Social Security Myths

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Previously, I took a closer look at the conservative “myth” that reducing tax rates raises tax revenue. This week I’ll look at a fiction frequently trotted out by those on the left: the rich get off easy on their contributions to Social Security.

A recent example is a Senate hearing (32 minutes into the tape) in which Tom Harkin, the Democratic Senator from Iowa, states that, because of the $106K cap on earnings subject to the Social Security tax, people making $400K paying Social Security tax on 25c out of every dollar while most people in this country pay Social Security tax on every dollar they make. This is true. But what Senator Harkin neglects to mention is that Social Security benefits are also capped.

Let’s look at 3 examples: Joe, making the median annual earnings of $40K; Sally, earning $100K and in the top 5% of earners; and Marilyn, making $150K. Each of them was born in 1950 and will retire at their full retirement age in 2016.

Using the Social Security Administration’s (SSA) benefits calculator , Joe will get a full retirement monthly benefit of $1184 when he retires. Using the default growth rates of income, the SSA estimates Joe’s lifetime income at $848K. Sally will get a monthly benefit of $2100 on estimated lifetime earnings of $2,119K. Sally has contributed 250% more than Joe but will receive less than double the benefit. Marilyn will receive a monthly benefit of $2434 based on a lifetime earnings estimate of $2,623K, triple Joe’s earnings.  Because of the social security contributions cap (currently about $106K), Marilyn has not contributed three times what Joe has contributed, but she has still contributed more than 2.5 times what Joe has contributed.  However, Marilyn gets only double the benefit that Joe receives.

In short, Social Security is both a safety net and an income redistribution scheme. An American Institute of CPAs (AICPA) report notes that Social Security was originally designed as a prepaid pension plan so that benefits received were dependent on contributions made by each person. That original design was amended a few years later to turn Social Security into a “pay-as-you-go” system where retiree benefits were paid for by the taxes of current workers. Although benefits were indexed to contributions, those who earned less received far more benefits in proportion to their contributions. Social Security thus became a hybrid income redistribution scheme for retirees. You can read a colorful history of pensions at the SSA web site.

Few conservative or liberal politicians readily acknowledge the income redistribution aspect of Social Security. The program has been “sold” to taxpayers as though it was an insurance product, similar to an annuity policy that anyone can buy from an insurance company. The only difference is that the federal government is the insurance company. Regardless of what one feels about the income redistribution part of Social Security, it has reduced “the poverty rate among the elderly from 35% in 1959 to 10% in 2003, the lowest of any adult group.” (Source) A recent report by the Census Bureau shows that poverty rates for seniors are 2/3 to 3/4 that of adults in general. Have we gone a bit too far in helping seniors? Poverty rates for children are at a shocking 20% plus, but few politicans dare to propose reducing benefits for the elderly to help children. Seniors vote. Children don’t. Because seniors have been convinced that Social Security is like an annuity insurance program, many seniors balk at any reduction in benefits. They are convinced that they paid in full measure for the benefits they receive.

As the examples above show, both Marilyn and Sally pay a portion of Joe’s benefits. Yet Joe probably thinks that he has earned every penny of his benefits because he “paid into the system.” This misconception is likely to make changes to Social Security benefits extremely difficult. Those who are well off know that they contribute far more into the system than they receive. Those who are less well off will prefer to “soak the rich” even more rather than give up benefit increases.

For those of you who like wrestling, you may be able to see in coming years the (cue up the loud music) “Social Security Smackdown” on a cable channel.

Government Vacuum

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Imagine a world where a quart of milk costs the same in 1950 as it does in 2000. That’s the imaginary world of inflation adjusted or constant dollars, which adjusts current dollars by the Consumer Price Index (CPI). Although imperfect, constant dollars gives us a way to compare apples to apples.

Tax cuts and increases have been a hot topic of political discourse leading up to the elections. In my earlier blog, I showed the income taxes (in inflation adjusted dollars) collected over the past half century. As you may have noticed, those taxes kept rising. With a growing population, it is natural that income taxes collected should continue to rise. What may not be so apparent is the rise in taxes collected PER PERSON.

In the table below (click to enlarge in a separate tab), I divided Office of Managment and Budget (OMB) data on individual income taxes by annual population figures from the U.S. Census Bureau to come up with a per person average of income taxes collected.

Per person means everyone! The federal government is collecting triple the amount of real money that they collected 60 years ago. If the cost per person of government was about $1000 in 1950 and it is $3000 now, are we getting triple in services from our government? Or are we getting screwed?

