Raising Payroll Taxes to Save Social Security will Cost the Average Worker $73,000
To resolve Social Security’s looming financial shortfalls, one of the primary ideas being promoted is to raise taxes. Such a proposal was recently outlined in a Fox Business commentary by financial planning and retirement specialist Gail Buckner, who asserts that a "small" increase in the payroll tax rate would cover Social Security's projected shortfalls for the next 75 years. However, a careful look at the plan's details show that the costs would be substantial, and even with these extra taxes, the program would still be fiscally unsound.
To summarize the plan and its political implications in Buckner's words:
I bet if you asked your friends and colleagues if they’d be willing to pay 1.3% more to shore up Social Security for the foreseeable future, the overwhelming response would be, "Is that all we need to do? I’m in!"
Of course, no politician will ever mention this. That would entail uttering the deadly phrase "raise taxes." (It would also make Social Security less useful as a means for scaring voters.) But, really, that’s what it would take: 1.3% more- if we act today. The longer we delay, the bigger the adjustment.
In reality, this proposal would cost workers far more than she suggests. Buckner arrives at her 1.3% figure by starting with the Social Security Administration's projection of a 2.67% long-term actuarial funding deficit. "In other words," she says, "if we raised the payroll tax rate by this amount today, we would solve the problem." She then slashes this figure of 2.67% in half because "employers and employees split" the payroll tax. However, that math is based upon a common misunderstanding about who bears the burden of taxes. As explained in the textbook Public Finance:
When we consider the burden of a tax, we must distinguish between the burden as it is specified in the tax law and the true economic burden. … Consider a simple example. The U.S. Social Security payroll tax requires that employers and employees split the tax, each paying one-half of the total. … But, the true economic incidence of the payroll tax is quite different. The employer has some ability to adjust the employee's wage and pass the employer's half of the tax on to the employee. In fact, the employee may bear the entire tax.
The Congressional Budget Office (CBO) concurs: "In the judgment of CBO and most economists, the employers' share of payroll taxes is passed on to employees in the form of lower wages." Likewise, the U.S. Government Accountability Office states: "While employees and employers pay equal amounts in social insurance taxes, economists generally agree that employees bear the entire burden of social insurance taxes in the form of reduced wages." Furthermore, self-employed workers must directly pay both the employee and employer taxes.
Thus, workers would bear the full 2.67% burden of the tax, not 1.3%. This may not sound like much at first glance, but this is a percentage point increase, not a percentage increase, meaning that the current Social Security payroll tax of 12.4% would increase by 2.67 percentage points or by 21%. And because this additional tax is levied every year, it would add up to significant money. For example, under this plan, average-wage earners now entering the workforce would forfeit an additional $73,458 of their salaries to payroll taxes over the course of a 45-year career. (This is measured in 2012 dollars. Without accounting for inflation, the figure is $150,323.)
Moreover, these additional taxes may not even come close to solving Social Security's fiscal problems. This is because the actuarial deficit of 2.67% is based upon the Social Security Administration's intermediate projections, which are highly tenuous. Although these projections "reflect the Trustees' best estimates of future experience," the Trustees emphasize that "significant uncertainty" surrounds these projections. More importantly, the track record of these projections offers cause for serious concern. For example:
• In 2010, the Social Security Administration projected that the program's trust fund would increase in real value through 2020. One year later in 2011, this projection was revised to 2018. One year after this, the projection was revised to 2012—or eight years earlier than estimated only two years prior. Hence, the trust fund in now projected to start declining in real value in 2013.
• The 2008 Trustees Report projected that Social Security would have $1.31 in income for every dollar it spent in 2011. The actual figure turned out to be $1.09.
• In 1977, President Carter signed a bill that increased Social Security payroll taxes and changed the formula governing benefit increases. At the signing ceremony, Carter said it "is never easy for a politically elected person to raise taxes," but these changes "will guarantee that from 1980 to the year 2030, the Social Security funds will be sound." As it turned out, the program's trust fund continued to deteriorate until 1983 when President Reagan signed a bill that further increased taxes, raised the retirement age, and made other changes to keep the program solvent.
Perhaps more significantly, a recent paper in the journal Demography found that the Social Security Administration is using an antiquated method to project life expectancies, and as a result, the program "may be in a considerably more precarious position than officially thought." For example, the study's findings indicate that by 2031, Social Security Administration projections understate the cost to keep the program solvent by an average of $553 per taxpayer per year (in 2012 dollars). And this accounts for only one of many uncertainties in the government's projections.
Hence, if politicians raise taxes to cover Social Security's projected shortfalls, the actual shortfalls might be much greater, requiring yet more tax increases. This has been the repeated history of the program. In fact, when the program began, the federal government sent a brochure to workers stating that "the most you will ever pay" to fund Social Security is an annual tax of 6% on your first $3,000 of earnings. Accounting for inflation, this is a maximum tax of $1,741 per person. Yet in 2013, the maximum Social Security payroll tax is $14,099 or eight times the promised maximum. This does not include other taxes that are also levied to fund Social Security.
Buckner says there is "plenty of time to act" to fix Social Security because the trust fund won’t become insolvent until 2033. In addition to the fact that this date is subject to a great deal of uncertainty, the longer we wait to address the problem, the higher the cost will be. For instance, if we wait until 2033 to fix the program's finances, the Social Security Administration projects that payroll taxes would need to increase by 32.8% to keep the program solvent, as opposed to 21% if we act now. This same principle applies to our national debt: the longer we fail to get it under control, the larger the problem becomes.
James D. Agresti is the president of Just Facts, a nonprofit institute dedicated to researching and publishing verifiable facts about public policy. He holds a Bachelor of Science in Mechanical Engineering from Brown University and has worked as a designer of jet aircraft engines, a technical sales professional, and chief engineer of a firm that customizes helicopters.