A tiny flickering light has emerged from the Social Security debate: The payroll tax is a tax, period. If you are at least 50 years old, it may be something better. If you are younger, it is just a tax.

If it is "just a tax"--- money taken from paychecks with little prospect for future benefit--- we find ourselves with a radically different view of who pays the highest taxes in America.

It isn't the rich or the very affluent. It's a skilled working stiff, the worker who earns somewhere between $38,000 and $98,000 a year.

You can understand this by considering the basic topic of the Social Security debate and how it affects every worker under the age of 50.   While there is plenty of money to pay benefits to those 50 and over, there won't be enough to pay the same benefits when those under 50 retire.

Expected payroll tax collections over the next 75 years will be short by about $4 trillion in today's dollars. Even if the Social Security Trust fund---the payroll tax overcharges collected since the Social Security reform of the mid 1980's--- is good money, benefits will have to be cut by 26 percent in the year 2041. That's when today's 30 year olds will be 66.

Topic No. 1   in the Social Security debate is how to cut benefits for workers under age 50. There is no Topic No. 2.

The preferred solution from President George W. Bush is to cut benefits and divert some of the payroll tax dollars into private accounts. The hope is that superior investment returns will make up for the benefit cuts.

Others want to cut benefits by changing how they are calculated, substituting price indexing for wage indexing. Since wages rise faster than inflation, the change would eliminate the $4 trillion shortfall by cutting benefits.

Still others reject private accounts and benefit reductions. They suggest that we increase payroll tax revenue by (1) a small increase in the payroll tax or (2) eliminating the $90,000 wage cap on the tax or (3) some combination of (1) and (2). Reader mail tells me that the 94 percent of all workers who earn $90,000 or less would solve the problem by eliminating the cap.

MFS Investment Management Chairman Robert Pozen, who offered the progressive price-indexing plan for cutting benefits, argues that raising the payroll tax cap would reduce public support for Social Security.

Well, if increasing payroll taxes on the 6 percent of all workers over the wage cap will reduce public support for Social Security, what will increasing taxes on the 64 percent of all workers most affected by progressive indexing do? Since the 64 percent of workers---younger workers with incomes between $20,000 and $90,000 today--- would see their future benefits cut while their current taxes remain the same, what he is proposing is a tax increase for younger middle income workers. Government will take the same amount of income today but future benefits will be reduced.

People, in my experience, are smarter than the technocrats think. Progressive Indexing may not be called a tax but it looks like a tax, feels like a tax, and acts like a tax. It is a youth-based tax.

The message coming from all these proposals is simple: The benefits anyone under 50 can expect from paying the payroll tax are at hazard.

They were at hazard in the Social Security reform of the mid-1980's.

They are at hazard today.

They will be at hazard whenever Congress is in session.

The payroll tax that promised--- and delivered--- retirement security for more than half a century is history.   Now it is simply a tax, like the Federal income tax. The younger you are, the more it will function as a pure tax because today's Social Security reform will be followed by another, and another.

Readers who think me cynical should consider that the mid-1980's reform was applauded as providing solvency for at least 75 years.

So let's examine our purported graduated income tax in this context. Let's see what the marginal tax rate (the rate applied to the last dollar of earnings) is for a single, self-employed worker at different levels of income.
  • If you are single and earn up to $8,200, your income is taxed at 15.3 percent because you will pay no federal income tax (FIT).
  • If you are single and earn over $8,200 but less than   $15,500, your income is taxed at a 25.3 percent rate (10 percent FIT, 15.3 percent employment (FICA) tax).
  • If you are single and earn over $15,500 but less than $37,900, your income is taxed at a 30.3 percent rate (15 percent FIT, 15.3 percent FICA)
  • If you are single and earn over $37,900 but less than $80,150, your income is taxed at a 40.3 percent rate (25 percent FIT, 15.3 percent FICA).
  • If you are single and earn over $80,150 but less than $90,000, your income is taxed at a 43.3 percent rate (28 percent FIT, 15.3 percent FICA).
  • If you are single and earn over $90,000 but less than $158,350, your income is taxed at a 30.9 percent rate (28 percent FIT plus 2.9 percent Medicare tax).
  • If you are single and earn over $158,350 but less than $334,650, your income is taxed at a 35.9 percent rate. (33 percent FIT plus 2.9 percent Medicare tax).
  • If you are single and earn over $334,650, your income is taxed at a 37.9 percent rate (35 percent FIT plus 2.9 percent Medicare tax).
Alternate table:

  
The New Reality of Taxes for Workers Under Age 50
This table uses the standard income tax tables, standard deduction of $5,000, personal exemption of $3,200, and 2005 payroll tax wage base of $90,000 to calculate the marginal tax rate on income at each level from $0 to more than $334,650.
Adjusted Gross Income Tax Rate Components of Tax Rate
$ 0 to $8,200 15.3% 15.3% payroll, 0% income tax
$ 8,201 to $15,500 25.3% 15.3% payroll, 10% income tax
$15,501 to $37,900 30.3% 15.3% payroll, 15% income tax
$37,901 to $80,150 40.3% 15.3% payroll, 25% income tax
$80,151 to $90,000 43.3% 15.3% payroll, 28% income tax
$90,000 to $158,350 30.9%    2.9% Medicare, 28% income tax
$158,351 to $334,650 35.9%    2.9% Medicare, 33% income tax
$334,650 37.9%    2.9% Medicare, 35% income tax
Source: Internal Revenue Service
  

For young workers--- anyone under 50--- there is no such thing as a graduated tax system in America. Nor is there generational equity.

This is why we need to privatize Social Security for young workers and guarantee the benefits of older workers and retirees with a national sales tax.

Tuesday, January 8, 2005--- "A New Deal for This Century"

Social Security, Medicare, and Generational Storm Reader

URL to come: Robert Pozen on Progressive Indexing