Political Economics

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As we approach the upcoming elections we hear some favorite myths of both the left and the right.  Today I’ll look at a favorite myth that is trotted out by supply side believers on the right.

Does lowering income tax rates produce more income tax revenue?  Below is a chart of historical income tax data from the Office of Management and Budget (OMB) – click to view larger image in separate tab.  After the Kennedy era tax cuts, revenue increased.  After the Reagan tax cuts, revenue initially decreased.  The Clinton era tax increases clearly show an increase in revenues.  The Bush era tax cuts clearly show a decrease in revenues.

Does lowering or raising tax rates produce more revenue? Increases or decreases in revenue may have more to do with the economy or rising asset values (capital gains taxes) than tax rates. Still, some conservatives will continue to insist that lower tax rates produce more revenue. The justification for their assertion is to look at TOTAL federal revenue, including social security taxes, to make their point. This is a sleight of hand argument since Social Security tax revenue is not affected by income tax rates but it is the only way that conservative supply side believers can make their point. They can only hope that their audience doesn’t look too closely at the facts – at least not until after the election.

Recession Procession

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Recently, the National Bureau of Economic Research (NBER) made their official pronouncement that the recession that began in Dec. 2007 ended in June 2009. In July 2009, the Federal Reserve had issued its unofficial estimation that the recession had just ended. This latest announcement by the NBER is a statistical confirmation of what the Federal Reserve had announced over a year ago. To many individuals and businesses, however, the recession is not over. In a CNBC interview, the renowned investor and billionaire Warren Buffett stated his more common sense definition that the recession is not over until production and income get back to the levels they were before the recession started. Most would agree.

There is no clear definition of the beginning and end of a recession but the NBER’s Business Cycle Dating Committee states that a recession is “a significant decline in economic activity spreads across the economy and can last from a few months to more than a year.” The rule of thumb is two consecutive quarters of negative GDP growth. But neither the NBER definition or the rule of thumb adequately captures the effect – how it feels – of a downturn in the economy. That is because the rule of thumb is based on quarter to quarter growth or decline in GDP. If GDP were a $1 and, over a year, fell to 80¢, then rose to 85¢ in the following quarter, the economy would still be terrible but the growth in GDP would be an annualized 25%. For this reason, Buffett’s rule of thumb gives a more accurate picture.

Below is a NBER chart of real, or inflation-adjusted GDP, with Dec 2007 being the benchmark of a 100. As you can see, our economy is still below the level of December 2007. (Click to view larger image in a new tab)

The severe downturn in manufacturing and retail sales tells a more complete picture, not only of the national economy, but the state and local economies which depend heavily on sales taxes for their revenue. Total unemployment is about 16% of the workforce and, until that situation improves, there will be only sluggish growth in sales, which in turn will keep on damper on GDP growth.

Debt Power

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Visitors to an air show may have had the opportunity to witness the vertical take off power of an F18 fighter jet.  Flying horizontally to the ground, the jet makes an almost 90° turn and shoots up into the sky, a breathtaking show of power for spectators.  Welcome to the airshow of the last three decades.  Below is a Federal Reserve graph of household debt. (Click on any graph to enlarge)

  Aren’t you impressed with the sheer power of consumer borrowing?  Next in our air show is state and local government borrowing.

Not to be outdone, Fannie and Freddie, the government sponsored mortgage companies, show off their impressive borrowing power.

And lastly, our federal government turns on the after burners and shoots up into the debt stratosphere.  This chart does not include the almost $5 trillion of debt the federal government owes its agencies, like the Social Security trust funds, or the Federal Reserve.

Together, we – after all, it’s our governments – are the Blue Angels of debt – or perhaps we should be called the Red Angels of debt.  Together, we have piled up over $31 trillion in debt, more than twice the national GDP. 

Even if we devoted 10% of a $14 trillion GDP to paying down all this debt, it would take over twenty years.  As any one of us knows, debt is a serious drag on savings and investment.  We can expect that the drag of this debt will be with us for many years to come.

Median and the Mean

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The mean or average is a different animal than the median, yet the two are sometimes confused.  The median is the middle of a data set – 50% of the data are below that middle, 50% are above.  The median housing price for an area is more representative of the area than the average price, which is skewed higher by really expensive homes.

A revealing look at an overall trend in wages is the following table from the Social Security Administration, showing the growing disparity between the median wage and the average wage for the past two decades.  Adjusting for inflation, the median wage, in 1990 dollars, has increased 11% from $14,498 to $16,095 ($26,514 in 2008 dollars).  The average wage, however, has increased 19% – from $20,172 to $24,071 ($39,652 in 2008 dollars).  In the far right column of the table, we can see the ratio of median to average wage declining, showing that the top half of income earners are seeing significantly better progress than the lower half.

