David R. Henderson  

The Interesting Political Economy of the Social Security Tax Cut

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My Hoover colleague Paul Gregory has an interesting op/ed on how things would look if the media treated Republican congressmen the way they treat Democrats. He takes a New York Times story and rewrites it the way people who oppose the extension of unemployment benefits and of the payroll tax cut would like it to be reported. His piece is worth reading.

It got me thinking more about something I had been wondering about: the interesting political economy of the recent bill. Recall that most Republicans were hesitant to renew the cut in the employee's portion of the Social Security tax and the extension of unemployment benefits to 99 weeks, the latter of which I called, on John Stossel's show, "positively French." Most Democrats were on the other side.

Start with the extension of unemployment benefits. What is one of Barack Obama's major problems right now, a problem that will make it harder for him to be re-elected? The high unemployment rate. What is one of the contributors to the high unemployment rate? Extended unemployment benefits. It's true that many Keynesians believe extending the benefits would increase aggregate demand. But even they have to admit the negative incentive effect of paying people to be unemployed. I guess they believe that the first effect outweighs the second. I don't. Of course, if you agree with these Keynesians, you won't find this interesting.

So if the disincentive effect outweighs the aggregate demand effect, the net result of a program that Obama strongly supports is a higher unemployment rate that would make it harder for Obama to be re-elected.

Now to the Social Security tax cut. In his rewritten news story, Gregory writes:

Economists warn that the extension of a temporary payroll tax cut threatens Social Security and saps strength from a fragile recovery. Republicans, intimidated by populist attacks from the Democrat left, agreed on Friday to the extension by voice vote in Congress.

The tax cut extension means that the social security trust fund will receive $159 billion less in 2011, causing it to run a deficit for a second straight year. The Social Security trust fund deficit will be paid from the general fund of the Treasury. "This pretty much ends the claim that Social Security is self-financing or that it doesn't contribute to the budget deficit," says Andrew Biggs, a resident scholar at the non-partisan American Enterprise Institute and a former deputy commissioner of the Social Security Administration.


Why is this interesting? When I talk about Social Security with people over age 60, many of them believe that there's a trust fund there, with lots of dollars in it, that they "contributed" to. Some even believe that the government has a special account with their name on it. They believe, in essence, that they have a property right to those benefits. Of course, not only is there no account with their name on it, but also there is no trust fund with actual money in it. I think, though, that the trust-fund belief is one of the main barriers to getting rid of, if only in slow motion, Social Security. As Biggs points out in the quote above, it will be increasingly hard to maintain that Social Security is self-financing. In other words, it will be increasingly clear to everyone that Social Security is a welfare program that takes tax revenue from current taxpayers. That fact will undercut the case for Social Security as a contractual obligation.

This means that Republicans, who tend to be more critical of Social Security, should like the de-linking of Social Security tax payments and benefits. They don't like it.

And, as noted, if Obama buys my reasoning about the effect of unemployment benefits, he should have wanted the benefits not to be extended to 99 weeks. But he wanted benefits extended.


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COMMENTS (15 to date)
Sonic Charmer writes:

The idea that extending unemployment benefits would work to Obama's disadvantage (by keeping unemployment up) may rely on an assumption that his potential supporters grasp and believe in such a cause-effect, and in related known economic principles. I believe such an assumption is unwarranted. There is an alternate story one can tell instead, in which Obama's potential supporters (a) are indeed distressed by the high unemployment rate but (b) perceive Obama, in extending the benefits, to be 'at least trying to do something about it, which is more than I can say for his opponents', and thus (c) become more, not less, loyal to Obama as a result. Obama wins.

The generic finding that high unemployment bodes ill for a President's reelection doesn't have to be symptomatic of any real economic knowledge or understanding on the part of the electorate, after all. Perhaps, it is just an effect of voters ignorantly punishing an incumbent for (supposedly) 'not doing anything about the economy' or 'not caring'.

Obama's position shows that he 'cares' and perhaps that's all the electorate, at root, really cares about. Indeed, I think it's pretty undeniable.

