Some Thoughts on the Recent 'Payroll Tax' Increase

The two-percent increase in the Social Security tax rate that went into effect on January 1, 2013 has generated a great deal of discussion in the media.  Much of it, not surprisingly, is inaccurate, uninformed, and disingenuous.

The reporting and analysis of this issue has totally ignored the distinction between federal income taxes (taxes used to fund the federal government) and "payroll taxes" (Social Security and Medicare taxes used to fund these specific entitlement programs).  Certainly much of this misreporting by the media is due to a basic ignorance of basic taxation concepts, but I suspect that more than a little bit of it is an intentional blurring of the two tax structures in order to accelerate the effort to bring "payroll taxes" in line with the progressive nature of our current federal income taxation system.  

By way of background, the Social Security tax rate was 6.2% from 1990 through 2010, and, as has always been the case, taxes were assessed only on wages up to the Social Security taxable wage cap.  This taxable wage cap, which increases each year based upon a CPI-like calculation, was $51,300 in 1990, growing to $106,800 in 2010.  Under this structure, employee-paid Social Security taxes were capped at $6,622 in 2010.  Employers matched employee Social Security taxes dollar-for-dollar, as they have been required to do since the inception of the program. 

The Social Security tax cap mechanism is in place because, like Social Security taxes, Social Security retirement benefits are capped as well.  For example, a high-income individual like Warren Buffett paid roughly the same dollar amount of Social Security taxes as his secretary did in 2010 and will, upon retirement, receive roughly the same amount (in dollar terms) of Social Security retirement benefits that she does.  As such, at every income level, Social Security benefits (in dollar terms) are directly proportional to the amount of Social Security tax dollars paid into the system.  Liberals refer to this tax policy as "regressive" because individuals who made above $106,800 in 2010 paid a lower effective Social Security tax rate than those who earned below $106,800 (more on that topic later).  They never look at the capped nature of the benefits side of the Social Security equation.  Clearer thinkers recognize and appreciate this as a totally rational tax policy.

In late 2010, as part of the negotiations concerning the extension of the then-expiring "Bush tax cuts" (which related to federal income taxes), the employee-paid Social Security tax rate was temporarily reduced from 6.2% to 4.2% (employer-paid tax rates remained at 6.2%) in 2011.  The reduction was subsequently extended to 2012.  In 2013 this cut was eliminated, thus resulting in the recent 2% increase.

What was the rationale behind the 2% reduction in Social Security taxes in the first place?  As is now widely known, between 45% and 50% of wage-earners pay no federal income taxes.  As such, the 2% reduction in Social Security taxes in 2011 and 2012 was a way for liberals to enact a "federal tax" reduction for many of the individuals who pay no federal income taxes whatsoever and who pay only "payroll taxes." 

But what about the impact of the lower Social Security taxes on the long-term solvency of the Social Security system?  One little-reported fact associated with the 2% Social Security tax reduction in 2011 and 2012 is that the lower Social Security taxes paid by employees in those years will have no effect on the employees' future Social Security benefits.  Because there is no corresponding decrease in future benefits, the temporary Social Security tax reduction will certainly accelerate the insolvency of the system.

The folding in of Social Security tax rates into a negotiation regarding federal income tax rates represented a dangerous blurring of the two distinct taxing mechanisms -- a blurring that began in the late 1960s, when Lyndon Johnson made a change in the federal budget process by including Social Security and all other trust funds in a federal "unified budget."  This blurring of the two taxing systems is dangerous because it gives credence to the progressive position that the Social Security system should be funded much in the same manner that other federal programs are funded.  That is, via a taxing mechanism (the current federal income tax system) under which roughly 10% of taxpayers earn 48% of taxable income and fund 71% of federal income tax revenue (and where the bottom 50% pay only 3% of federal income taxes).  According to liberals, if the "rich" pay a higher percent of the defense, veterans' affairs, transportation, the judiciary system, and other federal budget line items, shouldn't they fund a higher percent of the federal retirement system?

Nowhere has this blurring of federal tax concepts been more strikingly demonstrated than in Warren Buffett's breathtakingly disingenuous New York Times Opinion Page piece, published in August 2011, in which he stated that his "federal tax rate" of 17.4% was less than half of the average rate of 36.0% paid by his office workers.  In making this claim, Buffett combined both federal income and payroll taxes into one "federal tax rate."  His analysis deceitfully relied on the optics generated when Social Security and Medicare taxes are looked at as a percentage of total income.  Despite the inherent fairness of the Social Security taxing mechanism (as demonstrated above),  Buffett's effective Social Security tax rate approached 0% in 2010 (of his $40-million 2010 total income) because of the taxable wage cap, while his secretary's rate (assuming that her wages fell below the Social Security wage cap) was 6.2%.

