Social Security and The Payroll Tax Cut

Last Friday, Congress passed another extension to the payroll tax cut. It looks like this one will last until the end of 2012, at least. This has always been an issue that seemed like a slam dunk to me, especially for conservatives and libertarians. We spend so much time saying taxes are too high, so when one of the most liberal Presidents in living memory actually wants to cut taxes, why would we ever say no? Nevertheless, many Republicans and even a few libertarians I admire have resisted this tax cut, allowing the media to paint this most recent extension as "handing President Barack Obama a major victory in this election year" (that's Reuters at the Yahoo link above).

Even though this isn't likely to come up again for another ten months or so, I left a comment on Coyote's post above, and I'd like to echo those ideas here. If taxes are too high, I think we should cut them any chance we can, because we don't get too many chances. But the main issue with the payroll tax cut, for me, is how it relates to Social Security reform.

The Personal Case for Reform
I'm young enough that two things are true for me when it comes to Social Security:

1) The Cliff. The program isn't going to be there for me when I retire, not without major cuts to benefits or major tax increases. The most relevant graph is on slide 15 of this CBO report, reproduced at right. Although revenues are projected to stay rather constant, outlays are already greater than revenues and are expected to grow even more. That is, they're expected to grow until the trust fund runs out in the late 2030s, and the "payable benefits" line has a dramatic cliff. Suffice it to say, my earliest-possible retirement date doesn't come until after that cliff.

There are some (relatively) minor changes that could be made to push that cliff back a few years, such as raising the retirement age, raising the tax rate, changing the cost-of-living adjustment calculation, means testing benefits, etc. We might even push it back a few decades, but this ignores that in 2008 (PDF), the cliff wasn't supposed to come until the late 2040s. In less than four years, the cliff is some fourteen years closer. Considering demographics, including the high probability of advances in life extension, pushing the cliff back will only be a temporary solution (and we may not succeed at pushing it back in the first place).

2) There is still hope. If we do manage to enact meaningful reform (meaning some kind of personal accounts that move us away from pay-as-you-go), my retirement is far enough in the future that I have time to save up enough for my own retirement within the new system.

For these reasons, I personally hope that we switch to something like the Chilean model as soon as possible.

The Societal Case for Reform
Obviously, not everyone will be persuaded to do what is best for me alone, but I also believe that this is the best approach for the rest of society as well. The two facts above are even more true for everyone younger than me, and they are also mostly true for those a few years older than me. On the other hand, no serious proposed Social Security reform touches those who are already on benefits, and most don't change the program at all for those 55 or older, so those two groups won't see any difference anyway.

Those who stand to lose the most from immediate reform are therefore those in the 40-55 age range. However, given probable medical advances in the coming decades, those who are now in their 40s and 50s can likely expect to live to their 80s, 90s or beyond. They will live past the approaching cliff, and will have to deal with the same cuts in benefits that I would. The difference is that, unlike me, they might be able to push the cliff past their own deaths with only minor reforms.

The Payroll Tax Cut
The Social Security trust fund is held in Treasury securities. Like all Treasury securities, when the securities in the trust fund are redeemed, they are paid for from the general fund. Since the Social Security Administration is now running on a deficit, redeeming the Treasury securities it holds, Social Security benefits are already being paid for, in part, by the general fund. That general fund comes from all the other taxes we pay. The Social Security trust fund is real, but it is funded through general tax dollars, not through some special pile of cash we've kept separate from the rest of the economy somehow

This is a marvelous accounting gimmick. Indeed, from my view, the biggest argument against Social Security reform today is the false idea that nothing is wrong because we have the trust fund. Therefore, anything we can do to dispel this idea will be useful in achieving real reform early enough to make a difference for people like me.

How do we dispel this false idea? Well, education, partly through blog posts like this, is one way to do it. But a more effective way is to erase the accounting gimmick itself-- that is, draw down the trust fund until no one is able to ignore that coming cliff. The payroll tax cut accomplishes exactly that. If we keep the tax cut in place, Social Security runs a larger annual deficit, and has to draw down the trust fund faster than planned. The sooner we draw down the trust fund, the sooner we'll see real reform.

With the payroll tax cut, we're more likely to see real Social Security reform sooner. Add to that the libertarian-minded benefit of cutting any tax and the economics-minded benefit of giving every worker a little extra take-home pay, and, as I see it, extending the payroll tax cut is a clear victory for the good guys.