The War On Entitlements

The debate over reform of Social Security and Medicare is taking place in a vacuum, without adequate consideration of fundamental facts.

These facts include the following: Two-thirds of Americans who are over the age of 65 depend on an average annual Social Security benefit of $15,168.36 for at least half of their income.

Currently, earned income in excess of $113,700 is entirely exempt from the 6.2 percent payroll tax that funds Social Security benefits (employers pay a matching 6.2 percent). 5.2 percent of working Americans make more than $113,700 a year. Simply by eliminating the payroll tax earnings cap — and thus ending this regressive exemption for the top 5.2 percent of earners — would, according to the Congressional Budget Office, solve the financial crisis facing the Social Security system.

So why don’t we talk about raising or eliminating the cap – a measure that has strong popular, though not elite, support?

When asked by the National Academy of Social Insurance whether Social Security taxes for better-off Americans should be increased, 71 percent of Republicans and 97 percent of Democrats agreed. In a 2012 Gallup Poll, 62 percent of respondents thought upper-income Americans paid too little in taxes.

Medicare, in turn, is financed by a flat 1.45 percent tax on the first $200,000 of earnings for a single person and $250,000 for a married couple, matched by the employer, after which it rises by a modest 0.9 percent on all income above the $200,000 and $250,000 levels.

The Medicare and Social Security taxes are jointly known as FICA (for Federal Insurance Contributions Act) — or payroll — taxes. The combined FICA taxes are highly regressive. The non-partisan Tax Policy Center found that the poorest quintile pays a 7.3 percent FICA rate, while the top quintile pays 6.8 percent. The top 1 percent of the income distribution pays a 2 percent rate, and the top 0.1 percent pays just 0.9 percent. In other words, the rate paid by the poorest quintile is 8.1 times as high as the rate paid by the top 0.1 percent. The regressive character of the payroll tax, compared to the progressive structure of most other federal taxes, is clear in the accompanying chart (Fig. 1), from the Tax Policy Center:

In the case of Social Security, proposals to raise the age of eligibility for full benefits amount to a benefit cut of 6 to 7 percent for every year that eligibility was increased. “The reduction in monthly benefits for some beneficiaries would lower average income and increase poverty rates in the future among the elderly,” according to the Congressional Budget Office. If the retirement age were raised to 70, and if the early retirement age was kept at 62, the C.B.O. found that the penalty for those taking early retirement would increase: “people who claimed at 62 would receive only 55 percent of their primary insurance amount, compared with the 70 percent they would receive under current law.”

As 10,000 baby boomers turn 65 every day, 72 percent of them are currently without the protection of a defined benefit pension plan, which leaves growing numbers dependent on inadequately funded 401(k) and other voluntary (defined contribution) plans to keep their heads above water.

At the same time, life expectancy has been extended to unprecedented lengths:

A man reaching age 65 today can expect to live, on average, until age 83. A woman turning age 65 today can expect to live, on average, until age 85. And those are just averages. About one out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age 95.

In a 2012 report , the Government Accountability Office found that

older workers’ unemployment overall and long-term unemployment rates have increased dramatically since the recession began in 2007. In December 2011, the unemployment rate for older workers was 6.0 percent, up from 3.1 at the start of the recession, but down from its peak of 7.6 percent in February 2010. In particular, long-term unemployment rose substantially, and at a greater rate for older than younger workers. By 2011, 55 percent of unemployed older workers had been actively seeking a job for more than half a year (27 weeks or more).

In addition, the G.A.O. found that “long-term unemployment can put older workers at risk of deferring needed medical care, losing their homes, and accumulating debt.” In a survey of workers, the G.A.O. identified “out-of-date skills, discouragement and depression, and inexperience with online applications as reemployment barriers for older workers.”

And of course the elderly will be saddled with increased expenditures for medical care and other necessary services as they age.

Cutting benefits is frequently discussed in the halls of Congress, in research institutes and by analysts and columnists. The idea of subjecting earned income over $113,700 to the Social Security payroll tax and making the Medicare tax more progressive – steps that would affect only the relatively affluent — is largely missing from the policy conversation.