Curt writes:

Point 1: As David admits, important points here hinge on which story one "believes" - one would like to think that economists could come to some conclusion eventually, but I'm not going to hold my breath.

Point 2: Ok, Social Security is not (completely) self-funding, and there is no pile of actual money sitting around to be paid out. However there were years of overpayment into the program, and there were years of promises made to pay back the overpayment in future years. As soon as those promises became the slightest bit painful to politicians (i.e. they might have to cut something else that has a more concentrated voice in DC), Social Security goes on the chopping block. Folks like David seemingly won't be happy until Wall St gets even more opportunities to skim money off the 'retirement savings game' with some sort of privatized savings plan instead (or perhaps the burning hypocrisy of not calling SS a 'welfare program' is just so painful that it must be stopped to make some economists feel better about things).

David R. Henderson writes:

@Curt,
On Point 1, I have come to a conclusion.
On Point 2, I advocate abolishing Social Security, not privatizing it. People would then be free to invest in stocks, bonds, or anything else. So I don’t get the Wall Street reference. You know, Curt, another way to know what I think, instead of assuming, is to ask.

BillD writes:

If one side has to give up the story of the "trust fund", then the other has to give up the story of 1/2 the people not paying "income taxes".

Sonic Charmer writes:

If one side has to give up the story of the "trust fund", then the other has to give up the story of 1/2 the people not paying "income taxes".

Deal! There's no trust fund, and Social Security is a welfare program funded by regressive taxes.

I am happy to accept this description. Which faction wouldn't be, I wonder?

Peter writes:

"So if the disincentive effect outweighs the aggregate demand effect"

It likely does since the Fed will nullify any AD effect.

Charles R. Williams writes:

The existence of the Social Security Trust Fund is a political question, not a legal one. If the electorate believes that it exists, then it exists. When the money runs out who will the government stiff first - grandma or the Chinese government? When you are underwater on your mortgage and lose your job do you starve your kids to keep up the payments? Many people will view the matter in just this way. Suppose $3T in "real" treasury bonds are issued to the Trust Fund. Suppose the Trust Fund collects interest and buys and sells bonds to investors as necessary to invest payroll taxes and pay benefits. What has changed? Congress can liquidate the Trust Fund in an instant if the politics allow it.

Sonic Charmer writes:

Charles R. Williams,

Your framework ultimately just means that Social Security is a welfare program, ranking pari passu with all other such programs, and indeed all other government programs. That's fine but is still a far cry from the mental model most people have of SS, which is that there is some definite portion earmarked for them, because they've 'paid into' it. There is not, just as there is not an earmarked portion of funds for a welfare recipients, or for defense contracts, or for Planned Parenthood. The only thing there is, is the political will to continue to tax and fund the transfer payments, which is perhaps renewable but contingent.

Again, I ask, which faction would not be content with this description of SS?

David R. Henderson writes:

@BillD,
Are you saying it’s not true that roughly half of Americans pay no income taxes? I think it is true.
Possibly you’re saying that because you regard payroll taxes as income taxes? If so, I agree with you. But when I do (or, more accurately, my accountant does) my taxes every year, we see a big difference, in the IRS’s eyes and on the form, between income taxes and payroll taxes.

Mike Rulle writes:

Actually, there is an account with your name on it at the SS Administration website. It looks just like a brokerage account. Anyone can access their own account by supplying your SS number etc., and see what is "in it". The fact that it is a only promise to pay, rather than assets, surely escapes the average reader.

Reality has forced the need to change the semantics of social security and this relates to the politics of social security as well.

When the creation of the unified budget in 1969 occurred, it became extremely easy to treat all receipts as fungible---and from fungible comes the notion of using SS funds for expenses other than SS. Then in 1990 when it became obvious this would soon become a transparent budgetary problem, the decision was made to take SS "off budget", to hide the fact that SS payments were being used for the EPA, etc., etc.

