Dollars and Jens
Wednesday, April 25, 2007
Social Security — progressivity done correctly
I dislike the societal notion that "retirement" as such should be normal, to the point that not quitting what you do until you're sixty and making almost no money after you're seventy is abnormal, and I particularly dislike the government entrenching this idea by moving massive amounts of money around, but one of the things I like about Social Security is that it is progressive in a much better way than the income tax is: it is progressive with lifetime earnings, rather than one year's earnings. The numbers that follow, to illustrate, are my estimates, and are likely not to be too close to correct, but will certainly share the qualitative characteristics of the correct numbers, and should help me clarify my point.
A person making up to about $8,000 per year receives much more in Social Security retirement benefits than he's paying; in fact, the net Social Security tax is at a marginal rate of around -25%. From $8,000 to about $50,000, you're facing a marginal rate just a bit above 0; it's only from $50,000 up to $100,000 that you're paying closer to 8%. The income tax does this incorrectly: a person who makes $30k one year and $70k the next will pay a higher tax rate on the $70k than on the $30k, and will pay more in income taxes than if he had made $50k both years. For Social Security purposes, though, he will end up with the same net cost/benefit either way. Instead of penalizing volatility in earnings, it just becomes a transfer of wealth from people who made more than $50k per year on average over the course of their lives to people who made less than $50k, particularly to those who averaged around $10k.
Of course, a similar effect could be achieved with a progressive income tax and more liberal rules on tax-deferred savings; still, among those taxes that actually exist, the Social Security tax manages to be highly progressive without punishing people for having fluctuating income.