Stock market wags repeat the mantra that a rising tide raises all boats.  The tide of the past two decades has left half of the boats stuck in the mud.  

Poverty

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This past week the Census Bureau released their annual estimate of median income and poverty.  For 2009, the poverty level increased from 13.2% to 14.3%.  Economists and policy makers have been debating the definition and calculation of poverty since the introduction of the social welfare programs of the Great Society  in the 1960s.  Since the mid-nineties, many have called for a revision of the calculations that gives weight to cost of living variances in the country.  To most people, that makes sense.  Because it makes sense, it is a political hot potato.  The thresholds of poverty are used to determine eligibility for a number of federal programs.  Adjusting  those thresholds would qualify many more people for assistance in some areas, particularly larger metropolitan areas, while disqualifying some in rural areas where the cost of living is less.

How does the Census Bureau measure poverty?  They include all cash income but non-cash items like Medicaid, food stamps and housing subsidies, like Section 8, don’t count as income. (Source)  To qualify for housing assistance, the family’s income may not exceed 50% of the median income for the county or metropolitan area in which the family chooses to live.  The rent subsidy is generally the lesser of the payment standard minus 30% of the family’s monthly adjusted income or the gross rent for the unit minus 30% of monthly adjusted income.

Let’s look at two “traditional” families of four in Denver, Colorado, where wages and cost of living are only slightly above the national average. (Source)

In Family A, Dad works a regular job as a laborer for $12 an hour for 35 hours a week, slightly more than the median hours worked per week, earning about $22000 per year.  Family A’s income is at the poverty level, qualifying them for housing assistance, Medicaid, food stamps and other assistance programs for meeting their monthly bills.  Family A’s adjusted income per HUD standards is gross income less about $500 per dependent, or $20K.  They would pay 30% of that for rent, $6000, for an apt renting for about $9600 annually, receiving about $3600 in tax free income.  In addition, they would get about $325 in food stamps  per month, or another $4000 in untaxed income.  In addition, Dad would get $34 per week in Earned Income Credits, paid by his employer, for an annual total of about $1800.  Since they qualify for Medicaid, this family would have no or minimal health insurance premiums. This family would pay no federal or state income taxes but they would be subject to the FICA payroll tax of about $1650 per year. This family’s net effective income is about $30K.

In Family B, Dad works for $22 per hour for 35 hours a week, earning an annual gross of $40,000, about 16% – 18% less than the median household income for Denver but about equal to the median wage.  This family’s income is in the 40th percentile of Denver area income, slightly above that percentile for the country as a whole.  This family does not qualify for either  housing assistance, Medicaid, food stamps, the energy assistance program LIHEAP or the Earned Income Credit. Dad pays 50% of a $1200 HMO family medical plan which his employer offers, an annual cost of $7200.   This family pays about $120 per year in federal and state income taxes and $2500 in FICA taxes.  This family’s net effective income is also $30K.

Two families – one at the poverty level of income, one slightly below the median income level – have approximately the same level of disposable income.  Either there are a number of families classified as poor who really aren’t poor or about 40% of the households in this country are effectively at or below the poverty level.

Income Disparity

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Beth referred me to a Slate article by Timothy Noah on disparities in income during past century.  My reply below illustrates an example of how economists and others push a political agenda by “bending” the data or, in some cases, simply leaving out any data which might detract from, lessen the impact of or refute the author’s point.  My reply follows:


This article has a decided “liberal” slant.  The graph showing disparities in income leaves out “transfers of income”.  In July 2010, the BEA reported that transfer payments were 1/6 of total personal income, or about 30% of what people got paid in wages and salaries.  Transfer payments include Social Security, unemployment insurance, back to work welfare programs, pell grants, etc, etc.  There is disparity of income but Paul Krugman and others who have a strong political agenda pick out the data that most strongly shows their case.  Income is income.  In the early part of the 20th century there were no social safety net programs and few transfer payments.  Now, they comprise a significant part of income for a growing part of the population and should be included for comparison.

A final note:  There will always be disparities in income, disparities in circumstance, disparities in ability.  James Madison, the primary architect of the Constitution, was well aware of this and wrote in Federalist #10:
 
The diversity in the faculties of men, from which the rights of property originate, is not less an insuperable obstacle to a uniformity of interests. The protection of these faculties is the first object of government. From the protection of different and unequal faculties of acquiring property, the possession of different degrees and kinds of property immediately results; and from the influence of these on the sentiments and views of the respective proprietors, ensues a division of the society into different interests and parties.

