Friday, June 25, 2004

Does Social Security Subsidize the Rich?

David Cay Johnston has published a book entitled Perfectly Legal: The Covert Campaign to Rig our Tax System to Benefit the Super Rich – and Cheat Everybody Else (Portfolio, 2003). The title of Chapter 8 is “How Social Security Taxes Subsidize the Rich.” Suppose we take a look at this chapter and see if there is anything to be learned from it.

The chapter begins with the uncontroversial point that tax deferral makes excellent economic sense. To give my own examples, money invested in a 401(k), a 403(b), or a traditional IRA shelters money from taxation until such time as the money is withdrawn. The money saved on taxes can itself be invested for a return. Thus one has the use of money that would otherwise be paid in taxes. The net effect is that “a tax delayed is a tax reduced...”(p. 118) I could quibble
with that formulation, but I won’t.

Johnston proceeds: “If a tax delayed is a tax reduced, the opposite must also be true. A tax paid today that could have been paid years or even decades from now costs more, a lot more.” Johnston then goes on to claim that “For two decades working Americans have been paying farmore of one particular tax than they needed to at the time.” This tax is the Social Security tax. According to Johnston, “From 1984 to 2002 the government collected $1.7 million more than the agency paid out ....” Johnston refers to this as “overtaxing” (119) People who earn $87,000 per year or less (in 2003) belong to the class of the “overtaxed” since only they are subject to the 6.2% withholding. (The figure is 12.4% if one counts the employer’s contribution -- which of course comes out of the employer’s overall compensation.) Johnston infers from this that people earning above the $87,000 cut-off “get a tax break on every additional dollar they earn.” (119)
Johnston’s point is that earners below the $87 K threshold pay a certain tax that is not levied against those who earn above the threshhold, and that this is grossly unfair. It is a tax break for
the wealthy.

Now surely this reasoning is fallacious. First of all, Johnston equivocates on ‘tax.’ The SS ‘tax’is not a tax in the sense in which property, sales, and income taxes are taxes. A tax is money taken by the government to pay for government services. You want public schools and libraries and roads and bridges? Then you must pay for them. And what you pay you don’t get back. What you pay in taxes does not go into some fund from which you can expect to withdraw money in the future. I cannot go to the County Assessor and demand the money I paid in real estate taxes over the past ten years. If I do, he’ll say, “You received county services for your tax payments, now get out of here.” But SS payments are monies one is supposed to get back starting at retirement. The money does not go into individual accounts, but it does go into a fund from which one can expect to make withdrawals in the future. Furthermore, the amount one can expect in retirement is determined by the amount one has paid in while working. Of course, this SS money is not well-segregated from the general fund: money is ‘borrowed’ from the SS fund for general government purposes and special ‘bonds’ or IOUs are put in its place. But this does not alter the fact that SS withdrawals from worker’s paychecks are not taxes. To call them ‘taxes’ is an obvious misuse of the term.

Once one sees through the equivocation on the term ‘tax,’ one sees that it is nonsense to say that people who earn above $87,000 per year “get a tax break on every additional dollar they earn.” (119) This is pure liberal/Democrat obfuscation. It is not as if the ‘rich’ are getting away with not paying some tax they owe, for the simple reason that SS withholdings are not taxes. Those above $87K don’t pay in, but they also don’t get anything back of what they didn’t pay in. Nor does it make sense to say (not that Johnston says this, but many Dems do) that the SS ‘tax’ is regressive. It can’t be regressive for the simple reason that it is not a tax.

Suppose Jones earns $100K. By Johnston’s reasoning, Jones is getting away with not paying $(100-87) x .124 in taxes. And since he is not paying his ‘fair share,’ he is being ‘subsidized’ by ‘the poor.’

According to Johnston, SS “represents a double tax.” (119). One pays the SS tax on money that has already been subjected to income tax. Now although it is true that SS witholding is not pre-tax, it is wrong to speak of double taxation here, given that there are two senses of ‘taxation’ in play, a proper and an improper sense. Thus, pace Johnston, there is simply no decent analogy between this situation and the double-taxation of investment returns. Suppose I am a responsible person who maintains a cash reserve account for emergencies. I fund this account with after-tax dollars. But I also must pay tax on whatever miserable return I get on it. This is a clear case of double-taxation: one is penalized for one’s virtuous behavior. But it is an unacceptable semantic stretch to speak of contributions to a retirement program – which is essentially what SS is – as instances of double-taxation.

Johnston’s overall argument in this chapter is rather murky, but it is something like this. Whether intended or not, the effect of the increase in SS withholding in the 1980s was to offset the Reagan tax cuts rather than to shore up the SS system, which was ostensibly the reason for the increase. The result was that the rich paid less and the poor paid more. The money to run the government had to come from somewhere, and if the rich were paying less due to the Reagan cuts, then more had to be swiped from the SS trust fund. The extra money taken from Joe Lunchpail in the form of increased SS withholding “was used in a socialist scheme to redistribute income. Only instead of taking from those with big incomes to dole out money to the poor, this money was used to redistribute money up.” (124)

In other words, money is taken from the relatively poor workers to give to the fat cats. This is nice political rhetoric with its Marxist class-warfare overtones, but sloppy analysis. First of all, it ignores the fact that Joe Lunchpail will get his money back at retirement, and if he lives long enough, he will take out far more than he paid in. As I said, and as should have been self-evident without my saying it, the SS ‘tax’ is no tax in any serious sense. Second, the increase in SS withholding was arguably justified by the long-term problems with the SS system which came into view in the early 1980s: more and more retirees to support who live longer and longer. Third, although Johnston speaks of government socialism, he himself is a socialist in that he assumes that all wealth belongs to the government, not to those who produce it, and that government’s proper role is to ‘distribute’ this wealth.

Finally, Johnston offers no positive solution to the SS problem. The obvious solution is to gradually phase out the current system, and to replace it with individual IRA-type accounts. This would make it impossible, or at least very difficult, for the government to get at the SS money. It would also solve the problem of running out of money: no one could withdraw more than they had paid in plus return. Third, there would be a substantial return. Fourth, the individual accounts could be passed on through wills and trusts.

But instead of saying something clear and positive, Johnston presents a torturous and obfuscatory analysis that trades on equivocations on ‘tax’ and ‘socialism.’