The Washington cognoscenti are more inclined to discuss two main approaches that are far less costly for the affluent: means-testing of benefits and raising the age of eligibility for Social Security and Medicare. (Sidenote: policy makers and national journalists who weigh in on this issue generally earn more than $113,700 a year.) Means-testing and raising the age of eligibility as methods of cutting spending appeal to ideological conservatives for a number of reasons.

First, insofar as benefits for the affluent are reduced or eliminated under means-testing, social insurance programs are no longer universal and are seen, instead, as a form of welfare. Public support would almost certainly decline, encouraging further cuts in the future.

Second, the focus on means-testing and raising the age of eligibility diverts attention from a much simpler and more equitable approach: raising the payroll tax to apply to the earnings of the well-to-do, a step strongly opposed by the ideological right.

Third, and most important in terms of the policy debate, while both means-testing and eliminating the $113,700 cap on earnings subject to the payroll tax hurt the affluent, the latter would inflict twice as much pain.

The C.B.O. estimates that elimination of the payroll earnings cap would cost the well-to-do the equivalent of 0.6 percent of Gross Domestic Product, while substantially reducing Social Security payments to the top third of the income distribution, through means testing, would only cost those better off recipients the equivalent of 0.1 percent of G.D.P.

Theda Skocpol, a professor of government and sociology at Harvard and an authority on the history of the American welfare state, contended in a phone interview that policy elites avoid addressing the sharply regressive nature of social welfare taxes because, “at one level, it’s very, very privileged people wanting to make sure they cut spending on everybody else” while “holding down their own taxes.”

Gary Burtless, a senior fellow in economic studies at the Brookings Institution, agrees that elite proponents of cutting benefits for the elderly have a narrow view based on their own high incomes and comfortable lives: “The median voter has a much more well-rounded sense of the risks associated through everyday life than the elite,” he said in an interview.

In the rarefied community that sets many of the terms of national policy making, a recurring theme is the notion that the federal government is subsidizing the “good life” of the nation’s elderly at the expense of needed investments in young people, in infrastructure and in innovation.

Writing in The Times, Yuval Levin, the editor of the National Interest and a fellow at the Ethics and Public Policy Center, argued on Feb. 19 that both Democrats and Republicans

should agree at least to spend less money on the wealthy — via means-testing. It may surprise some Americans to learn that the United States spends quite a lot on the affluent, especially through the entitlement programs at the heart of the budget fight: Social Security and Medicare. Both programs move money from relatively poorer young people to relatively richer old people, and they are growing ever more expensive. Means-testing — allocating benefits according to need — might offer both sides a way out.

Not to be outdone, the Heritage Foundation, bastion of the Republican right, has called for the imposition of tough means-testing on both Social Security and Medicare. The plan would cut benefits in half for a single person when income exceeds $82,000, and eliminate benefits altogether for those making more than $110,000. Benefits for married couples would be cut in half when their combined income reaches $137,000 and are eliminated altogether when income reaches $165,000.

“At the end the day,” write the authors of Heritage’s “Saving the American Dream,”

our plan, while economic in nature, has a higher moral purpose. If entitlements are not reformed, the next generation and future ones will have to pay punitive tax rates that will end liberty as we have known it. Our proposal aims to preserve America’s promise bequeathed to us by past generations.

Contrary to the claims Heritage is making, current levels of federal taxation are at historically low levels, and the increases needed to finance restoration of the Social Security trust fund will not break the bank.

Federal tax revenues in 2009, 2010 and 2011 have been 15.1 percent, 15.1 percent and 15.4 percent of Gross Domestic Product, lower than any level since 1950.

The Congressional Budget Office estimates that the amount of new revenue required to bring the Social Security trust fund into balance over the next 75 years would amount to 0.6 percent of G.D.P.

The same C.B.O. document presents a series of alternative ways to achieve such a goal, including the elimination of the current $113,700 cap on income subject to the Social Security payroll tax. If the cap or ceiling were lifted, the amount of money raised would be 0.6 percent of G.D.P., the exact amount of income needed to get Social Security out of the red — a striking coincidence.

This approach has substantial public support, which is reflected in one of the findings in the extensive NASI survey that there is “a sharp contrast between what Americans say they want and changes being discussed in Washington.” The report goes on:

Large majorities of Americans, both Republicans and Democrats, agree on ways to strengthen Social Security — without cutting benefits. Fully 74% of Republicans and 88% of Democrats agree that “it is critical to preserve Social Security even if it means increasing Social Security taxes paid by working Americans.”

