The 2 Percent Solution

It is no surprise that President Obama’s fellow “progressives” were dismayed at his agreement to continue the Bush-era income tax rates for everyone, including high earners. But their reaction to his deal with Republicans on Social Security taxes is revealing.

The president was very pleased that Republicans agreed to reduce workers’ Social Security taxes by two percentage points next year. This break, which replaces the “Making Work Pay” credit that was part of Obama’s 2009 economic stimulus bill, is worth a lot more money to middle-income wage earners. Obama probably expected Democrats everywhere to be happy about this.

Some are, but others are not. Defenders of Social Security sense that this tax break could be an important step toward undoing Social Security’s retirement scheme, which amounts to taking money from today’s workers to pay yesterday’s. I think they are correct: The deal will make Social Security’s Ponzi-like funding mechanism crystal clear. Once they see what this means, today’s workers may not want to go back.

The math gets a little complicated. The Making Work Pay credit is a complete refund of Social Security taxes paid by the worker (but not by the employer); the credit is limited to $400 per year. That’s the amount of Social Security tax paid by a worker who earns a little less than $6,500 a year. Only workers who earn $75,000 or less get the full credit. Those who earn $95,000 or more get nothing. They pay full Social Security taxes, which amount to 6.2 percent on the first $106,800 of their income

The president’s agreement with Republicans is a better deal for anyone who earns more than $20,000 next year. The reduction of 2 percentage points in the Social Security tax will shave $400 in tax off that $20,000 of wages. But because the reduction is not limited, people who earn more, save more. Someone who earns $50,000 will save $1,000 in taxes next year. Workers who earn at least $106,800 will get the maximum savings of $2,136. Married couples in which each spouse earns the Social Security maximum can save up to $4,272.

This one-year tax holiday is one of the most expensive elements of the tax compromise, estimated to cost between $110 billion and $120 billion. One might have thought deficit-wary Republicans, many of whom have been sounding alarms about Social Security funding for years, would have been skittish. But the GOP has uttered nary a negative word about this aspect of the deal.

In contrast, Democrats and politically liberal allies are not happy – though I have not seen or heard much from Democrats who actually run for elected office. They, after all, would have to justify their opposition to the same middle-income wage earners whose struggles they so often chronicle.

Instead, the criticism has come mainly from the left-hand lane of the blogosphere, where commentators (including me, though I travel mostly in the slow lane) can say what’s on their minds without worrying too much about who gets upset.

Just hours after the tax cut compromise was announced, Jane Hamsher of the liberal blog firedoglake.com appeared on the PBS NewsHour broadcast, sounding the alarm.

“It is ridiculous that […] this idea is coming from the Democrats,” Hamsher told interviewer Gwen Ifill. “And anybody who gets Social Security or ever hopes to get Social Security should be very concerned that the Republicans are finally getting a foothold into it like this.”

Hamsher accused Republicans of wanting to “starve the beast” of Social Security by cutting off inflows to the program’s trust fund, even though benefit payments will continue. “Up until now, the trust fund has been solvent and has been able to pay out its own benefits.”

Yes, Social Security is solvent – if you consider IOUs from the deeply indebted U.S. Treasury to be spendable assets, and if you define solvency as being able to scrape together the cash to pay the bills every month.

But that’s not how actuaries, or anyone else who can walk through a balance sheet without getting lost, define solvency.

If Social Security were solvent, next year’s reduction in tax revenue would have no effect on the security of current retirees’ benefits. At most, the program would have to make an offsetting cut in future benefits to today’s workers. People who saved taxes next year would see a minor reduction in their own promised benefits down the line. There is no such benefit reduction in the compromise plan, however. As always, Social Security promises benefits that it does not collect the money to pay.

Sooner or later, this shell game, like all pay-as-you-go promises, will come to a sad end. The 2011 payroll tax holiday will lay bare the trade-off for workers. Because they are paying less next year, the government will have to go out and borrow more money to pay Social Security benefits next year – not many years down the line. The program lives from hand to mouth. We are not funding our own retirements; we are paying for our parents, while we leave our children to pay for us.

Those struggling middle-income workers are not struggling despite Social Security. They are struggling, in significant part, because of it. A couple with a combined $100,000 in wages sacrifices $6,200 – plus another $6,200 paid by their employers – to provide pension checks to retired workers right now. On top of that, there is another $2,900 in combined Medicare taxes, to provide health insurance to those retirees. Meanwhile, the current workers may not be able to save for their own retirement, and may not be able to afford health insurance. (We can leave a review of the health care overhaul for another day.)

Of course, we cannot just pull the rug out from under today’s retirees, or people who are close to retirement. It’s too disruptive and unfair. Any changes to Social Security will have to be gradual, with a lot of lead time. But they also will have to be substantial. The program, as designed, is unsalvageable. It always was. It is just a matter of time before economic reality catches up with it.

Next year’s tax holiday is a nod toward economic reality. For Social Security advocates, that’s a deeply disturbing prospect.

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