In order to exaggerate and maximize this claimed "federal tax rate differential," Buffett also included in his comparison employer-paid Social Security taxes (taxes that neither Buffett nor his secretary even pay!) to double the apparent "federal tax rate" differential generated by Social Security taxes to 12.4%.  This mirage explains roughly two thirds of the alleged "federal tax rate" differential Buffett claimed.  The rest of the differential can be explained by a similar reliance on the optics of effective Medicare tax rates and his omission of his share of the federal corporate taxes paid by the corporations in which he owns stock.  That Buffett's abject intellectual dishonesty regarding this issue was not exposed by the media (including conservative outlets like Fox News or the Wall Street Journal) is truly a mystery. 

In order to convert the current, rational Social Security taxing mechanism to a "progressive" taxing mechanism, liberals will attempt to (a) increase or eliminate the wage cap aspect of the Social Security taxing mechanism or (b) inject means-testing into the determination of Social Security retirement benefits.  Under these scenarios, higher-income taxpayers will either see their Social Security taxes dramatically increase (without a commensurate increase in retirement benefits) or be denied retirement benefits after being forced to contribute hundreds of thousands of dollars into the Social Security system over the course of their careers.  This will be sold as a way to keep Social Security solvent, but in reality it is a scheme to shift Social Security to a system whereby the tax burden will fall more and more on "wealthy" taxpayers (just like the funding of the federal government via federal income taxes).  The system will turn into yet another federal income redistribution scheme.  From each according to his means...     

I am not a big supporter of the Social Security (for many, many reasons).  But I do recognize the innate fairness of the taxing mechanism currently used to fund this flawed program.  Replacing its current rational tax mechanism with a progressive one will not solve the problem and will certainly accelerate our drift toward a European-style social welfare state.  If the long-term solvency of the system is what is desired, then the Social Security retirement age needs to be raised, and younger participants should be allowed to direct a portion of their contributions to privately directed funds beyond the reach of the federal government.    

The two-percent increase in the Social Security tax rate that went into effect on January 1, 2013 has generated a great deal of discussion in the media.  Much of it, not surprisingly, is inaccurate, uninformed, and disingenuous.

The reporting and analysis of this issue has totally ignored the distinction between federal income taxes (taxes used to fund the federal government) and "payroll taxes" (Social Security and Medicare taxes used to fund these specific entitlement programs).  Certainly much of this misreporting by the media is due to a basic ignorance of basic taxation concepts, but I suspect that more than a little bit of it is an intentional blurring of the two tax structures in order to accelerate the effort to bring "payroll taxes" in line with the progressive nature of our current federal income taxation system.  

By way of background, the Social Security tax rate was 6.2% from 1990 through 2010, and, as has always been the case, taxes were assessed only on wages up to the Social Security taxable wage cap.  This taxable wage cap, which increases each year based upon a CPI-like calculation, was $51,300 in 1990, growing to $106,800 in 2010.  Under this structure, employee-paid Social Security taxes were capped at $6,622 in 2010.  Employers matched employee Social Security taxes dollar-for-dollar, as they have been required to do since the inception of the program. 

The Social Security tax cap mechanism is in place because, like Social Security taxes, Social Security retirement benefits are capped as well.  For example, a high-income individual like Warren Buffett paid roughly the same dollar amount of Social Security taxes as his secretary did in 2010 and will, upon retirement, receive roughly the same amount (in dollar terms) of Social Security retirement benefits that she does.  As such, at every income level, Social Security benefits (in dollar terms) are directly proportional to the amount of Social Security tax dollars paid into the system.  Liberals refer to this tax policy as "regressive" because individuals who made above $106,800 in 2010 paid a lower effective Social Security tax rate than those who earned below $106,800 (more on that topic later).  They never look at the capped nature of the benefits side of the Social Security equation.  Clearer thinkers recognize and appreciate this as a totally rational tax policy.

In late 2010, as part of the negotiations concerning the extension of the then-expiring "Bush tax cuts" (which related to federal income taxes), the employee-paid Social Security tax rate was temporarily reduced from 6.2% to 4.2% (employer-paid tax rates remained at 6.2%) in 2011.  The reduction was subsequently extended to 2012.  In 2013 this cut was eliminated, thus resulting in the recent 2% increase.

