Should Congress Raise the Payroll Tax When the Economy Recovers?

Dean Baker has just written another piece on Social Security. Dean and I have always disagreed at some fundamental level on the best way to run opposition against those that are committed to weakening and ultimately destroying this vital program. Thus, while Dean and the MMTers are on the same philosophical team (we all want to preserve the program), we run our offence using very different strategical play books.

When it comes to Social Security, MMTers have taken many pages out of Robert Eisner’s play book. To my mind, no economist has been a more honest and forceful defender of the program. (Eisner was Professor Emeritus at Northwestern University and one of Bill Clinton’s friends and former teachers. He passed away in 2010.)  In my favourite piece on the subject, Eisner said:

The notion that Social Security faces bankruptcy begins with a fundamental misconception, that payment of benefits somehow depends upon the OASDI (Old Age and Survivors and Disability Insurance) trust funds. The trust funds are merely accounting entities….

…Our payroll taxes or “contributions” go directly to the United States Treasury. Our benefit checks come from the Treasury-and those receiving them can verify on those checks that the payer is the Treasury of the United States, and not any trust fund. Social Security payments are an obligation under law of the U.S. government. Our government and its Treasury will not,indeed cannot, go bankrupt. As Federal Reserve Chairman Alan Greenspan has recently put it, “[A] government cannot become insolvent with respect to obligations in its own currency.”

Baker’s latest piece is interesting because it shows that he has at least one foot in the Eisner door. He says:

While there is nothing in prin­ci­ple wrong with fi­nanc­ing So­cial Se­cu­rity in part out of gen­eral rev­enue for two or three years in the mid­dle of a se­vere eco­nomic down­turn, the ques­tion is what will hap­pen when the economy recovers enough that we no longer need this tax cut as stim­u­lus. In prin­ci­ple the tax should sim­ply re­vert to its nor­mal level.

When the economy recovers, Baker is worried that Congress will lack the political will to raise payroll tax rates, leaving the program vulnerable. He says:

If the Social Security tax were not re­stored to its for­mer level, then we could in prin­ci­ple con­tinue to make up the dif­fer­ence from gen­eral rev­enue. How­ever, there cer­tainly is no agree­ment that this will be done. Since its in­cep­tion, So­cial Se­cu­rity has been fi­nanced from the des­ig­nated pay­roll tax. This tax has been used to sus­tain the trust fund, which is in prin­ci­ple sep­a­rate from the rest of the bud­get.

Okay, there is a bit of MMT in here — the government could always make up the difference from general revenue — but the rest of the argument breaks sharply from Eisner, who explained that the perceived funding of Social Security through a dedicated payroll tax is nothing more than a useful myth.

Baker accepts that myth, arguing that as long as Congress has the guts to return the payroll tax to its original rate after the recovery takes hold, then the Trust Fund “would be suf­fi­cient to keep the pro­gram fully funded through the year 2038 and more than 80 per­cent funded through the rest of the century.”

To ensure that this happens, Baker proposes:

[A] very sim­ple way around this po­ten­tial prob­lem. If we want to give a tax cut to work­ers equal to 3.1 per­cent of wages, as Pres­i­dent Obama has pro­posed, along with a sim­i­lar cut to some em­ploy­ers, we can just write that into the law with­out any ref­er­ence to So­cial Se­cu­rity.

In other words, the tax cut would take the form of a tax credit that is paid out to work­ers and firms in ex­actly the amounts that Pres­i­dent Obama pro­posed. How­ever this credit would have no con­nec­tion what­so­ever to the So­cial Se­cu­rity tax, which con­tin­ues to get col­lected at its nor­mal rate.

MMTers would argue against this. Indeed, we have argued in favour of a more generous payroll tax cut — i.e. reducing FICA withholdings to zero for employees and the employers — and we would prefer to keep it that way so that the entire program is overtly, and permanently, funded out of general revenue.  Baker has vehemently opposed our policy recommendation, arguing that it would make the program vulnerable to attack if it lacked a dedicated source of funding.  So Baker wants to make sure the Trust Fund is “there” in order to protect Social Security from attack.

Here’s how Eisner dealt with the same problem:

Expenditures alleged to be related to trust funds are often less than their income-witness the highway and airport  funds as well Social Security. There is no particular  reason they cannot be more. The accountants can just as well declare the bottom line of the funds’ accounts negative as positive – and the Treasury can go on making whatever outlays are prescribed by law. The Treasury  can pay out all that Social Security provides while the accountants declare the funds more and more in the red.

For those concerned, nevertheless, about the “solvency” of the trust funds, there are simple, painless remedies for this accounting problem….why not award balances in the Trust Funds, instead of the current 5.9 percent interest rate on long-term government bonds, [a] higher return… [for] it was not God but Congress and the Treasury that determined the interest rate to be credited on the non-negotiable Treasury notes of the fund balances.”

So Congress could simply agree to credit the Trust Funds at 10, 25, 40, 100, or 500 percent, making the entire “problem” go away. At 100 percent interest, even the most pessimistic CBO official would have to give the fund a clean bill of health, and future retirees could get 100 percent of the benefits they have been promised.

Which solution should progressives advocate?  Baker’s tit-for-tat replacement tax that promises to preserve Social Security in its current state — able to pay just 80 percent of promised benefits to future retirees?  Eisner’s tongue-in-cheek remedy that artificially pumps up the size of the Trust Fund to astronomical proportions in order to placate the accountants?  Or the MMT solution that advocates a straightforward payment of promised benefits to all future retirees?

About Stephanie Kelton 24 Articles

Affiliation: University of Missouri

Stephanie Kelton, Ph.D. is Associate Professor of Economics at the University of Missouri-Kansas City, Research Scholar at The Levy Economics Institute and Director of Graduate Student Research at the Center for Full Employment and Price Stability.

Her research expertise is in: Federal Reserve operations, fiscal policy, social security, health care, international finance and employment policy.

Visit: Economic Perspectives

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