The wrong way to fix Social Security
By Scott Sumner
Governor Chris Christie wants to reduce Social Security benefits for the rich:
As part of the plan, he’ll propose phasing out Social Security payments for those making more than $80,000 in other income and eliminating them for those making $200,000 or more a year.
This is a good idea in general, but the specific proposal is awful. He should be trying to make the program more progressive, but ends up with a plan that is unfair to savers. Christie should be proposing higher payroll taxes on the rich, but is actually proposing higher income taxes on the rich.
Many people have trouble understanding this distinction, so consider the following thought experiment:
Imagine identical twins that each make $150,000/year from age 25 to 65, and then retire.
Can we agree that these two people are equally affluent? Now suppose one chooses to spend all that money when it’s earned and relies on Social Security when he is old. The other invests half his income each year and becomes quite affluent by age 65. Neither brother is better off than the other; they both have identical lifetime consumption in present value terms. It’s just that the thriftier brother chooses to defer his consumption to later years, and thus consumes more in nominal terms. The other brother could have done the same, but chose not to. Just as you can’t say apples are better than oranges if their price is the same, you can’t say four apples in 40 years is better than one apple today if their price is the same.
Economic theory suggests that both brothers should face the same tax rate. Their lifetime consumption should be reduced equally, relative to the no-tax case. A simple payroll tax would be neutral regarding the saving vs. consumption decision. So would a VAT. Indeed even a progressive payroll tax would be neutral. But an income tax would discriminate against the thriftier brother, imposing a higher tax rate on future consumption than current consumption. It would double tax money that is saved. That’s perverse, especially given that saving provides the funds for investment, and hence future economic growth.
Now suppose there was a third brother, who made only $50,000/year. Is there an argument for taxing that person at a lower rate? Yes, you can easily make an argument for progressive taxation on utilitarian grounds. Not everyone will buy the argument, as it’s hard to do interpersonal utility comparisons, but you can make a plausible case for progressive taxation.
But there is no plausible case to be made for Christie’s proposal, which is to raise income tax rates on the affluent elderly. If he wants to fix Social Security in a way that makes the system more progressive, he should have proposed trimming retirement benefits for those whose lifetime wage income was above a certain threshold. Unlike the Christie plan, a phase out based on lifetime wage income would not distort the decision as to whether to consume now or in the future. It would not discourage saving and investment.
I usually visualize the Democrats as representing the “one marshmallow” Americans. Tax policy is one of the very few areas where the GOP appeals to voters favoring free markets and small government. If the GOP also begins to favor anti-saving tax policies then we are really in deep trouble. Let’s hope Christie is an outlier, one of those RINOS who will soon switch to the Democratic Party.