There seems to be a lot of talk coming from the candidates lately about changing the payroll tax. In my first (maybe second) diary here at dKos, I wrote something about how I would like to see it drastically cut (if not entirely eliminated). However, changes in the payroll tax bring up some very important questions of what the payroll tax and Social Security really are.
Is the payroll tax really a tax or a fee? Is Social Security a retirement program or a welfare program?
These are both vital questions to answer before work can be done on reforming a system that will bankrupt the government is nothing is done about it. If you have any questions about the social and economic harm ignoring the Baby Boomer Bomb (when all the Baby Boomers retire), just look to Europe. We are still ten years away the real pinch starting, yet they are already having demostrations against cutting pension benefits.
Some history
In 1935 the Social Security Act was passed in the Great Depression era problems. It originally only covered a subset of workers and wasn't intended for everybody. FDR referred to it as a pension in front of Congress when first talking about it. Two years later, in 1937, the Federal Insurance Contribution Act was passed creating a 2% payroll tax (on something like the first $450 of 1937 wages) and expanding Social Security to now cover dependants and survivors. Later, it was expaneded to cover even more workers and added Disability Insurance to the pile. Since then the number of people it covers has grown to 95% of workforce and benefits have been expanded multiple times. Oh, yeah, and the tax rate has gone a tiny bit to 15.3%.
Oh, it was never menar to be "means tested" either, meaning that everybody pays in and gets (mostly) the same benefits paid out.
What is the payroll tax?
The payroll tax is actually a collection of taxes. The largest is the FICA tax that is used to pay for Social Security but it also include a Medicare tax. The FICA tax is 12.4% and applies to the first $87,000 of income (this adjusted every year for inflation) and the Medicare tax is 2.9% applying to all income. There are a couple of other smaller taxes, like the FUTA tax (created originally as a temporary surtax to replenish unemployment funds, but since then extended multiple times).
Of that 12.4% and 2.9%, half is officially paid for by the employer and half by the employee, so people when they look at their pay stubs only see 6.2% and 1.45% deducted. It's a myth. An accounting trick to hide the true cost of the tax. An employer will hire somebody if his total marginal benefit is greater than his total marginal cost, including wages and taxes and benefits. Saying that the employer pays for half of your payroll tax is like saying that they pay for your income tax.
To make this abundantly clear just look to how the payroll tax is actually paid. It isn't even separated from the income tax withholdings. The employer makes a single bulk payment to the government, making no distinction between income and payroll taxes and the government makes an estimate on how much is income and how much is payroll tax. After tax returns are filed, that estimate is refined. See, no difference.
Where does the money go, and how is it paid out? It always goes to and comes from the general fund.
Out of the yearly incoming funds, first transfer payments are made to those receiving benefits, and then the surplus is traded in for special Treasury bonds. That means there is no real Social Security surplus. Those funds exchanged for bonds are used for other expenditures. In a little more than 10 years, the OASI (Old-Age Survivors Insurance) trust will be running negative, meaning that its payouts will finally be larger than its intake. However, there isn't really anything sitting there to make payments with. Those outflows will have to come from the general fund, meaning taxes or bonds sold to the public. There is no real trust fund. Money never even really exchages hands within the government that I know of. It is it all accounting only: the treasury received tax payment from business, payments are made to benefit receivers, the amount left is then credited to the OASI trust in the form of bonds.
The problem comes in about 10-15 years. At that point, the OASI trust will be taking in less than is pays out. Those payments will have to come from the general fund since there is no lockbox of cash or surplus sitting there.
How are benefits calculated, and what are the implications of changing the tax rate?
In keeping with the pension idea, benefits are calculated based on the amount paid in (well, based on your salary taking into account the cap on the FICA tax). The Old Age part of the program is supposed to give back about 50% of your wage. Things are tipped to make the payment slightly progressive, where those earning less will receive a little more than 50% of their wage and those earning more will receive a little worse return, but in nominal dollars it still is the more you put in the more you get out.
To see how Social Security is treated more as a pension than an insurance policy, just look at the retirement age adjustments. If somebody retires at 65, they receive full benefits, but people can also retire later and receive larger benefits based on the idea that they contributed more (and there is also reduced benefits for early retirement too).
The benefit scales were calculated based around giving out a certain benefit level based on the taxable amount paid in. As the FICA tax rose and the tax base was pushed higher, benefits were adjusted upward too.
Enough background. What does it mean for that changes?
Well, if you eliminate the wage ceiling to which the FICA tax applies, then how do you adjust the benefits paid out? According to the pension philosphy, benefits would have to rise too, but that kind of defeats the purpose. Or you have to change the philosophy and start calling Social Security a welfare program and means test it. Or if you lower the sociual security tax rate, since you pay in less, then shouldn't you also get less out? (Well, there are many people that actually get less out than they put in already, and some of these people aren't even rich.)
As a way around the means testing argument and ways to make the payroll tax more progressive instead of flat, things like the Earned Income Tax Credit (EITC) have been created. While mostly applying to those with kids, it provides a way to refund some of the payroll tax without having to touch the payroll tax.
Also, Social Security payments are now taxed. This I find to be extremely silly. (I think its only 85% are taxed.) Now when you get a payment, some younger person is paying into the fund, the cash goes to the government, then to you, then turned around right back to the governemnt in taxes. Is it just me or does anybody else find all this kind of dumb? Well, I know it's not just me, as many others have written about the absolute craziness of all this.
There has been things written on what would happen if the ceiling was removed, so the FICA tax applied to all income (and they usually don't paint a good picture as slapping a 15% tax on any segment of society would be massive), but I should ask some people that I work with and know more about this issue than me if there is anything written on killing of ceiling along with a reduction in the rate that combined would be revenue neutral. I'm sure somebody out there has put it through their models.
Benefits of lowering the payroll tax
The last thing I read placed a 1 percentage point reduction in the payroll tax as creating like 400,000 jobs and boosting GDP growth by 0.2 percentage points (a couple people I know thing that for larger payroll tax cuts, this is far too conservative an estimate, like a 10 point cut of the payroll tax to 5% would be at least 3 more points of GDP growth in the next year).
These numbers were with keeping the current ceiling. With the revenue neutral cuts, it probable wouldn't show up in GDP, but would more likely show up in capital and income distribution.
(Oh year, a disclaimed. Social Security is a complex subject and not my thing, but I do work with others who know this stuff much better than me, so don't take everything I say as correct, but I think it is.)
(After rereaging this quickly, it sounds terrible. Oh well. Not time to fix it.)