Friday, February 4, 2011

Aiding the Economy and Social Security through a Payroll Tax Modification Program

The economy is suffering the severest slowdown since the Great Depression, and the efforts to date of the government and the commercial sector have done little to ameliorate the economy’s problems.  Unemployment is at a near-record high and is showing no sign of improving.  The essential problem is that current financial flows of money and credit through the economy do not match the expectations of people for activity of the economy.  In other words, people have no money, so they can’ t spend it on the homes, cars, travel, etc., that are needed to boost the economy.  In the previous decade this problem was masked by the willingness of consumers to borrow in order to finance their purchases.  Since the recession this borrowing has slowed dramatically, leading to a downward spiral of reduced consumption and falling employment.  The solution, therefore, is to get money to the people who will spend it--those in the so called working and middle classes.
The plan outlined below intends to simultaneously: boost the economy by giving money to workers who are likely to spend it, 'fix' SS by returning it to the pay-as-you-go structure it had for its first 50yrs, give workers back their money so they can use some of it to pay down some of the onerous debt load they are now under, ensure that SS is not raided to pay for other expenditures, while not increasing the national debt, but requiring debt ownership to shift from the Social Security Trust Fund to other holders.

One of the largest expenditures affecting the middle class is the Payroll Tax (FICA), which funds Social Security.  For 2009 and 2010 the Social Security portion of FICA was 6.2% each from the employee and the employer, for a total of 12.4%, to a maximum income of $106,800/yr.  Until recently the total collected from the Social Security tax exceeded the amount paid out each year, with the excess being placed into the Social Security Trust Fund.  This fund was created in 1983 at the encouragement of Federal Reserve Chairman Alan Greenspan as a mechanism to address expected future shortfalls in the system.  Since that time the Trust Fund has amassed a significant total of $2,540B at the end of 2009.

A reduction of the Payroll Tax has the potential to boost the economy, as people in the income brackets for which Social Security makes up a significant portion of total taxes paid, i.e., those making under $100,000/yr, will likely spend much of this extra income available to them.  Such a reduction in the Payroll Tax will create numerous economic benefits by helping to realign the financial flows with expected economic activity.  This will boost consumer spending, leading to increased employment and increased business investment to meet rising demand.  The lower Payroll Tax will also allow those who are struggling under mortgage debt to be better able to meet mortgage payments and avoid default by using some of the retained income for debt reduction.  Similarly, it will increase the ability of potential home buyers to purchase a home, and support home prices as the extra retained income that can be counted on for many years will allow home buyers to qualify for larger mortgages, although willingness to take on more debt may be lower now than before the financial crisis began.

A fixed, short-term reduction in the Payroll Tax will not likely have many of the aforementioned benefits if consumers do not anticipate that it will last for many years.  Rather, a modification of the Payroll Tax schedule for the coming decades will lead to predictable future tax expectations, a reliable expectation of extra retained income, and more predictable financial behavior as a result. 

The modification of the tax schedule will also provide a mechanism for drawing down the Social Security Trust Fund in a defensible and predictable manner.   The drawdown will not add to the National Debt, because the funds in the Trust Fund are already held as Treasury securities.  That is, these funds are already part of the National Debt.  Drawing down the Trust Fund would entail swapping one set of securities, held by the Trust Fund, for another set held by some other lender.  Such a transfer would require finding new buyers for government debt, but this is already an existing issue with the current, large budget deficits.  An additional benefit, as shown below, is that securities currently held in the Trust Fund are yielding 4.9%, while the new securities would likely yield far less, thus resulting in a savings to the government on interest payments on the debt.  In this way the Trust Fund is actually serving as a “rainy day fund” for the economy, by providing the stimulus funds to those who are most likely to stimulate the real economy.  

During 2009, Social Security took in $807B in receipts and paid out $686B in expenditures, resulting in an increase in the Trust Fund’s holdings of $121B.  Of the receipts, $667B were contributions from the Payroll Tax, $22B were from taxing benefits, and $118B were from interest on government securities held by the fund, yielding an average annual return of 4.9%.  Using 2009 as an example, if the Social Security tax rate were reduced from 12.4% to 8%, with the cut coming out of the employee, rather than the employer, contribution, contributions would have been $430B, resulting in an extra $237B of funds in the hands of likely consumers.  This change would have drawn down the Trust Fund by $116B to $2,424B at the end of 2009.  The median family income in 2009 was $50,000.  Applying the rate cut of 4.4% would mean $2200 extra in the budget of those families, which is a significant amount for such families.  If even half is spent rather than saved, this would produce an additional $1100 of consumer spending for such a family.

A schedule for Social Security contributions over the next 10-20 years can be devised to allow a gradual, monotonic increase in the contribution rate and an asymptotic transition to the break-even level for the year for which the Trust Fund is exhausted.  Thus, the system will once again become self supporting with a yearly balanced budget as was the case before the 1983 financialization.  Creating such a schedule would take some analysis by the Social Security actuarial office using their projections of expenditures, payrolls, economic growth, etc.  

For the purposes of this paper an example of an extreme limiting case of maintaining the 8% contribution level from 2010 until the Trust Fund is exhausted. This example was derived using the SS Trustees’ predictions for the next 10 years.  In this example the Trust Fund is exhausted at the end of 10 years, and the contribution rate is raised to 11.2% to provide the needed receipts to match expected expenditures.  N.B. that this contribution level is still lower than the current 12.4% level.  The contribution level for Social Security will need to be adjusted either annually, or as needed, to match the expected expenditures for each year.

This plan would allow the transition of Social Security back to the original ‘pay-as-you-go’, balanced budget model that was implemented in 1935, and worked well for almost 50 years.  The advantage of the original plan was that it was an economic plan, not a financial plan.  That is, the framers recognized that beneficiaries do not produce, and that a fraction of production needs to be transferred from producers to beneficiaries each year.  That regardless of how a plan is financed, the underlying transfer of good and services occurs each year from producer to beneficiary.  Thus the simplest mechanism is to simply tax the value of the transfer on the producers and provide those funds to the beneficiaries each year.

The result of such a Social Security tax schedule modification will be an immediate stimulus to the economy that will not add to the National debt, a drawdown of the Trust Fund over an extended period of time provides certainty for future contributions and expenditures, a smooth transition to a balanced budget for Social Security in the future, and the establishment of a mechanism and expectation of regular changes in the contribution rate.

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