The recent policy of reducing the Social Security payroll tax and
replacing the foregone revenue with general government funds represents a
fundamental departure from Social Securityfs historic self-financing
principle.
The implications of severing the programfs contribution-benefit link
are not yet clear. To the extent that it is either precedent-setting or
permanently undermines previous public perceptions of Social Security as an
earned benefit, the change could pose substantial ramifications for future
Social Security policy.
In a new Mercatus Center study, Charles Blahous,
senior research fellow at the Mercatus Center at George Mason
University and public trustee for Social Security and
Medicare, reviews the philosophical basis for Social Securityfs unique financing
structure; considers what the movement toward general-revenue financing may mean
for the future of the program; and discusses what, if anything, can be done to
restore the program to its self-financed, earned-benefit roots.
BACKGROUND
For most of Social Securityfs history, there has been a strong
bipartisan commitment to preserve the programfs self-financing principle. As
President Franklin D. Roosevelt designed it, its benefits would be financed by
workersf contributions, not by general revenues. This earned-benefit structure
was intended to distinguish Social Security from welfare; to impose fiscal
discipline within the program; and, notably, to ensure program benefits enjoyed
special political protection from competition elsewhere in the budget. As FDR
explained:
gWe put those payroll contributions there so as to give the
contributors a legal, moral, and political right to collect their pensions and
unemployment benefits. With those taxes in there, no damn politician can ever
scrap my Social Security program.h
But over the past several years, commitment to this principle has
weakened, as lawmakers have become less willing to tax workers at the level
required to finance rising benefit costs. The trend culminated in the 2010
decision to reduce Social Securityfs principal financing stream—the payroll
tax—for economic stimulus and to turn formally to general revenues to subsidize
the program. This shift threatens to fundamentally alter Social Securityfs
intended designation as an earned benefit as well as the long-standing
protections that status has provided.
Below is a brief summary.
KEY POINTS
- FDR designed Social Security as a self-financed program to
distinguish it from welfare, to impose fiscal discipline within the program,
and to ensure all working people had a sense of having earned their
benefits—all of which worked together to protect benefits from political
pressure and budgetary competition.
- Since its inception, Social Security has enjoyed a unique level
of political support because it was structured on the self-financing
principle. With relatively minor exceptions, there remained a strong
bipartisan consensus through the mid 1990s to preserve this structure.
- Over the past several years, commitment to this practice has
progressively weakened as lawmakers have become less willing to tax workers,
particularly lower-income workers, at the level required to finance rising
benefit costs.
- While several policies had already been enacted to shift Social
Security financing burdens tacitly from individual payroll tax payers to the
general government fund, the self-financing link remained formally intact
until the payroll tax cut was enacted in 2010 and made effective for
2011–12.
- In 2010, President Obama and Congress formally severed the
Social Security programfs contribution-benefit link with the enactment of the
payroll tax cut, which included a provision to tap general revenues to
subsidize Social Security benefit payments.
- If Social Securityfs contribution-benefit link continues to
deteriorate, it could transform public perceptions of the program into
something more akin to welfare.
SUMMARY
Introduction: Franklin D. Roosevelt and the Ethic of an Earned
Benefit
From its inception, Social Security was intended to be, and has
since been perceived to be, distinguished from a welfare program, in which
recipients collect benefits based on need while others provide revenues based on
their ability to pay.
President Franklin D. Roosevelt understood that a program financed
from general taxes would be exposed to competition from other federal programs
for budgetary resources and, thus, to constant pressure to limit costs, either
by constraining benefit levels or by limiting the number of those eligible to
receive them. As FDR insisted:
gWe must not allow this type of insurance to become a dole
through the mingling of insurance and relief. [Social Security] is not charity.
It must be financed by contributions, not taxes.h
After the 1983 Social Security Reforms: Still Self-Financing
or Not?
Through most its history, Social Security was operated essentially
on a gpay as you goh basis. Each year, tax collections and benefit expenditures
were approximately balanced. Before the mid-1980s, while Social Security
maintained separate trust funds, the residual balances of these funds were kept
relatively small as a matter of deliberate federal policy.
In the early 1980s, however, Social Securityfs financing crisis
resulted in a landmark bipartisan agreement to ensure program solvency for
decades to come. One result was that, from the mid-1980s until 2010, Social
Security ran substantial annual operating surpluses, causing its trust fund
balances and interest earnings to explode. It is largely owing to these interest
credits—paid not by participating workers but from the general fund of the U.S.
Treasury—that the combined Social Security Trust Funds will remain solvent
through 2033.
So, while the landmark 1983 program reforms did not destroy
conceptual support for Social Securityfs self-financing principle, they did
bring into question whether self-financing would continue to be observed in
practice.
The Enduring Strength of the Self-Financing Concept through
the Mid-1990s
Despite the analytical complexities introduced by the 1983
amendments, the foundational principle that Social Security should be an earned
benefit, self-financed through participant contributions and tracked in separate
trust funds, retained enduring bipartisan support through the mid 1990s, even
among experts who were otherwise sharply divided in their Social Security policy
preferences.
As one example, President Clintonfs 1994–96 Social Security Advisory
Council unanimously opined: gSocial Security should be financed by taxes on
workersf earnings, earmarked taxes on benefits, and interest earnings on
accumulated reserves, without other payments from the general revenue of the
Treasury.h
Cracks in the Consensus: Proposals to Break Social Securityfs
Contribution-Benefit Link
1999. The introduction of President Clintonfs gSave Social Security
Firsth proposal marked the first point at which discussions of departing from
Social Securityfs self-financing structure entered the political
mainstream.
