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Posts Tagged ‘Unfunded Liabilities’

Under current law, Social Security is supposed to be an “earned benefit,” where taxes are akin to insurance premiums that finance retirement benefits for workers. And because there is a cap on retirement benefits, this means there also is a “wage-base cap” on the amount of income that is hit by the payroll tax.

For 2011, the maximum annual retirement benefit is about $28,400 and the maximum amount of income subject to the payroll tax is about $107,000.

It appears that President Obama wants to radically change this system so that it is based on a class-warfare model. During the 2008 campaign, for instance, then-Senator Obama suggested that the programs giant long-run deficit could be addressed by busting the wage-base cap and imposing the payroll tax on a larger amount of income.

For the past two years, the White House (thankfully) has not followed through on this campaign rhetoric, but that’s now changing. His Fiscal Commission, as I noted last year, suggested a big hike in the payroll tax burden. And the President reiterated his support for a class-warfare approach earlier this week, leading the Wall Street Journal to opine.

Speaking Tuesday in Annandale, Virginia, Mr. Obama came out for lifting the cap on income on which the Social Security payroll tax is applied. Currently, the employer and employee each pay 6.2% up to $106,800, a level that rises with inflation each year. …Mr. Obama didn’t hint at specifics, though he did run in 2008 on a plan to raise the “tax max” by somewhere between two to eight percentage points for the top 3% of earners. …most of the increase could be paid by the middle class or modestly affluent—i.e., those who merely make somewhat more than $106,800. A 6.2% additional hit on every extra dollar they make above that level is a huge reduction from their take-home pay. If the cap is removed entirely, it will also mean a huge increase in the marginal tax rates that affect decisions to work, invest and save. In a recent paper for the American Enterprise Institute, Andrew Biggs calculates that this and other tax increases Mr. Obama favors would bring the top marginal rate to somewhere between 57% and 68% when factoring in state taxes. Tax levels like these haven’t been seen since the 1970s.

Obama is cleverly avoiding specifics, largely because the potential tax hike could be enormous. The excerpt above actually understates the potential damage since it mostly focuses on the “employee” side of the payroll tax. The “employer” share of the tax (which everyone agrees is paid for by workers in the form of reduced take-home wages) is also 6.2 percent, so the increase in marginal tax rates for affected workers could be as high as 12.4 percentage points.

This video from the Center for Freedom and Prosperity, narrated by yours truly, elaborates on why this is the wrong approach.

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One of my presentations at CPAC addressed America’s long-term entitlement crisis. I was part of a panel organized by the National Taxpayers Union, and I discussed how to solve the long-run fiscal problems caused by Social Security, Medicare, and Medicaid.

The lighting and focus leave something to be desired, but hopefully my message is crisp and clear.

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There are two crises facing Social Security. First the program has a gigantic unfunded liability, largely caused by demographics. Second, the program is a very bad deal for younger workers, making them pay record amounts of tax in exchange for comparatively meager benefits. This video explains how personal accounts can solve both problems, and also notes that nations as varied as Australia, Chile, Sweden, and Hong Kong have implemented this pro-growth reform.

Social Security reform received a good bit of attention in the past two decades. President Clinton openly flirted with the idea, and President Bush explicitly endorsed the concept. But it has faded from the public square in recent years. But this may be about to change. Personal accounts are part of Congressman Paul Ryan’s Roadmap proposal, and recent polls show continued strong support for letting younger workers shift some of their payroll taxes to individual accounts.

Equally important, the American people understand that Social Security’s finances are unsustainable. They may not know specific numbers, but they know politicians have created a house of cards, which is why jokes about the system are so easily understandable.

President Obama thinks the answer is higher taxes, which is hardly a surprise. But making people pay more is hardly an attractive option, unless you’re the type of person who thinks it’s okay to give people a hamburger and charge them for a steak.

Other nations have figured out the right approach. Australia began to implement personal accounts back in the mid-1980s, and the results have been remarkable. The government’s finances are stronger. National saving has increased. But most important, people now can look forward to a safer and more secure retirement. Another great example is Chile, which set up personal accounts in the early 1980s. This interview with Jose Pinera, who designed the Chilean system, is a great summary of why personal accounts are necessary. All told, about 30 nations around the world have set up some form of personal accounts. Even  Sweden, which the left usually wants to mimic,  has partially privatized its Social Security system.

It also should be noted that personal accounts would be good for growth and competitiveness. Reforming a tax-and-transfer entitlement scheme into a system of private savings will boost jobs by lowering the marginal tax rate on work. Personal accounts also will boost private savings. And Social Security reform will reduce the long-run burden of government spending, something that is desperately needed if we want to avoid the kind of fiscal crisis that is afflicting European welfare states such as Greece.

Last but not least, it is important to understand that personal retirement accounts are not a free lunch. Social Security is a pay-as-you-go system, so if we let younger workers shift their payroll taxes to individual accounts, that means the money won’t be there to pay benefits to current retirees. Fulfilling the government’s promise to those retirees, as well as to older workers who wouldn’t have time to benefit from the new system, will require a lot of money over the next couple of decades, probably more than $5 trillion.

That’s a shocking number, but it’s important to remember that it would be even more expensive to bail out the current system. As I explain at the conclusion of the video, we’re in a deep hole, but it will be easier to climb out if we implement real reform.

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I’m just making up the 1.94 percent number, but the International Herald Tribune reported last year that unfunded liabilities in France are nearly 550 percent of GDP. The news reports don’t include any estimates of what Sarkozy’s reform will mean, but I would be surprised if it had a big impact on France’s long-run fiscal nightmare. But, as the old saying goes, a journey of a thousand miles begins with a first step, and Sarkozy has pushed through the reforms notwithstanding protests and riots from left-wing unions and brain-dead students (who don’t seem to realize that they’ll pay even higher taxes if entitlements aren’t reformed).

Under pressure from the government, the French Senate voted Friday to raise the retirement age from 60 to 62, a victory for President Nicolas Sarkozy after days of street rage, acrimonious debate and strikes that dried up the supply of gasoline across the country. The vote all but sealed passage of the highly unpopular measure, but it was unlikely to end the increasingly radicalized protests. The coming days promised more work stoppages and demonstrations by those who feel changing the retirement age threatens a French birthright. …Leftist critics called the move a denial of democracy by an increasingly confrontational president. “No, you haven’t finished with retirement. You haven’t finished with the French,” said Socialist Sen. Jean-Pierre Bel, alluding to an apparently unflagging determination by unions, now joined by students, to keep protests alive — even through the upcoming week of school holidays.

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The Economist has a fascinating webpage that allows you to look at all the world’s nations and compare them based on various measures of government debt (and for various years).

The most economically relevant measure is public debt as a share of GDP, and you can see that the United States is not in great shape, though many nations have more accumulated red ink (especially Japan, where debt if much higher than it is in Greece).  As faithful readers of this blog already understand, the real issue is the size of government, but this site is a good indicator of nations that finance their spending in a risky fashion.

By the way, keep in mind that these figures do not include unfunded liabilities. For those who worry about debt, those are the truly shocking numbers (at least for the United States and other nations with government-run pension and health schemes).

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