Those who hold and those who are without property have ever formed distinct interests in society. Those who are creditors, and those who are debtors, fall under a like discrimination. A landed interest, a manufacturing interest, a mercantile interest, a moneyed interest, with many lesser interests, grow up of necessity in civilized nations, and divide them into different classes, actuated by different sentiments and views. The regulation of these various and interfering interests forms the principal task of modern legislation, and involves the spirit of party and faction in the necessary and ordinary operations of the government.

The violence of factions had brought down previous republics like Greece and Rome.  What can remedy this natural tendency of people to form factions?

There are two methods of curing the mischiefs of faction: the one, by removing its causes; the other, by controlling its effects.
There are again two methods of removing the causes of faction: the one, by destroying the liberty which is essential to its existence; the other, by giving to every citizen the same opinions, the same passions, and the same interests.

Realizing that the cures for faction are worse than the disease of faction, Madison constructed a Constitution by which the different factions in this country would push and pull for power.  Unlike utopians who dream of a better world if only people weren’t so self-interested, Madison understood that self-interest was natural to people and developed a legislative structure that could hopefully balance those competing interests.
Today we have become a country of factions fighting for federal largesse:  farmers who want price supports, the unemployed who want benefit extensions, students wanting more generous student loan programs and grants, industrial towns wanting government support to bring businesses to their area, banks and car companies wanting bailouts, consumers wanting ever more protections, seniors wanting generous cost of living adjustments to their pensions, people wanting more regulations, people wanting less regulations, etc, etc.  We are turning into a country of supplicants raising our voices in a cacophony of “Gimme” and “It’s mine.” 
And we call ourselves a great nation.

Taxes and King Kong

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As the wounded giant ape King Kong clung tenaciously to the spire of the Empire State Bldg, a cynic on the streets below remarked “If the planes don’t get him, they’ll tax him to death.”

Shortly after the invention of taxes in 492,000 B.C. came the invention of weary cynicism by those who had to pay the taxes.

Although income and social security taxes make up the majority of taxes we pay, it is the myriad little taxes that seems to get our goat. You have probably seen something similar to the following in an email or posted somewhere on the web:

Not one of these taxes existed 100 years ago:

Sales Tax, Hotel Tax, School Tax, Liquor Tax, Luxury Tax, Excise Taxes, Property Tax, Cigarette Tax, Medicare Tax, Inventory Tax,Car Rental Tax, Real Estate Tax, Well Permit Tax, Fuel Permit Tax, Inheritance Tax, Road Usage Tax, CDL license Tax, Dog License Tax, State Income Tax, Food License Tax, Vehicle Sales Tax, Gross Receipts Tax, Social Security Tax, Service Charge Tax, Fishing License Tax, Federal Income Tax, Building Permit Tax, IRS Interest Charges, Hunting License Tax,
Marriage License Tax, Corporate Income Tax, Personal Property Tax, Accounts Receivable Tax, Recreational Vehicle Tax, Workers Compensation Tax, Watercraft Registration Tax, Telephone Usage Charge Tax, Telephone Federal Excise Tax, Telephone State and Local Tax, IRS Penalties (tax on top of tax), State Unemployment Tax (SUTA), Federal Unemployment Tax (FUTA), Telephone Minimum Usage Surcharge Tax, Telephone Federal Universal Service FeeTax, Gasoline Tax (currently 44.75 cents per gallon), Utility Taxes Vehicle License Registration Tax, Telephone Recurring and Nonrecurring Charges Tax, etc, etc. 


I get as annoyed as the next person at paying many of these taxes but I would rather have the inventions that spurred some of these taxes.  Some of these taxes have been around for more than a hundred years.  Like so much information on the internet, the list is partly true. Property, hotel and lodging taxes have been with us for centuries.  School taxes began with the advent of public education.  In this country, school taxes began in the mid 19th century.  There were no cars or telephones so no taxes of what did not exist yet.  Someone not wanting to pay these taxes could simply not own a car or telephone.  The IRS was not invented till about 1913 – coming up on a 100 year anniversary for that most hated institution.  Get out the party hats!

The marriage license tax dates back to the 17th century according to this history of London.  In earlier centuries there was “aid” or scutulage, paid by peasants to their lord for the eldest son’s marriage.  For those who want to go back to the old days, have at it.  I will stay in the present, thanks.

