Bloomberg News

Obama Payroll Tax Cuts Seen Undermining Social Security

December 09, 2011

(Updates with Blahous comment in 17th paragraph.)

Dec. 5 (Bloomberg) -- Some Democratic lawmakers say that, while President Barack Obama’s plan to cut payroll taxes may strengthen the U.S. economy, it may have some unintended fallout: weakening Social Security.

The lawmakers and advocacy groups say they are concerned the tax cuts may undermine political support for the retirement program, which provides benefits to almost 55 million Americans and is funded by the payroll levies.

“I don’t object to putting more money in people’s pockets, and there are lots of ways to do that, but not with Social Security,” said Representative Rush Holt of New Jersey, who said he will have a hard time supporting the White House plan.

Should Congress fail to extend the break, set to expire in four weeks, millions of Americans will see their paychecks start shrinking in January. That would be a setback for the economy and could subtract 0.7 percentage point from economic growth, according to Mark Zandi, chief economist at Moody’s Analytics.

Still, Obama’s proposal comes amid growing concern about Social Security’s finances. The program has begun spending more on benefits each year than it receives in payroll tax revenue and, starting in 2036, won’t be able to pay full scheduled benefits, according to the trustees’ latest report.

The system is funded by a 12.4 percent payroll tax equally divided between workers and employers. Congress cut the employee portion this year by 2 percentage points. Obama wants to reduce it further next year, to 3.1 percent, while offering the same rate to employers that take on new workers. The Social Security funding that is lost would be made up through general revenue.

Not the Last?

Social Security advocates say they fear these cuts won’t be the last. It may not be any easier for Congress to allow them to lapse next year, with the elections in November and the unemployment rate projected by the Congressional Budget Office to average 8.5 percent. Forcing the government to tap further into general revenue could lead to the kind of funding fights that Social Security has avoided until now.

Representative Jerrold Nadler, a New York Democrat, said he supports extending the payroll tax cut, though reluctantly.

“To take it away would be a body blow to the economy,” said Nadler, who called the tax cut a “very bad” change in Social Security policy. So “we’ve got to live with it for another year or two.” Massachusetts Democrat Barney Frank said that while he didn’t like the tax cuts initially, it would be a “great mistake” not to continue them now.

‘Straight Politics’

Some critics of Obama’s proposal say their wariness stems from Social Security’s unique character. It was designed in 1935 by President Franklin Roosevelt to be an autonomous program that paid its own way through a dedicated tax.

Though the payroll tax is regressive -- it hits lower- income Americans harder -- Roosevelt believed the levy would make the program politically impregnable. That’s because Americans would feel their benefits had been “bought and paid for” by their payroll taxes by the time they reached retirement, said tax historian Joseph Thorndike.

“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions,” Roosevelt said, according to a 1941 memorandum written by Luther Gulick, an adviser. “With those taxes in there, no damn politician can ever scrap my Social Security program. Those taxes aren’t a matter of economics; they’re straight politics.”

Threat to Legacy

Until recently, the program’s special status was underscored by statements the government mailed to more than 150 million workers tallying how much they have paid in Social Security taxes and how much they can expect to receive in retirement. The government said it is suspending those mailings to save money and plans to make them available online.

Critics say the administration’s tax-cut plan threatens that legacy because it would replace with other revenue the $265 billion the congressional Joint Committee on Taxation estimated would be forgone by Social Security next year.

While transferring other revenue into the program would ensure benefits aren’t cut because of the tax reduction, Social Security advocates may have a harder time arguing that seniors’ benefits were bought and paid for by their payroll taxes.

Chuck Blahous, a former Bush administration economic adviser who now sits on Social Security’s Board of Trustees, called the Obama plan a “very fundamental transformation” in how the program operates.

‘Severe Trouble’

“When you start funding Social Security that way, you basically destroy any notion that people really paid for their Social Security benefits,” he said. “Once we destroy that, we’re going to destroy a lot of the political protections that Social Security has long enjoyed.”

Blahous added, “We’ve got this political dynamic that says, ‘Well, if you don’t extend this, then you’re in favor of raising taxes on poor working people. If that’s the dynamic, then Social Security is in really severe trouble.”

The ambivalence over tapping into the funding for the popular retirement program is underscored by a split among advocacy organizations for the elderly. AARP, the largest group, supports the payroll tax cuts -- as long as they are temporary - - while the National Commission to Preserve Social Security & Medicare has criticized the administration’s plan.

No Danger

Alan Krueger, the chairman of the White House Council of Economic Advisers, denies there is any danger to the system. He told reporters in a Nov. 29 briefing, “I don’t think this jeopardizes the Social Security trust fund or the solvency of Social Security. The trust fund is made whole by general revenues.” And he said Obama has proposed a way to fully pay for his tax-cut plan.

Senator Dick Durbin, the chamber’s second-ranking Democrat, also rejected the complaints. He said the government has been borrowing surplus Social Security revenue to pay for other programs, and promising to repay it later with other tax revenue, so the money has already been mixed.

“This is not the first time,” he said. Durbin, of Illinois, said he hoped the tax cut would be allowed to lapse next year though he said he couldn’t rule out another extension.

It’s that uncertainty that concerns some lawmakers.

“We shouldn’t let the federal government undermine Social Security by convincing Americans that they don’t really have to pay for it,” said Senator Joe Manchin, a West Virginia Democrat. “If we extend the cuts this year, what about the next year and the year after? When does it stop?”

--Editors: Mark McQuillan, Jim Rubin.

To contact the reporter on this story: Brian Faler in Washington at bfaler@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net


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