The 2% (non) Solution: Part One

by Bruce Webb (cross posted at new dedicated (and partially funded) blog Social Security Defender)

As part of the Tax Cut deal Obama cut with Republicans there was included a one-year cut of 2% of payroll out of the 6.2% employee share of the overall 12.4% of payroll sent to Social Security. This cut was ostensibly designed in a way that held harmless the Trust Funds, the dollars not being sent from paychecks instead being replaced by transfers from the General Fund. Plus the diversion is on paper only temporary. But in reality this deal not only should have raised red flags, it also should have blown reveille and set off the disaster warning klaxons. This deal represents a terrible danger to Social Security in at least two ways and is terrible policy besides. More below the fold.

If the so-called Payroll Tax Holiday stood on its own, you could argue that it is mildly progressive in that for one year it reduced the taxes of everyone on their first $106,800 of income while paying for it out of taxes that are mostly incident on the top 50%. Unfortunately it effectively replaced the expiring Making Work Pay tax credit which directed all of its benefits to families making at most $70,000. The net result may be a tax hike for as many as one in three workers. The whole grim business is described in this Huff Post piece: Obama-Republican Deal Could Mean Tax Hike For One In Three Workers by the appropriately named Ryan Grim. From my point of view the fact that the tradeoff was suggested by Republicans is all you need to know, millionaires will get a tax cut ten times of that of a single person working at FPL in a minimum wage job.

However this particular issue, however important from an economic justice and income inequality standpoint is somewhat peripheral to Social Security itself. And there are plenty of people more qualified than me to comment on it, starting with Mr. Grim, so over to them on this one. Instead I want to discuss two threats posed to Social Security, one that just brings the funding shortfall much closer in time and is pretty well recognized, and a second that is more subtle but presents an existential threat to Social Security itself.

The first threat is fairly simply stated: in today’s Washington D.C. there is no such thing as a ‘temporary’ tax cut. As long as Republicans have anything to say about it (and since they are effectively calling the shots even before they take control of even the House) there is no such thing as restoration of existing levels of taxation after a ‘tax holiday’, instead any such cuts will be presented as a tax increase, in this case a massive one. Because they can and will play games with percentages. That is while the cut is presented as ‘only’ 2% and so to reasonable minds would seem a small part of the revenue flow, it represents 16% of the total revenue flow generated by FICA payroll tax and a whopping 32% of that taken out of workers’ paychecks. Moreover taking the employee share simply back to 2010 levels means an increase from 4.2% to 6.2% or a whopping 47% TAX INCREASE. That is you can expect Obama to get headline credit for a 2% cut but get blamed for a near 50% increase even though it is the same dollars in question.

The anticipated rhetorical spin is only the start of the danger. Social Security Title 2 (what we know as Soc Sec today) has always been a closed system, to paraphrase Lincoln ‘of the worker, by the worker, and for the worker’, having taken nothing directly from capital it owed nothing to capital. Moreover because of the way that its dedicated taxation and later benefit levels were set up it was largely insulated from the Budget and Appropriations process. While opponents of Social Security could and did play games with the 1% of cost related to Administration, an amount that is exposed to those processes, that game playing didn’t put the whole system at risk (though it caused a lot of misery on the Disability Insurance side, where Admin has always been scandalously underfunded). But in 2011 a very substantial chunk of Social Security income will come from the General Fund. And while it is always possible that the next Congress will just ease that General Fund burden by letting the ‘holiday’ lapse on schedule there is no guarantee that they wouldn’t simply leave the 4.2% rate in place while cutting the subsidy from the General Fund and so blowing around a $120 billion hole in the income stream for 2012 and every year after. With the net effect of bringing the projected date of Trust Fund depletion back dramatically from its current 2037 date, perhaps as early as 2020.

Of course this might appear just too raw and hypocritical for the Republicans, that after crying ‘crisis’ they did what they could to precipitate it, but it opens the door for other chicanery. For example the Republicans could offer to leave the 4.2% rate in place, lower the replacement subsidy by 50% and ‘compromise’ by cutting future benefits in a way that offsets the other 50%. And then just repeat this exercise every year in their typical framing of separating “spending we CAN’T afford” (which always seems to be social spending) from “spending we can’t NOT afford” (which seems to be everything military and any efforts to raise revenues).

Social Security has been protected throughout its history by the wall represented by a dedicated payroll tax and a Trust Fund whose reserves were drawn from that same stream. This Administration just breached that wall, apparently in the futile attempt to show ‘seriousness’ and ‘bipartisanship’ which in this case translates to ‘willingness to screw your own base’.

This payroll tax holiday was a terrible policy choice to start with, continuation of Making Work Pay or direct transfers from the General Fund to workers would have been more effective and better targeted stimulus than a tax cut that also flows to millionaires. But the danger is not restricted to the direct breach in the wall. Instead there is a lurking Trojan Horse. Subject of Part Two.