Eliminating the payroll tax
February 2, 2016
In an April 16, 2015 essay, I suggested eliminating the special tax treatment of capital gains and dividends as a way to reduce the income gap between rich and poor. Along with that, I recommended eliminating the corporate income tax. Another way to reduce the gap is to eliminate the Social Security tax and start funding the Social Security payments from the income tax.
Currently, Social Security is funded by a tax on wages. 7.65% is paid by the employee and 7.65% by the employer. (Actually, 6.20% of that 7.65% is for Social Security and 1.45% is for Medicare.) Eliminating this tax and funding Social Security from the income tax would dramatically shift the burden to the rich, who then would have to pay on all of their income rather than just wages up to the limit of $118,500. Low income families whose only income is from wages and who now pay little or no income tax would, in effect, get a 7.65% increase in take-home pay.
The current system forces poor, often young, families to give up 7.65% of their wages for a benefit they won't get until age 66 or later. This doesn't make sense at a time when they are struggling to feed, house and educate themselves. The poverty line for a family of 4 is $24,250, yet with those earnings, $1,855 would be taken out for Social Security. It should not be our policy to tax people into poverty. It would be better to wait until those young families are a little more secure and can afford to put something aside. That is what funding from the income tax would do: let them off the hook when they are just scraping by and come after them when they are doing a little better.
I won't attempt to estimate how much the shift would increase the income tax rate. The tax base for funding Social Security would no longer include the wages of those with low incomes, but it would expand to include wages in excess of $118,500 a year and all other income types previously excluded: capital gains, dividends, rent and interest.
This would mean that Social Security benefits could no longer be based on earnings. Everybody would get the same amount, although that amount could vary with the age at which benefits are started (as it does now). It would be more like a guaranteed income than an earned benefit. We'd have to come up with a fair transition from the old system to the new.
Considerable cost savings would occur when the government no longer has to keep that huge data base of earnings information it needs to calculate benefit amount. Having to consider age as the only eligibility requirement would further reduce administrative costs.
Employers would see savings from not having to administer payroll deductions for Social Security and periodic remittances to the SSA.
Employers would also see a 7.65% reduction in cost per employee - their share of the Social Security tax. Of course, their income tax would go up to fund the new system, but firms with little or no profit would get some relief. Even if an employer's income tax increase exceeds his savings from not having to pay the Social Security tax, its cost per employee would be 7.65% less, which should enable it to hire more of them, reducing unemployment.
A single safety net for the aged
Along with ending the payroll tax and shifting Social Security funding to the income tax, I would raise the benefit high enough that all other government programs aimed at providing income security for retirees could be eliminated. I don't know how high that would be, but it should be well above the poverty level and more than the current average $1,295 a month Social Security benefit. Adequate, not generous. Anything beyond that would be the individual's responsibility.
Ending all other retiree income security programs would mean that contributions to your retirement plan by you and your employer would no longer be tax free, making such plans pointless. There would be no more IRAs (individual retirement accounts), traditional or Roth. And there would be no Keogh plans for business owners. Eliminating these "tax expenditures" would simplify the tax code and increase federal tax revenues by $161.6 billion in 2016:
The above figures are from page 42 of "Estimates Of Federal Tax Expenditures For Fiscal Years 2014-2018," a publication of the U.S. Congress' Joint Committee on Taxation.
Defined benefit disaster
The killing off of defined benefit pension plans should have occurred decades ago. They've turned out to be a budgetary disaster for state and local governments. The city of Lansing has to set aside $5,831,197 this year to fund pension costs for current and future City retirees ("normal cost") plus $14,601,327 as a payment on the $238,968,679 arrearage, or "unfunded accrued pension liability."
These figures for Lansing come from the latest actuarial valuation reports. The city has 2 retirement systems, one for police and firefighters (P&F) and one for other employees (ERS). The P&F actuary report is here and the ERS report is here. Except for the totals - which I calculated - the figures come from page 12 of each report:
(Note: The above figures are for pensions only. There also is a shortfall in funding for other post-employment benefits (OPEB) - mainly, retiree health care. Those amounts are $341.7 for P&F and $210.8 for ERS. The figures come from actuarial valuation reports done for each system - P&F and ERS - in February 2015 based on information provided by the City as of December 31, 2013. The figures may be found in the Executive Summary on page 1 of each report. Recent contract changes will likely reduce those amounts.)
Some of Lansing's neighbors aren't doing so hot at funding pensions, either. The following municipalities are members of the Municipal Employees' Retirement System (MERS). Their total liability, value of assets and percent funded can be obtained from Appendix B of the MERS Actuarial Valuation Report for 2014. I calculated unfunded actuarial accrued liability by subtracting total liability from value of assets.
At the state level, the Judges Retirement System is in good shape, but the others are not. Yes, the Public School Employees Retirement System is underfunded by over $26 billion. The figures come from the Comprehensive Annual Financial Reports for 2015:
Send comments, questions and tips to firstname.lastname@example.org. If you'd like to be notified by email when I post a new story, let me know.