Thought du Jour

Americans unofficially refer to their tier 2, contributory government pension scheme as ‘Social Security’. The programme is funded pay-as-you-go from contributions (payroll taxes). For many years, Social Security revenues have exceeded expenditures, but eventually benefits will have to be cut, or payroll taxes increased, to balance the account without government subsidies.

Social Security is ‘universal’ in the sense that participation is mandated, and the same rules apply to all workers. Benefits depend on the record of contributions and are nil if this record is shorter than forty quarters (ten full years). Many Social Security pensions are very small, indeed. Nonetheless, for a majority of seniors the monthly government benefits are very important. Two-thirds of Americans older than age 65 depend on Social Security for at least half of their income.

NY Times contributor Thomas B. Edsall wonders why politicians focus on introduction of means tests, or raising the age of eligibility, and ignore completely the possibility of broadening the base for payroll taxes.

Currently, earned income in excess of $113,700 is entirely exempt from the 6.2 percent payroll tax that funds Social Security benefits (employers pay a matching 6.2 percent). 5.2 percent of working Americans make more than $113,700 a year. Simply by eliminating the payroll tax earnings cap — and thus ending this regressive exemption for the top 5.2 percent of earners — would, according to the Congressional Budget Office, solve the financial crisis facing the Social Security system.

So why don’t we talk about raising or eliminating the cap – a measure that has strong popular, though not elite, support? ….

The Washington cognoscenti are more inclined to discuss two main approaches that are far less costly for the affluent: means-testing of benefits and raising the age of eligibility …. ['Saving Social Security' by] cutting spending appeal[s] to ideological conservatives for a number of reasons.

First, insofar as benefits for the affluent are reduced or eliminated under means-testing, social insurance programs are no longer universal and are seen, instead, as a form of welfare. Public support would almost certainly decline, encouraging further cuts in the future.

Second, the focus on means-testing and raising the age of eligibility diverts attention from a much simpler and more equitable approach: raising the payroll tax to apply to the earnings of the well-to-do, a step strongly opposed by the ideological right.

Third, and most important in terms of the policy debate, while both means-testing and eliminating the $113,700 cap on earnings subject to the payroll tax hurt the affluent, the latter would inflict twice as much pain. ….

Theda Skocpol, a professor of government and sociology at Harvard and an authority on the history of the American welfare state, contended in a phone interview that policy elites avoid addressing the sharply regressive nature of social welfare taxes because, “at one level, it’s very, very privileged people wanting to make sure they cut spending on everybody else” while “holding down their own taxes.”

Thomas B. Edsall, “The War On Entitlements“, Opinionator, New York Times, 6 March 2013.

There is much more at the blog post. Thanks to Mark Thoma for the pointer.

Journalist Thomas Edsall (born 1941) is a full-time professor at Columbia University. His latest book is The Age Of Austerity: How Scarcity Will Remake American Politics (Doubleday, 2012).

Douglas Walker has posted a thoughtful comment on yesterday’s post, titled “wealth tests are taxes”. I think the comment is important, so reproduce the gist of it here, and attempt to give a response that it deserves.

Yesterday’s post centred on the plight of a Detroit woman on Supplemental Security Income (SSI) who works part time and lives frugally in a low rent trailer park, but chooses not to save any of her earnings because if her accumulated savings were to become larger than $2,000 she would become ineligible for SSI.

Douglas objects to the fact that the woman is receiving SSI even though she obviously has an income in excess of that necessary to provide for her basic needs:

SSI and other benefits are not intended to transfer income. Their purpose is to provide some minimal level of living that society deems adequate. In the example given below the woman had a part-time low wage job which, when SSI was added, provided her with current purchasing power above what she must have regarded as an adequate level of consumption. So, rationally, she could have saved the extra income or in this case seemingly irrationally spent it on marijuana. Her SSI should have been lowered to match her own evaluation of her consumption needs.

Moreover, Douglas thinks that the $2,000 allowable savings is too generous – potential beneficiaries should be forced to spend all their savings before receiving SSI:

If people have saving in the bank why should others be asked to reduce their consumption and potential wealth to preserve the existing wealth of someone else? It’s not fair to the average taxpayer. Let people draw down on their wealth until they are truly in need.

Douglas is correct in stating that the purpose of SSI is provision for basic needs of recipients. According to the Official Website of the US Social Security Administration:

Supplemental Security Income (SSI) is a Federal income supplement program funded by general tax revenues (not Social Security taxes):

It is designed to help aged, blind, and disabled people, who have little or no income; and

It provides cash to meet basic needs for food, clothing, and shelter.

But Douglas is wrong to assert that SSI is not designed to transfer income. It is impossible for government to help low-income aged, blind and disabled people without transfering income to them from general government revenue, i.e. from taxes that are paid predominantly by those who are more wealthy. What Douglas objects to, I suspect, is not that transfers exist, but that they are too large and are given to those who, after transfers from government, end up with more than a subsistence income.

I also think that Douglas is wrong to assert that the woman in Detroit was “seemingly irrational” by spending her excess income on marijuana rather than saving it. It is true that she purchased an illegal drug (marijuana) rather than a legal drug (alcohol or tobacco) that might have been the choice of others, but her failure to save was a rational decision. Even a few dollars of additional savings could cause her to lose her entire SSI benefit.

To discuss the plight of this SSI recipient further, it is helpful to look at some numbers, even if some of them are necessarily semi-hypothetical.