The question in the NASI survey reads as follows:

Workers currently pay 6.2% of their earnings to Social Security, matched by the employer. One proposal would very gradually raise the Social Security tax rate over the next 20 years. Example: For a worker earning $50,000, gradually raising the tax rate by 1/20th of 1% per year for 20 years would mean, each year, paying about 50 cents more per week, matched by the employer. This change would close 53% of Social Security’s financing gap. Do you favor or oppose this change?

Sixty-nine percent of respondents favored the proposal, including 65 percent of Republicans; 11 percent opposed; and 21 percent had no opinion.

A Kaiser Family Foundation poll (see Figs. 2 and 3) found strong opposition to reductions in Medicare and Social Security benefits and strong support for taxing the rich.

In fact, let’s go back and look at the dependence of retirees on Social Security. Fig. 4 illustrates data from the Employee Benefit Research Institute which shows the dependence on Social Security in 2010 for those over the age of 65 by quintile. For the first and second quintiles – the bottom 40 percent of the income distribution – Social Security provides nearly 90 percent of total household income. For those in the middle quintile, Social Security accounts for over 75 percent of total income.

On Nov. 12, 2012, the trustees of the Social Security and Medicare trust funds issued a report concerning Social Security:

After 2020, Treasury will redeem trust fund assets in amounts that exceed interest earnings until exhaustion of trust fund reserves in 2033, three years earlier than projected last year. Thereafter, tax income would be sufficient to pay only about three-quarters of scheduled benefits through 2086.

The trustees estimate in the same report that the Medicare trust fund will reach “exhaustion” even sooner: 2024.

My conversations with a range of academics and policy analysts revealed very little consensus over strategies to deal with the fiscal crises facing the two major entitlement programs. Thoughtful scholars like Timothy Smeeding, a professor of public policy at the University of Wisconsin, Madison; the economist Jonathan Gruber of M.I.T.; and Eugene Steuerle of the Urban Institute, contend that my own favorite solution, eliminating the cap on income subject to Social Security taxes, goes too far, and that that ceiling should instead be raised to somewhere between $150,000 to $215,000.

Robert Reischauer, a former director of the Congressional Budget Office and a current trustee of the Social Security and Medicare trust funds, said he could see the advantage of raising the age of Social Security eligibility to encourage more labor force participation as long as federal policies lessened the cost to employers of hiring older workers. He cautioned that such a step should include protection of benefits for low-income workers forced by hardship to take early retirement.

James Wetzler, former chief economist on Congress’s Joint Committee on Taxation and a former New York State tax commissioner, warned that increasing tax burdens on the affluent, while reducing or eliminating their retirement benefits, poses the danger of “creating a class of influential people — relatively high earners — with a vested interest in eliminating the program.”

Elite anxiety over entitlement-driven budget deficits and accumulating national debt has created a powerful class in the nation’s capital. The agenda of this class is in many respects on a collision course with mounting demands for action by those lower down the ladder to address the threat to government social insurance programs. Intransigent opposition by the better off and their representatives to raising the necessary revenue means that not only Social Security and Medicare face a budgetary ax.

Among the additional likely casualties: WIC, which provides free nutrition for women, infants and children; long-term and emergency unemployment compensation benefits; low-income housing vouchers; vaccines for poor children; schooling for children with disabilities; special education; preschool programs; child care for disadvantaged and vulnerable children; after-school programs; treatment of the mentally ill; and meals for sick and homebound seniors.

This conflict could not have come at a more difficult time: the United States is in the midst of a zero sum struggle requiring politicians to pick losers, not winners. The population of those over 65 is set to multiply, with longevity steadily increasing even as median annual household income for the population at large has shrunk to $51,584 in January 2013 from $54,000 in 2008.

In this kind of conflict over limited goods, one of the most valuable resources that can get lost in the fray is the wisdom of the electorate at large. In this case, the electorate is pointing toward progressive tax increases for those closer to the top far more readily than members of the political class, for whom high-earners are a crucial source of campaign contributions.

The very nature of the basic security Americans are entitled to is at stake.