Arnold Kling  

Kotlikoff's Social Security Plan

Poverty and Social Pressure... Pension Guarantee Hazards...

Lawrence Kotlikoff has a long description in today's Boston Globe.

One way to make up for the loss in revenue from privatization as well as cover the existing revenue shortfall is dramatically but gradually to cut Social Security benefits. Such cuts are part of each of the commission's plans [referring to the Social Security reform commission of the first Bush term]. The commission's report uses artful language to hide this fact. But the proposed cuts are huge. The second plan, for example, indexes the initial receipt of retirement benefits to prices, rather than wages, as is currently the case. Over time, this means that Social Security benefits would replace an ever smaller share of workers' pre-tax wages. In the long run, Social Security would protect those in abject poverty, but that's it.

The three key elements of the Kotlikoff plan are:

Step 1 shuts down, at the margin, the retirement (Old Age Insurance, or OAI) portion of Social Security. Current retirees continue to receive their full retirement benefits, and current workers receive all the retirement benefits now owed to them, but that's it. There is no further accrual of Old Age benefits.

* Step 2 eliminates the employee FICA taxes (7.65 percentage points of the total 15.3 percentage point employer plus employee tax), directing these contributions to individual Personal Security accounts. The employer FICA contribution continues to finance Social Security disability, survivor, and Medicare benefits.

* Step 3 uses a roughly 10 percent federal retail sales tax to replace employee FICA taxes and pay off all accrued Old Age benefits. Over time, the sales tax rate falls as more and more of the accrued benefits are paid off.

One immediate concern I have is that the 10 percent retail sales tax would turn out to be permanent, rather than temporary. These political economy issues are difficult to manage.

For Discussion. One of Kotlikoff's concerns with ordinary privatization plans is that they transfer the cost of paying for today's retirees to workers in the distant future. Is the sales tax a useful mechanism for putting some of the cost onto current and near-term retirees?

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CATEGORIES: Social Security

COMMENTS (9 to date)
Tom writes:

Without getting into the merits of Kotlikoff's plan, I'd opt for a surtax on the income tax. The creation of a national sales tax would be costly (a new bureaucracy and more paperwork for businesses). An income-tax surtax could be implemented quite simply, by piggybacking on the existing tax system.

On the other hand...once implemented, a sales tax might eventually be substituted for the income tax. That would be a good thing.

Brett Peven writes:

Could not agree with you more. It's hard to imagine that less than 100 years ago there was no income tax at all, and now it is so onerous. There should be no doubt that bureacratic politicians will find a "good" use for the 10% federal sales tax once the social security system is made whole.

rvman writes:

Not only is the surcharge dangerous, it is an unnecessary complexity. There are people who would otherwise support this basic framework who will vote no because of the "federal sales tax" aspect, or will hold it up for exemptions for rents, housing sales, food sales, what-have-you. A surcharge income tax administered along the deduction set of the AMT would be much more progressive and easy to append to the bill. The surcharge could just go away the next time some Reagan/Kennedy comes along and streamlines the tax system.

Scott Schaefer writes:

While Professor Kotlikoff claims his plan "pulls no punches" and that his plan "entirely replaces a system that is broke ...", his plan does little more than "play with the details" -- it is built on the same fundamental flaws which have led to the current system.

It is well beyond the scope of this forum to engage in a truly serious debate on the current Social Security system, much less the relative merits/demerits of consumption vs. income vs. payroll taxes. In addition, I have not yet read the complete plan description. However, it is worthwhile to point out a few of the problems with the Professor's plan:

1) "The government [i.e. SOME TAXPAYERS] matches the PS contributions of low-income workers, making the new system as progressive as it wants. It also contributes on behalf of the disabled and unemployed". Which necessarily results in the new plan being constantly subjected to political pressures and perverse economic incentives.

2) "... having the government [i.e. SOME TAXPAYERS] guarantee that at retirement PS balances will equal at least the sums of past contributions adjusted for inflation". Which, in addition to making the method used to measure inflation subject to (additional) political pressure, creates another form of government "guarantee".

