Social Security: A Macroeconomic Issue

By Eric Rothenburg

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APRIL 2005 - The issue of how to save Social Security crosses the fields of accountancy, economics, and sociology. With the first batch of baby boomers starting to retire within the next five years, and for 20 years thereafter, tremendous demographic changes will affect all aspects of life within the United States, including how we provide for retirees and disabled workers.

Why Social Security?

As a result of the stock market crash of 1929 and the subsequent bank failures, especially during the period 1932–1934, tremendous wealth was lost in the United States. While this affected many Americans, it affected older Americans more because they would not have a long time horizon to recover this lost wealth before retirement. Social Security was originally set up as an immediate response to this loss of wealth to retired and soon-to-be-retired people. Having a “government pension” financed by a tax was of utmost concern in 1935; it was an immediate response to this huge “evaporation” of wealth.

The Social Security payment itself is a transfer payment. The recipient does not have to do anything currently to receive this check (e.g., perform a service); all recipient must do is reach the retirement age of 65. In this sense, therefore, it is no different from unemployment insurance or income maintenance.

The Social Security tax was set up in a cumbersome way, however, because the tax is shared by both the employer and the employee. Currently it is 6.2% each on the first $90,000 worth of income; self-employed individuals pay both portions, for a total of 12.4%. In a sole proprietorship, there is a deduction for adjusted gross income (AGI) of one-half of the Social Security tax remitted. Corporations can deduct Social Security taxes as an operating expense. In 2005, the maximum amount that can be withheld per employee is $5,580 ($11,160, including the employer portion ).

Regressive Versus Progressive

The Social Security tax is inherently a regressive tax. For example, A earns $25,000 per year, B earns $90,000 per year, and C earns $350,000 per year. The marginal tax rates based on disposable income are as shown in the Exhibit. For convenience, the example uses a 10% marginal tax rate for A, a 25% marginal tax rate for B, and a 40% tax rate for C.

Above the $90,000 cap, the tax becomes very regressive. Therefore, the Social Security burden is heavier for middle-income people than for upper-income people. Also, A is probably not saving that much for retirement, and B and C are saving a great deal more. In this scenario, B and C would probably rely more on their 401(k) and other retirement accounts than on Social Security. A is at the mercy of the Social Security payment and probably would have very little retirement income from other sources.

With this background, consider the following:

  • Individual discretionary retirement accounts are quite risky and would hurt low-income individuals more than they would middle-income and upper-income individuals. If wealth were to somehow “evaporate” again, as in the Great Depression, where would A go for retirement assistance?
  • Capital markets are by their nature very volatile. Interest rates, the state of the economy, corporate profits, and psychological perceptions play an important role in stock and bond valuations. For example, if baby boomers start taking stock outflows in 2010 that exceed the inflow of nonretirees’ savings, stock market valuations would deteriorate by the nature of supply and demand.
  • The $90,000 taxability ceiling should be eliminated. Unfortunately, many people would argue that this would create an economic slump. In the same respect, however, we have a progressive income tax system in place. As soon as we stop thinking of Social Security as insurance and start thinking of it as a tax, the perspective of having an actual limit would no longer make sense. (A similar tax, that for Medicare insurance, stands at 1.45% on all income.)
  • Raise the retirement age. Life expectancies have increased significantly since Social Security was enacted. I suggest full retirement benefits at age 70 and partial benefits at age 65. People today can work much longer than before. Many people in their 60s, 70s, and 80s can work part-time jobs as part of their “retirement” lifestyle.

To enact this, perhaps we should use the current age of 60 as the cutoff point. In other words, people under 60 (i.e., the baby boomers, Generation X, and the millennial generations) will probably have accumulated more wealth and transfers of wealth than any prior generation. Therefore, I would keep the current system intact for people 60 and older and switch to this new system for people under 60.

There is no quick-fix solution to Social Security. This issue will still take many years to resolve fully. Let us hope it is fixed by 2010, the year that the first baby boomers will retire and start receiving benefits. I look forward to comments from other accountants and economists.

Eric Rothenburg, CPA, is an associate professor of accounting and economics at Kingsborough Community College of the City University of New York.




















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