The 2013 Federal benefit rate for SSI is $710 a month. Some states supplement this (from ten to two hundred dollars), but Michigan does not. Some wealth is not counted in determining eligibility for SSI. Ownership of a primary residence, for example, does not count, nor does ownership of a car if one is needed because of lack of public transportation. Always included in the $2,000 wealth test are cash, bank deposits, stocks and bonds. I do not know how the SSI manages to monitor the amount of cash stuffed in mattresses, but apparently the agency is able to carry out this task!

Once an applicant passes the wealth test, an income test remains.

Earned Income is wages, and net earnings from self–employment. The SSI benefit is reduced by $1 for every $2 after the first $65 of earned income each month.

Unearned Income is all income that is not earned, such as income from pensions (including Social Security pensions), State disability payments, unemployment benefits, interest on savings, and cash from friends and relatives. SSI benefits are reduced by $1 for each $1 of unearned income, after a free allowance of $20 a month.

Deemed Income is the part of the income of a spouse with whom an applicant lives, which is used to reduce the amount of an SSI benefit if the spouse is not eligible for SSI. This does not apply to our Michigan example, as the lady lives alone.

Now for our semi-hypothetical example. Let us, for simplicity, disregard unearned income, and assume that our SSI beneficiary works half-time (20 hours a week) for the minimum wage, which is $7.40 an hour in Michigan. Her monthly income, then, would be as follows:

$641.33 (Gross wages)
-65.00 (Not counted in the income test)
$576.33 divided by 1/2
=288.17 (Countable income)

$710.00 (SSI Federal benefit rate)
-288.17 (Countable income)
=421.83 (SSI Federal benefit)

With these assumptions, the woman’s gross monthly income is $1063.16. Her net income would be less, as she would have to pay a 6.2% social security payroll tax on wages as well as a sales tax of 6% on most purchases of goods and services (presumably not marijuana, though!).

Let us suppose that the $710 SSI Federal benefit rate is a good measure of the cost of living at a basic level. Douglas proposes that we reduce the SSI benefit so that our beneficiary has only this amount of total monthly income. How can this be done? There are two possibilities, and neither is viable.

One option is to reduce the Federal benefit rate by roughly half, to $356.84, leaving the income test unchanged. This would yield the desired gross income of $710 a month for our lady, who has a part-time job, but other recipients of SSI – who are unable or unwilling to work – would be left with incomes far below that needed for survival in Michigan. This option is clearly unacceptable if our goal, in the words of Douglas, is to ensure that everyone enjoys “some minimal level of living that society deems adequate”.

A second option is to retain the SSI benefit rate of $710, but reduce it by one dollar for each dollar of income from any source, earned or unearned, with no exempt (‘not counted’) amount. Our semi-hypothetical Detroit beneficiary would find her SSI benefit falling from $421.83 to $68.67 and her gross income falling from $1063.16 to $710.

But would our lady continue to work 20 hours a week at a low-paid job? People – even those who are not wealthy – respond to incentives. Why would she continue to work if she receives no reward, no increased income from her sacrifice? This option, like the first, is clearly not viable. Its unintended consequence is the creation of poverty traps, from which the poor have no incentive to
exit. Wealthy taxpayers, though, could then point fingers at the ‘undeserving poor’ who prefer to remain on the dole rather than work for a living.

Is there a third option? I do not see one, but perhaps Douglas has one in mind.

Three years ago EconLog hosted an excellent discussion of means tests. The blogs were excellent, and comments by readers were sometimes even better. “White Detroiter”, for example, wrote:

There still are some programs that include wealth as a means test. Supplemental Security Income (SSI) doesn’t allow you to have more than $2,000 in savings and still receive benefits.

A few years ago I knew someone who was on SSI but had a part time low wage job. She lived in a very low rent trailer park and used the public bus system to get around (she was legally blind so she had no use for a car). Between the SSI and her part time income she was capable of building significant savings but if she did she would lose her SSI. So she spent everything she had on things like marijuana and never really got ahead in life.

“White Detroiter” wrote in response to a comment of Bill Conerly:

Some welfare programs in the past had wealth as a means test. A family on welfare that lived frugally and accumulated an emergency reserve savings account risked disqualification, whereas the family that spent every penny that came in were sure to continue.

Both were responding to EconLog blogger David Henderson who, in an otherwise excellent post, wrote:

Without exception, every time I’ve seen someone advocate means testing, he uses income as his measure of means. This completely ignores wealth. Although income and wealth are highly positively correlated, the correlation is not close to 1.0. Therefore means testing would discriminate in favor of wealthy people with low income.

David Henderson, “Problems with Means Testing“, EconLog, 5 February 2010.

Wealth tests are frequently used in developing countries, and occasionally in high-income countries, such as Hong Kong, Australia and the United States. Sometimes, as in the example of SSI (a noncontributory basic pension in the US), the test is draconian.

As I have said many times, “means tests are taxes”. It follows that a wealth test is a tax on savings, just as an employment test is a tax on wage income, and an income test is a tax on all income.

“White Detroiter” provides a human face for the consequences of a wealth test on very modest SSI benefits. Incidentally, SSI also requires an income test, such that beneficiaries lose 50 cents of benefits for each dollar of “earned income” (such as wages) and one dollar for each dollar of “unearned income”, such as income from a pension, or interest on savings.

People respond to incentives – even when they are poor.