Friday, May 11, 2007

Why should the wealthy subsidize middle class retirement benefits?

One of the ongoing arguments over Social Security is the notion that the 'wealthy' should pay more taxes to help make sure that the system has adequate funding. The most common suggestion is that the income limit subject to FICA taxes should be raised or eliminated. Doing so would naturally bring in more revenue and would help maintain solvency. Of course, this suggestion is generally made by people who would also argue that Social Security isn't, or shouldn't be turned into a welfare program. I've got news for these people, Social Security already is a welfare program, and raising the income limit would just make it more of one.

To understand why this is so, you have to think about how Social Security benefits are determined. The benefit is based on what you pay in over your working career, particularly your later years, but the payback is bottom weighted. This means that lower income workers see a larger return on the amount they paid in than do higher income workers. For example, a worker born in the mid '40s whose earnings are in the bottom 20% might see a return of 5% on their FICA 'investment based on current law. The middle 20% of workers born that year might see %2 and for someone in the upper 20% the return might be %1. Clearly lower income workers are being subsidized by higher income workers, or to put it more clearly, money paid in by higher income workers is being transferred to retirees who earned lower incomes during their career.

So we are faced with a situation where higher income workers born in the mid 40's can only expect maybe a 1% return on their FICA. However, the situation is even more grim for younger workers. A higher income work born in 1970 can be expected to earn a return of 0% on their 'investment'. Lower income workers can expect %4 and middle income workers can still expect %2.

Let's now implement the 'solution' of raising the income limit on FICA taxes. This will mean that higher income workers will pay even more into the system, but will not see an increase in benefits. Now, instead of just earning a paltry 0% on their investment, they can expect to receive a negative return on their investment. All of this in an effort to keep paying benefits to middle and lower income retirees. If this doesn't constitute middle class welfare, I don't know what does.

The truth of the matter is that Social Security has always been a welfare program. Raising income subject to FICA tax just makes it more so.