The Back Door Flat Tax

The Bush Administration is probably both the most ideologically driven and the most secretive in American history. The combination makes it very hard to determine its real motives on many issues, including Social Security privatization. To some extent secrecy and ideology feed one another; if we don’t know how the Administration justifies its policies even to itself, we can’t bring reason to bear to criticize them very effectively. This combination also allows the Administration to benefit from the rationalist illusion that dominates the thinking of modern men and women—surely, we suppose, they must have some good reason for what they are doing?
All of this applies, in spades, to the Social Security controversy, since no one can has even dared to claim that private accounts will either improve the financial picture of the federal government or provide money for equal or higher benefits to retirees. What the plan is actually designed to do remains something of a mystery, other than give conservatives the satisfaction of having undone the major achievement of the New Deal. But in remarks a couple of weeks ago, President Bush opened the door to a new interpretation when he indicated that he might be willing to lift the $90,000 cap on payroll taxes. Some one within his Administration may have decided to try to repeat the great trick that Ronald Reagan played in the 1980s—to claim to cut taxes, while actually redistributing them to bear more heavily on income than on wealth, and to make them less regressive.
As of now, workers making up to $90,000 pay a 6% Social Security tax, matched by their employer (they pay 12% if they are self-employed). Income over $90,000 is not subject to the tax. This is obviously very unfair to two-career couples: two earners making $180,000 total could pay twice the tax of a single worker with the same income. It also makes the tax regressive. If you made $900,000 last year, you paid just .6%, not 6%, to the Social Security Administration.
The President opened the door yesterday to putting an end to the cap. This move, according to the only estimate I have seen in a news story, should increase receipts by $100 billion a year. At first glance this sounds like a good idea, and eventually, in my opinion, it will be—but not yet. That is because we do not need that money to pay for Social Security benefits yet—under current predictions, we won’t need it until 2018, and those predictions are conservative. But the Bush Administration does need that money, desperately, to try to reduce the deficit it has created. What we have here, actually, is a replay of the trick that Ronald Reagan pulled in 1983—to sell a more regressive tax system as a tax cut.
Despite oceans of Republican rhetoric over the last 25 years, Ronald Reagan did not cut federal taxes. Although his initial cuts and a recession essentially froze revenues for two years, from fiscal 1981 to fiscal 1989 federal revenues rose from $599 billion to $991 billion, and did not decline as a percentage of GNP. What changed was where the money came from. The share provided by Social Security payroll taxes—significantly increased in 1983—rose from 30% to 36%, while the shares provided by personal and corporate income taxes fell by 3% each. By 1989, the excess of Social Security receipts over benefits totaled $52 billion, all of which was spent by the federal treasury in return for 3% bonds. The excess for fiscal 2004 is $151 billion. Meanwhile, as I have already noted, the percentage of federal taxes represented by Social Security receipts has continued to rise until it has nearly equaled personal income tax receipts. Adding the new $100 billion by eliminating the cap would increase Social Security receipts over personal income tax receipts. More importantly, it would allow the Administration to claim a $100 billion cut (about 20-25%) in the ballooning federal deficit. It would also increase the growth of the trust fund by $100 billion a year, increasing the claim on the federal treasury that future generations will have to pay off. While the Trust Fund is, as I pointed out before, a real asset protected by the US Constitution, it is not self-financing, and the Federal Government will have to raise taxes or increase borrowing when it comes due sometime in 2018 or later.
In a sense, the Administration, by lifting the cap, would be introducing a flat tax through the back door. Taxes wouldn’t be completely flat, since personal income taxes remain progressive (although less than half as progressive as they used to be), but as personal income tax rates continue to shrink, the flat 12% payroll tax (counting the employer contribution) would represent more and more of total receipts. Meanwhile, the wealthiest Americans would be working on more and more ways not to count their income as taxable wages and salaries.
All this does suggest, to me, a more sensible means of doing something about Social Security and its impact. We should now do away with the $90,000 cap, but we should also cut back payroll taxes to the level actually required to pay current benefits. This cut would be substantial. Fiscal 2004 receipts from contributions were $472 million, and ending the cap would raise that, reportedly, to $572 million. Fiscal 2004 benefits totaled $415 million. Without the cap, the payroll tax could be reduced by 27% and still pay current benefits—in other words, from 12% to about 9%. That is the figure that everyone, regardless of income, should start paying now. And every year, as needed, that figure should be raised by the small amount necessary to continue paying full benefits—until we find it expedient to begin drawing on the Trust Fund instead. This would have the additional benefit of providing a real tax cut for low-income workers, who are much more likely to spend it and give the economy a boost—the situation that prevailed during the growth years of the 1950s and 1960s, which were actually much more impressive than what has happened in the era in which we have been abandoning progressive taxation.
As Pat Moynihan pointed out in 1984 or so, as soon as he realized what had happened to the reform he had promoted, Social Security should be separated from the rest of the Federal government. The reform I suggested above would, of course, add $166 billion more to the federal deficit. That should be financed with higher progressive income and corporate taxes—simply returning to the level of the Clinton years would probably do the trick. But that would be a more economically just America, and that is not what the Administration wants.