Over a hundred years ago, you would pay a horse tax, a saddle tax, a buggy tax, a tax on the lodging of the animal, and in larger cities, a tax to clean up the streets after your horse did his thing.  Horses were the 19th century’s version of a stimulus program for anyone who could use a shovel.  There was no unemployment tax because there were no unemployment benefits.  If you lost your job, you moved your family in with friends or other family or lived on the street or in a vacant warehouse.  Those were the good old days.  If you want to experience those good old days, you can visit any number of countries where people still live like that even when they have jobs.

An episode of Star Trek that we will never see is the one about taxes in the 23rd century. Although they had – or will have? – replicators, replicators can’t materialize everything.  So a likely subspace email in the 23rd century would list: Replicator tax, Subspace Access tax, Quantum Fluctuation tax, Starship tax (someone’s got to pay for all those trips), Transporter tax, Atomic Anatomy Conversion tax, Peripheral Dispersion tax, Dilithium Crystal Tax, Dilithium Mining Tax, Dilithium Resource Replenishment Fund for Mining Planet’s Inhabitants Tax, Faster Than Light (FTL) Access Tax, Wormhole Endangerment Tax, Captain Kirk Acting Lesson Tax, Vulcan Ear Tax, Data Cosmetic Tax, Dr. McCoy Liquor Tax, Holodeck Tax, Holodeck Modeling and Engineering Tax, and the one tax that really griped people of the 23rd century – the Sulu Sword Tax.

The future looks – well, kinda like the present – with a few changes.

Reagan and Obama

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As the 1982 elections approached, Ronald Reagan’s Presidency was unpopular. The unemployment rate was 9.7%, about the same as it is now. Interest rates were high: a 6 month CD paid about 13% interest, which was good for those who had savings but terrible for small business owners who had to work extra hard to pay the 20% interest rate banks were charging for business loans. The dead carcasses of 17,000 businesses littered the economic and social landscape, one of the highest failure rates since the 1930s depression. The stock market was in the doldrums – why bother investing in stocks when bonds and CDs paid such generous interest rates?  GDP had grown an anemic 2.2% the past year.  The national debt had gone up by 14% that year.  In short, the Reagan Presidency was promising to be one of the worst in American history. 

In 1982, the voters realized that they had traded in a bumbling governor from Georgia, Jimmy Carter, for a bumbling governor from California, Ronald Reagan. After the election, Democrats, already in control of the House of Representatives, were given another 25 seats and a commanding majority.  The Republicans continued to hold a slim majority in the Senate.

Shortly after the election, Reagan launched his “Star Wars” or Strategic Defense Initiative (SDI), long on imagination and his willingness to further bankrupt this nation, but rather short on any actual ability to employ such a grandiose scheme.  In the first year of Reagan’s reign, tax rates had been cut but the Social Security tax had been raised so, for most of us working for a living, it was pretty much of a wash.  Inflation was killing us.

If you are an older Republican, you may have forgotten those years.  They have been conveniently hidden under the party mattress by the Republican campaign machine and the retelling of the “Reagan legacy.”  In the seventies and early eighties, there was so much distrust in the judgment and morality of elected representatives that it was a strategy by some disaffected voters to pull alternate levers in the voting booth, voting Democrat on one row, then Republican on the next row, in order to gridlock the government.

Reagan kept on borrowing on the taxpayer’s credit card.  By the time he left office, the national debt had tripled. 

Midterm elections often are a vote on the Presidency and the dominant party. The Democrats may have to give up most of the 30+ Congressional seats they won in 2008, making it even more difficult for President Obama to get his agenda enacted.  In 30 years, how will the story of the Obama presidency be told?  Will it be altered or swept under the table by the Democratic campaign machine just as the Republican machine has retold the Reagan years?  Probably.

Both Reagan and Obama had monumental tasks in their first few years, burdens so great that neither of them could achieve their goals in a short two years.  However, voters focus on the present, throwing hindsight, history and perspective out the window as they drive down the rutted road of the present.  The political machines of both parties know this and play to that short attention span. Unemployment is high, just as it was in Reagan’s 2nd year.  Obama can only hope that, by 2012, the unemployment rate gets down to the 7.4% rate it was in 1984, when Reagan came up for re-election. 

Traditionally, the political campaigns get into gear after the Labor Day holiday.  There is one thing we know for certain:  we will be entertained by a lot of lies and half truths for the next few months.  If you listen to talk radio, both conservative and liberal, you are accustomed to this kind of entertainment year round.

(Side note 9/8) Here is a CNN  review of some of the tax policies and their effects during the Reagan administration.