3) In direct contradiction to the assertion advanced in Step 6 that "the allocation of the portfolio is thus determined by the marketplace, not the government", Step 8 assures us that "the Social Security Trustees determine which foreign financial markets to include in the global index fund".

Thus, the plan continues the long-standing expansion of state control. Albeit wiht differing detatils, and wrapped in different terms, the plan is fundamentally a tax to coerce us to save our own money, decide what form that saving may take, and decide when we can withdraw it. It may well be that the plan is the "best" that can be enacted given current economic and political realities. However, it is another of a plethora of plans for reform.

A truly serious debate would begin with a root cause analysis of the the reasons why the current system is broke, and what prior mistakes must be avoided. A good starting point would be Professor John Attarian's study at

Lawrance George Lux writes:

The basic fault with Lawrence Kotlikoff's proposal lies in it's being an acceptable alternative to the current system, but it has long-term flaws. The Sales Tax aspect will reduce Consumer Demand, and never will be repealed if put in place. Seniors will restrict their Consumption, and no one remarks on the necessity to maintaining such Consumption for a wide range of Business Profits. Private Accounts, even Index Funds, will show only an arthmetic gain, as Winners and Losers balance out. The final note is health care costs will eat this plan. lgl

Robert writes:

Whatever we do to fix social security has to:
1. Slow the rate of growth of the Old Age benefit for existing retirees (no addressed)
2. Encourage people to work longer
3. Encourage wealth creation

The plan appears to ignore 1. If a consumption tax accomplishes 2&3, maybe. Maybe we can do the Fair Tax plan and eliminate social security and income taxes.

Jeff writes:

I have a question about the Social Security crisis. What are the assumptions that the crisis is based upon? Is there any way to find out what happens under different assumptions? It seems to me that as long as the US is an attractive place to work compared to other countries we could immigrate our way out of a crisis caused by uneven age distributions. So when the baby boomers retire we allow a certain number of people who are say age 20-30 to immigrate and get jobs.

It is unreasonable to suggest that when a large number of people retire the number of jobs will decrease by any substantial amount. I would suggest the number of jobs would hold steady and either wages will rise (decreased supply) or immigration will occur. Either trend would tend to offset the increased liability as a comparatively large segment of population retires.

Taylor writes:

We all know that once taxes are in place, they are very difficult to repeal. That's why in Macro economics we assume taxes constant. They're very sticky.

The best plan for social security reform I've seen is the answer from the Cato Institute's Michael Tanner: The 6.2 Percent Solution: A Plan for Reforming Social Security.

Also, I wrote an article on the subject of reform, which you can find here.

Buckaroo writes:

I think it is reasonable to explore VAT taxes to supplement OASDI and perhaps also Medicare expenses.

My personal preference is to cut payroll taxes and adjust the VAT tax rate to the level of benefits approved. There should be strict PAYGO rules requiring the trust funds to maintain certain levels, so any imbalance of benefits would become quickly apparent in the form of taxes. I wouldn't eliminate payroll taxes, but would phase them down by about half over about a ten year period, with the VAT phasing in over the same timeframe.

My preference to substitute VAT for a portion of payroll taxes is based on a few things. First, VAT taxes would broaden the tax base, so that the burdens of supporting an aging population would not need to be increasingly put on the shoulders of younger workers. Second, VAT and payroll taxes should have a similar (regressive) impact over a lifetime, roughly maintaining the linkage between taxes paid and benefits received. There would be some winners and losers among generations; this is one reason why any shift should be phased in gradually, so the transition is spread across demographic groups.

Third, I like the idea of a VAT tax over payroll taxes precisely because it would reward work (and domestic employment) and discourage consumption (and in particular, imports). This preference might be short-sighted, but we've got a twenty-five year track record of accelerating trade deficits and overconsumption, so it seems like the right direction to go at least for the short to medium term.

This is all independent of any shift to personal accounts or of means of truly separating the trust funds from general revenues.

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