Under the proposal, Social Security would have had a new claim on
general tax revenues and be given the authority to spend substantially more on
benefits than it had generated in taxes. The taxpayers who provided these
revenues would not, however, be given additional benefit credits, nor would
their additional contributions be tracked separately on W-2 forms in the
historic manner of other FICA contributions.
Although the Clinton proposal was never seriously considered, Social
Security experts at the time understood that it would have fundamentally changed
the nature of the program. Over the following decade, a number of other
proposals were introduced to require higher-income taxpayers to subsidize Social
Security with progressively assessed taxes that would not earn benefit
credits.
2010. The influx of Baby Boomers onto the retirement and disability
rolls, combined with an economic recession, caused Social Security to run a
deficit of expenditures over tax income for the first time since 1983. These
fiscal strains arose following a decade of changing opinions among some
influential thinkers in favor of breaking Social Securityfs contribution-benefit
link and subsidizing benefit payments through progressively assessed taxes,
drawing the era of Social Security as a self-financed, earned benefit nearer to
a close.
The Lure of Payroll Tax Relief
As bipartisan commitment to preserving Social Securityfs
contribution-benefit link has eroded, the attraction of payroll tax relief has
risen. By 2010, four crucial political factors were present: misperceptions that
the payroll tax was regressive; discomfort among lawmakers with charging workers
for the full cost of their Social Security benefits; a desire to offer gtax
reliefh to the nearly half of American households who owe no federal income tax;
and fading commitment among some advocates to maintaining Social Security
self-financing. These and other factors combined to create an environment
conducive to cutting the payroll tax, subsidizing the program with general
revenues, and abandoning Social Securityfs historic design as a self-financing
program.
The Abandonment of Self-Financing: The 2011–12 Payroll Tax
Cut
The current administration and Congress formally broke the Social
Security programfs contribution-benefit link with the enactment of the 2010
payroll tax holiday. With a desire for short-term stimulus but unwilling to
reduce benefit payments, policymakers decided to reduce the Social Security
payroll tax and to subsidize the program from the general fund.
Congress and the President must soon decide whether to allow the
existing payroll tax cut and accompanying general revenue transfer to expire or
be continued beyond the end of 2012. But even if the full payroll tax is
restored, the policy implications of the recent payroll tax cut are potentially
substantial.
Implications for Taxpayers and for the Federal
Budget
The provision of substantial general revenue to Social Security
commits the federal budget—and the income tax payers standing behind it—to
supporting rising benefit costs for a longer period of time. The effect of the
transfers also postpone the programfs projected insolvency date, diminish the
apparent urgency of legislative
action, postpone needed reforms, cause more beneficiaries to be on the rolls
by the time a legislative solution is finally negotiated, and constrain the
policy options available to maintain self-financing.
The Future of Social Security in the Era of General-Revenue
Subsidization
There are essentially four possible future courses for Social Security
policy:
- Continuation. Social Security continues to receive substantial
subsidies from the general fund while its historic ethic of self-financing is
tacitly abandoned.
- Recurrence. Current general-revenue subsidies terminate on
schedule, but a precedent is established whereby lawmakers feel free to resume
such subsidies whenever they believe other policy considerations warrant their
use.
- Termination with lasting policy effects. Current general-revenue
subsidies terminate on schedule and are not revived, but the publicfs
perception of Social Securityfs role is significantly altered by the awareness
that benefit payments are subsidized from the general fund.
- Termination with no lasting policy effects. General revenue
subsidies are terminated on schedule, public awareness of the subsidies
remains limited, and lawmakers henceforth treat the 2011–12 practice as a
one-time exception to long-standing policy and strictly enforce self-financing
in the future.
The fourth scenario could only transpire if lawmakers re-adopt the historic
requirement that Social Security tax collections be sufficient to fund its
benefit payments, solely excepting the $217 billion in general-fund subsidies
provided during 2011–12.
Under the other scenarios, Social Securityfs future is substantially
different because of general-revenue financing. It is impossible to know when
continued general-fund subsidization would so alter public perception of Social
Security as an earned benefit as to precipitate other transformative changes in
Social Security policy. This could, however, happen within the next few years as
general-revenue subsidies replace net-tax surpluses in the importance of their
contributions to the balance of the Social Security Trust Funds.
For most of its history, Social Security benefits have been treated
differently from programs financed from the general government fund. Benefits in
general-fund-financed programs have historically grown more slowly than Social
Securityfs—for example, by being indexed for price inflation rather than the
faster wage-growth index that is used to calculate Social Security benefits.
General-fund-financed programs are also more likely to be subjected to means
testing and to sudden changes in eligibility criteria. These differences reflect
a dynamic in which lawmakers value the interests of income taxpayers who support
programs through the general fund on a par with those of beneficiaries. It is
therefore possible that the policy change to finance Social Security from the
general fund will bring with it a number of other potential policy changes.
Conclusion
The end of the requirement that payroll tax assessments be sufficient to
finance Social Security benefit payments could undercut the strength of recent
arguments for future increases in the programfs payroll tax base. The
introduction of subsidies from the general fund may well influence other value
judgments of Social Security policymaking concerning continued wage indexation
of the benefit formula, whether a contribution-benefit link is maintained, how
eligibility ages are set, and formal means testing, among others.
In sum, the end of self-financing could mean an end to policy dynamics that
have historically rendered Social Security unique and thereby prompt
consideration of policy options that have traditionally been applied only to
what have been popularly thought of as welfare programs.
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