see how much that is in terms of income taxes, we can look at tax data for 2007 (the last year in which it wasn't distorted by the recession) and see that personal and corporate income taxes combined then equaled 11.2% of GDP.

Since 1.43 divided by 11.2 equals 0.1277, we can estimate that an across-the-board income tax increase of 12.8% on both individuals and businesses will be needed to pay for Social Security 20 years from now. From that time on the cost of Social Security benefits pretty much stabilizes, so that ought to do it.

Perspective: Compared to other tax increases of the past, just how "big" and politically achievable is a 12.8% income tax increase worth 1.43% of GDP? Well ...

[] The 1983 tax increases that "saved" Social Security the first time it went broke -- and which traumatized the Washington political establishment sufficiently to paralyze it into inaction until the very last moment -- amounted to 0.24% of GDP, or only about 1/5th the size of the tax increase needed by 2030.

[] The 1993 Clinton tax increase -- which was able to pass the Democratic-controlled Senate only with vice-president Al Gore's tie breaking vote, after passing a Democratic-controlled House by only 218-216 (a single voter's difference) -- amounted to only 0.83% of GDP, and was 42% smaller than this tax increase needed by 2030.

So when people glibly tell you, "Oh, Social Security by itself isn't such a big deal, not a real problem", history tells us otherwise -- getting tax hikes through on this scale, even on much smaller than this scale, is a problem.

And, alas, of course at the same time even bigger tax increases will be arriving. The same chart tells us the cost of Medicare will increase by 2.23% of GDP, 56% more than Social Security's rise in cost. And Medicare's cost does not stabilize there, it keeps rising forever.

Combined, the revenue increase need for Social Security and Medicare is 3.66% of GDP, which equals about a 33% across-the-board income tax increase by 2030 -- 4.4 times larger than the increase Clinton managed to squeak through on a tie-breaker.

And I haven't mentioned the rising cost of Medicaid, or of unfunded federal and military pensions, or of .... but I digress.

For Social Security, now you know the answer and have the data sources to back it up.