This per se would not have been a problem. But it became a problem when the Pols realized they had "extra" money to spend (plus it was easy to raise taxes because SS is a savings program!), which they did---while also being able to mask the fact that they were doing so.

The difference between the two oft quoted amounts (is it $11 trillion or $16 trillion?) of US Treasury debt currently outstanding comes from this budgetary accounting conflation. The actual amount outstanding is the lower one---$11 trillion (or so). The other "$5 trillion" is the amount of social security "taxes" used for expenditures other than social security cumulatively since the program began. That is also the mysterious trust fund---merely an accounting device----and the cumulative amount (to date) of this particular lie.

The government insists it is a savings program on the one hand, yet we have now been calling it a tax on the other. Imagine if it were a real savings program, rather than the general tax that it is? How many congressman would vote for decreasing the income received that goes into 401k investments? So we now have the best of the best Orwellian worlds. We cut "taxes" for the middles class while maintaining the fiction of a SS Trust Fund of savings. Money for nothing and chicks for free.

For a politician to say this out loud is apparently politically "controversial".

It feels hopeless. BTW, under the concept that SS is deferred savings (to the individual it is), taxes should be owed just like on 401k withdrawals. I tried explaining that to a congressman once----

BillD writes:

@David Henderson:
Correct. Our system taxes wages, both gross and net.

The form of payment, through 1099 or FICA contributions, isn't as important as the substance that all wage earners (excl. any EITC offsets) are funding the current system of government (retirement and non-retirement programs).

Ellen writes:

If Social Security pensions are not considered pensions because current taxpayers guarantee/pay for the Social Security pensions, then government/union pensions should not be considered pensions either. Many government/union workers claim they do not pay into Social Security because they pay into pensions guaranteed by the taxpayer. Since government/union pensions are guaranteed by the taxpayer, then government/union pensions can be eliminated/reduced like Social Security. Congressional pensions are guaranteed by the taxpayer, therefore they can be eliminated/reduced too. Since the Pension Benefits Guaranty Corp (PBGC), a government organization (http://www.pbgc.gov/) uses taxpayer money to guarantee the benefits of companies who can no longer afford defined benefit plans, we could eliminate/reduce the PBGC pensions/payouts, since taxpayer money is used. We could end all taxpayer guaranteed pensions and claim it is welfare since the recipients might receive more than they put in and all of them are being supported by current taxpayers. The taxpayer can no longer afford to guarantee any pensions.

Charles R. Williams writes:

Sonic Charmer,

My point is that there is a hierarchy of public priorities and that the legal status of the Social Security Trust Fund is irrelevant to the place the Social Security program has in that hierarchy. I would contend that other transfer payment programs like servicing the national debt could well be cut before social security benefits. In other words social security beneficiaries are just as "entitled" to the benefits "promised" on the sheets of paper the government sends out as the Chinese government is entitled to the return of principal and interest on the treasury debt they purchased. Social Security is politically sacrosanct. That's what makes people's individual "accounts" real.

Carly EngageAmerica writes:

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Daniel DeCamp writes:

It's interesting how dismissive you are of the concept of aggregate demand when considering extending unemployment benefits and how accepting you are of the idea that it just makes people want to continue to be unemployed.

The idea that giving people who lost their jobs through no fault of their own a temporary income so they can continue to pay their bills and survive till they can find a better solution only makes them want to continue to be unemployed is ludicrous, while the idea that helping them by extending their unemployment insurance to keep money flowing in a slow economy makes perfect sense.

This is what bugs me so much about conservative economic ideology. The people who subscribe to it seem to care much more about defending some dogmatic, anti-government political ideology and less about helping people and making an economy work for everyone.

Their often simplistic argument against the liberal Keynsian approach to economic problem-solving, that it just makes people lazy and depend on government more, reveals a lack of empathy as well as a zero-sum game, scarcity mentality.

Nixon said, "We are all Keynsians now." Then Reagan said, "The government isn't the solution to our problems, the government is the problem." And that's when the problems started.

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