Laurence J. Kotlikoff proposes to replace the payroll tax with a sales tax.
replacing the payroll tax with a sales tax is the same as (a) eliminating the payroll tax ceiling, (b) taxing wealth at the payroll tax rate, and (c) taking advantage of the expanded tax base to lower the payroll tax rate.
Next, Kotlikoff would stop accruing Social Security benefits. That is, workers would be entitled to the benefits that they have earned based on their taxes paid to date, but going forward they would use private accounts. Those accounts would work like this:
All account balances are invested in a single, global, market-weighted index fund, providing all workers the same fully diversified portfolio and rate of return. The government fully guarantees the downside; workers can only gain from investing in the market. At retirement, balances in this Personal Security System are gradually sold off and converted to inflation-indexed pensions. The Social Security Administration handles all paperwork, investing and pension conversions. Wall Street plays no role and collects no fees.
For Discussion. What would be the economic affect of Kotlikoff’s plan?
READER COMMENTS
Mcwop
Nov 10 2004 at 8:42am
Arnold, not sure if you meant economic affect or effect.
The economic affect would be positive for millions of workers that feel SS payroll taxes are dropped into a black hole out of their control. The psychological fear that the rules for collecting SS benefits will continuously change, which makes planning difficult, should diminish. A national sales tax tied to a national savings program may highlight the importance of saving versus consumption as well.
It is an interesting proposal.
Dezakin
Nov 10 2004 at 9:29am
The red herring in this argument is the implication that a national sales tax is a good in itself.
While there are benifits to a sales tax over a payroll tax, a better solution would be to replace both with a clean (deductionless) progressive tax system The problem with any income tax system is the political temptation to enact deduction programs; But sales taxes are regressive, and regressive taxes are a drag on demand.
I suppose if you are especially cynical you can argue that a payroll tax, while bad for employment figures, is good for the economy because it penalizes labor more than productivity enhancing capital investment.
Lawrance George Lux
Nov 10 2004 at 12:01pm
I don’t trust Government bureaucrats to do anything, especially invest large amounts of money. The next thing they would want Profit-sharing.
National Sales tax would have to be at too high a rate to gain equivalent revenues. National and State Sales taxes combined would easily exceed 12%. A real drain on Consumer dollars would show up on GDP estimates.
The indexed pension accounts violates the very conditions for which SS was formed, a steady, consistent income for Retirees. lgl
Boonton
Nov 10 2004 at 1:30pm
This sounds like sending people to a casino with $100 in their pocket and the gov’t will guarantee them against any losses. Everyone will walk out rich but the bill to the taxpayers will be huge.
Fundamentally nothing can grow faster than the world economy forever. Investors in a ‘world index fund’ cannot reap larger returns than the overall growth rate of the world without someone else seeing lower returns. In essense we are still left with a system that is one part welfare and another part forced savings. The welfare part, like all welfare, will cost real money that has to come from someone who will be the taxpayer.
mcwop
Nov 10 2004 at 4:34pm
The SS bill to taxpayers is already huge:
– Greater than12% of payroll
– Benefits that are scheduled to be paid to future recipients under current law will probably be reduced (kinda like a loss from the stock market)
-The retirment age will increase reducing benefits to many recipients
-The taxes that fund Social Security will probably be raised to draw additional resources from the economy to the program.
-Resources consumed by other federal programs will be needed to cover the gap between Social Security’s outlays and revenues.
-The federal government’s borrowing will increase, which would be another way to draw more resources from the economy to Social Security. That borrowing would need to be repaid by future generations through increased taxes and/or reduced federal spending
Boonton
Nov 10 2004 at 4:54pm
In other words future generations will pay for our retirement. Is there really a way out of this arrangement?
Bob
Nov 10 2004 at 5:02pm
No, although the word “pay” confuses the issue. Future generations will produce what we consume in retirement. How hard they have to work to produce what we consume is not fixed. We could make it easier by consuming less by retiring later or accepting a lower standard of retirement living. We could make it easier by adding more productive capital to the economy before retiring (in a private system we would have to do this in order to have something to entice the next generation to support us).
Boonton
Nov 10 2004 at 5:08pm
Granted but financial savings does not necessarily add anything to productive capital. Consider a person who socks his money away in a bank only for the bank to purchase bonds backed by credit card balances. His ‘savings’ is not going to productive capital (new factories, machines, etc.) but to finance other peoples’ dissavings (aka consumption).