What was the rationale behind the 2% reduction in Social Security taxes in the first place?  As is now widely known, between 45% and 50% of wage-earners pay no federal income taxes.  As such, the 2% reduction in Social Security taxes in 2011 and 2012 was a way for liberals to enact a "federal tax" reduction for many of the individuals who pay no federal income taxes whatsoever and who pay only "payroll taxes." 

But what about the impact of the lower Social Security taxes on the long-term solvency of the Social Security system?  One little-reported fact associated with the 2% Social Security tax reduction in 2011 and 2012 is that the lower Social Security taxes paid by employees in those years will have no effect on the employees' future Social Security benefits.  Because there is no corresponding decrease in future benefits, the temporary Social Security tax reduction will certainly accelerate the insolvency of the system.

The folding in of Social Security tax rates into a negotiation regarding federal income tax rates represented a dangerous blurring of the two distinct taxing mechanisms -- a blurring that began in the late 1960s, when Lyndon Johnson made a change in the federal budget process by including Social Security and all other trust funds in a federal "unified budget."  This blurring of the two taxing systems is dangerous because it gives credence to the progressive position that the Social Security system should be funded much in the same manner that other federal programs are funded.  That is, via a taxing mechanism (the current federal income tax system) under which roughly 10% of taxpayers earn 48% of taxable income and fund 71% of federal income tax revenue (and where the bottom 50% pay only 3% of federal income taxes).  According to liberals, if the "rich" pay a higher percent of the defense, veterans' affairs, transportation, the judiciary system, and other federal budget line items, shouldn't they fund a higher percent of the federal retirement system?

Nowhere has this blurring of federal tax concepts been more strikingly demonstrated than in Warren Buffett's breathtakingly disingenuous New York Times Opinion Page piece, published in August 2011, in which he stated that his "federal tax rate" of 17.4% was less than half of the average rate of 36.0% paid by his office workers.  In making this claim, Buffett combined both federal income and payroll taxes into one "federal tax rate."  His analysis deceitfully relied on the optics generated when Social Security and Medicare taxes are looked at as a percentage of total income.  Despite the inherent fairness of the Social Security taxing mechanism (as demonstrated above),  Buffett's effective Social Security tax rate approached 0% in 2010 (of his $40-million 2010 total income) because of the taxable wage cap, while his secretary's rate (assuming that her wages fell below the Social Security wage cap) was 6.2%.

In order to exaggerate and maximize this claimed "federal tax rate differential," Buffett also included in his comparison employer-paid Social Security taxes (taxes that neither Buffett nor his secretary even pay!) to double the apparent "federal tax rate" differential generated by Social Security taxes to 12.4%.  This mirage explains roughly two thirds of the alleged "federal tax rate" differential Buffett claimed.  The rest of the differential can be explained by a similar reliance on the optics of effective Medicare tax rates and his omission of his share of the federal corporate taxes paid by the corporations in which he owns stock.  That Buffett's abject intellectual dishonesty regarding this issue was not exposed by the media (including conservative outlets like Fox News or the Wall Street Journal) is truly a mystery. 

In order to convert the current, rational Social Security taxing mechanism to a "progressive" taxing mechanism, liberals will attempt to (a) increase or eliminate the wage cap aspect of the Social Security taxing mechanism or (b) inject means-testing into the determination of Social Security retirement benefits.  Under these scenarios, higher-income taxpayers will either see their Social Security taxes dramatically increase (without a commensurate increase in retirement benefits) or be denied retirement benefits after being forced to contribute hundreds of thousands of dollars into the Social Security system over the course of their careers.  This will be sold as a way to keep Social Security solvent, but in reality it is a scheme to shift Social Security to a system whereby the tax burden will fall more and more on "wealthy" taxpayers (just like the funding of the federal government via federal income taxes).  The system will turn into yet another federal income redistribution scheme.  From each according to his means...     

I am not a big supporter of the Social Security (for many, many reasons).  But I do recognize the innate fairness of the taxing mechanism currently used to fund this flawed program.  Replacing its current rational tax mechanism with a progressive one will not solve the problem and will certainly accelerate our drift toward a European-style social welfare state.  If the long-term solvency of the system is what is desired, then the Social Security retirement age needs to be raised, and younger participants should be allowed to direct a portion of their contributions to privately directed funds beyond the reach of the federal government.