Wednesday, December 28, 2011

Payroll Tax Cut Doesn't Alter Social Security's Status

Randall Holcombe argues that the payroll tax cut will alter Social Security's status:

"The Social Security program has been based on the premise that it works like a pension program. Workers pay in to the program when they are working, and then collect pension benefits when they retire. Retirees are entitled to those benefits because they paid for them through the payroll tax when they were working.

Despite the fact that the Social Security program is run like a Ponzi scheme, the entitlement aspect of the program is difficult to argue against. Workers have been told all their lives that in exchange for paying the payroll tax, they are entitled to retirement benefits.

The payroll tax cut severs that link. The payroll tax has been cut in half, and the difference is being made up from general revenues. Workers can no longer say they paid their taxes and are entitled to their benefits, because half of those taxes are now coming from general revenues, just like any other entitlement program."

However, Holcombe is wrong to argue that before the payroll tax cuts there was a strong link between the the taxes paid collectively and the benefits received.

Holcombe seems to think that Social Security works like the new Swedish pension system where there is a direct link between how great assets the government pension funds have and how high benefits the retirees receive, something that for example meant that following the 2008-09 economic slump, pensions benefits received by retirees were automatically reduced because the slump meant that the funds received lower revenues and because the value of the stocks they held fell.

By contrast, Social Security benefits (like benefits in the old Swedish pension system that was in place until 1994) have never been linked to how high payroll tax benefits the government have received, they have instead been linked to inflation. This means that when revenues have fallen due to recessions, it has always been compensated through "general revenue". Compensating a reduction in revenues due to lower tax rates is in principle no different from compensating a reduction in revenues due to a lower tax base. The alleged link between payments and benefits have never been more than an accounting illusion meant to deceive people about the program's true nature, a deception that Holcombe seems to have fallen for.


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