Likewise, consider the effect of the SSI surplus in reducing the deficit (and briefly helping generate a surplus). Treasury bonds are purchased back from the public. Presumably those holding the bonds (or in the case of deficit reduction those who would have purchased the bonds that weren’t issued) will seek another place to put their money. They could purchase corporate bonds or stocks and this may in fact go towards increasing today’s capital stock.
The underlying issue is that tomorrow’s economy is going to provide our retirement no matter what. Anything that improves tomorrow’s economy, therefore, will make it easier for us to enjoy a nice retirement without too much of a burden on our kids and vice versa.
shamus
Nov 10 2004 at 6:56pm
Employment would increase, as it would cost less to hire workers. Savings would grow, since goods and services would cost more.
In theory, interest rates would decrease, as the government would be on a sounder fiscal footing. And, in theory, the dollar would get stronger, as the US would save more and have greater economic strength.
There doesn’t seem to be any economic downside to this proposal.
Bob
Nov 11 2004 at 12:51pm
Boonton, we seem to agree on 90%, certainly that it is real capital that matters and that financial capital does not always represent claims on real capital. But I fail to see why private financial savings (e.g., socking money in a bank) would be less important than public financial savings (Treasury issuing fewer bonds or even retiring bonds). In both cases the “savings” can go to real investment or to consumption. Is there a marginal propensity to invest/consume argument?
Anyway, my basic position is that the current system stinks because a private system would require people to accumulate a stock of real capital (or claims on real capital) that could be passed to the next generation in exchange for retirement support. As a voluntary transactions, both generations would win. As it is, the next generation counts on the goodwill of the previous to accumulate productivity-enhancing real capital instead of consuming everything.
But this is a hypothetical discussion anyway – social security is best understood as a vote buying scheme that has gotten too expensive to work much longer.
Boonton
Nov 12 2004 at 9:36am
As I demonstrated a privatized system would not force people to increase claims on real capital. It’s quite easy for purchases of stocks, bonds and other financial instruments to go towards the finance of consumption rather than real capital. What you need to show is not only will a private SSI system increase real capital but that this increase will not be offset by the decrease in real capital caused by reduced gov’t saving.
This rasies another issue, how starved is the US economy for capital really? How effective would a shot of additional capital really be in increasing long term growth? Finally, R&D is often treated as a current expense in accounting rather than capital. Going into the future will R&D end up being more important to long run economic growth than increased capital?
Lawrance George Lux
Nov 12 2004 at 12:06pm
Boonton
Check out my post on the Social Security Fund at my blog:
lgl
Lawrance George Lux
Nov 12 2004 at 12:09pm
Boonton,
Somehow it would not take the link:
http://laglux.blogspot.com/
It basically shows how to intergrate the Fund into the economy. lgl
Bob
Nov 12 2004 at 1:01pm
Boonton,
Your point about financial assets is granted, but you’re taking it too far. In a private system you MUST see people buy stocks in the secondary market with the payment going toward consumption. That is how productive real assets are transferred from the old, who no longer want to work, to the young, who need to work and can be much more productive if they can use/build on the existing capital stock. This is how the first generation “pays” the second generation to support their retirement. How much productive capital the first generation accumulates determines how much retirement they can “buy.” The second generation is responsible for maintaining/adding to the real productive capital stock. How good a job they do determines how much they get from the third generation when it comes time for the second generation to retire. The retiring generation benefits in proportion to how good a job they do adding to the productive economy (which makes it easier for the subsequent generation to suppor them). Incentives are aligned and personal responsibility with direct personal benefits presumably increases the “real” savings rate (I doubt this is provable, but it is logical). Even better, both generations are guaranteed to benefit when it’s voluntary.
Your position seems to define the existing system as a portable, fully-funded defined benefits pension. It’s not. Because the existing system is coercive, for years Congress could simply tilt the game (the “price” at which the capital is transferred) to the small group (old folks), screwing the large group (workers), to buy votes. It isn’t the baby boomers retirement that dooms social security so much as it was the baby boomers entering the work force. This allowed Congress to raise SS payouts to unsustainable levels, planting the seeds for the program’s eventual demise. Boomers’ retirement is like the cancer that kills the patient ten years after the original radiation exposure. In 1950 the SS program as we know it was doomed in 2015. Politicians *are* that predictable.
Boonton
Nov 12 2004 at 2:27pm
SSI’s payments are not at unsustainable levels. To assume such you have to assume horrible economic growth for the next 70 years, you cannot make this assumption and at the same time assume stocks will happily grow as much as they did for the previous 70 years. This is consistent with what I mean by saying the only thing that really determines the lifestyle of tomorrow’s retirees is tomorrows econoomy.
I agree with your depiction of savings but I disagree it is really relavent to our discussion. SSI is one part forced savings and one part welfare. Welfare, by definition, is expensive. There is no magical money tree that we can pull money down from to give to poor people that won’t cost us anything. If there was we’d just point the tree out to those in need 😉
The forced savings element in welfare can and should be partially phased out. The way to do this is to return SSI back to what it was originally…mostly welfare and a little bit of a pension system. This can be done by:
1. Raising the retirement age to keep in line with expanding lifespans.
2. Introduce incentives to encourage able bodied elderly to stay in the labor market. (carrots)
3. Modestly means test welfare to cut benefits for the well off. (stick)
4. Introduce a ‘SSI-lite’ option for those around 40 or 45. Lower taxes in exchange for reduced benefits later on.
Do these things and you’ll be able to decrease the cost of SSI while preserving its essential functions; providing a modest income for those too old to work and providing a welfare system against poverty. This can also be done so as to freeze or possibly decrease payroll taxes…hence addressing the concern about ‘returns’.
One added thought, while we are crying about the need to encourage savings and privitize SSI what are 401K’s, IRA’s, Roth-IRA’s, MSA’s, and so on? If your inclination is to save there are a host of incentives built into the tax code, a savings inclined person can easily enjoy an income 10% or higher than a savings disinclined person who suppsedly makes the same money.
AJ
Nov 12 2004 at 8:51pm
How will taxes be collected if Bill Gates decides to spend all his wealth by buying things off e-bay???
PELLUCID
Nov 14 2004 at 7:43am
I’m too close to the middle of the bell curve to grok the math in most econ articles. If only I had completed high school! But this one is easy to debunk on the basis of how the average Joe would react to it.
A national sales tax at any level more than a penny or two would encourage cheating, big-time. We are already at that point with current state/local sales tax rates in most places. Want to see? Go to any Sam’s Club, stand by the register, and watch the things people are buying with their sales tax exemption number. You can bet they are the final consumer on a bunch of that stuff, no matter what the paperwork they file with the state may say.
The idea of a US gov’t guaranteed world index fund is kinda funny. We have that much power? Really?? I guess history actually did end!!! How about something we already have… inflation-indexed US gov’t bonds. Most Americans would see them as safer than anything involving foreigners.
The elephant in the living room than the experts can’t see is how ownership of SS savings would change people’s behavior. People have a natural desire to leave a legacy for their children and grandchildren. It’s not just money, of course, we want to hand down our values and opinions and stories as well. But if we knew that our heirs would get whatever SS savings we didn’t spend on our own retirement, we would act better. Maybe we would buy a smaller condo, and get along better with the kids, and travel more frugally, and figure out cheaper ways to die. I have no clue how this would affect savings or investment or productivity. And why should most people care? The idea of having savings they can call their own would trump any economist’s abstract ideas.
Capt. Bob Knaus
S/V PELLUCID
Boonton
Nov 15 2004 at 11:34am
This isn’t as difficult as it may sound. All such an index fund would do is take every single stock there is that is traded on a relevant exchange and order them in terms of daily market cap. Maybe Microsoft would be 1.02% of all the world’s companies…GM 0.715% and so on. Then the fund would simply buy shares in that proportion. Each day or week the fund would adjust itself as prices change. In effect such a fund would simply be buying the entire stock market…
Edge
Nov 18 2004 at 2:53pm
VAT to replace payroll taxes – I think this is an idea worth exploring. Probably best to phase something in over many years, with the original (10 or so year) goal of cutting payroll taxes in half and adjusting the VAT rate to whatever level of social insurance benefits is agreed upon.
I think a VAT would be similarly regressive as a payroll tax, but it should broaden the base considerably as the population ages, and it should help bring our external trade balance under control. But I think these issues should be carefully considered, and gradually phasing VAT in might be the best way to assure that transition costs&benefits are smoothed out and spread around.
Global market index fund: Biggest concern here is that I think index funds are fine as long as they comprise a small part of the market. The more money that flows to indexing, relative to well informed professional active management, the more the tail can wag the dog.
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