Replace Social Security payroll tax with national sales tax

With Iraq on the front burner, domestic policy is getting short shrift in the presidential campaign. Two issues – the tax system and Social Security – deserve much more attention.

Notwithstanding recent tax cuts, our tax system places a huge burden on middle-class Americans, reducing not just their take-home pay but also their incentives to work and save. And Social Security is a walking time bomb with no obvious means, apart from highly regressive payroll tax hikes, of covering two-fifths of its future benefit commitments.

To his credit, President Bush addressed tax and Social Security reform, albeit briefly and separately, in recent weeks. He indicated that a national retail sales tax is worth exploring and suggested letting workers invest some of their Social Security taxes in private accounts.

Sen. John Kerry objected. A sales tax, he said, would raise the tax burden on the middle class. And privatizing Social Security would leave the elderly’s retirements subject to volatile financial returns. As a student of the tax and Social Security systems, I see where Sen. Kerry is coming from. But I also see a way to combine both reforms to meet his concerns.

The three-part plan, which has been endorsed by more than 150 top U.S. academic economists, is titled the Personal Security System. Part 1 replaces Social Security’s payroll tax with a federal retail sales tax. Part 2 eliminates any further Social Security benefit accrual, paying (with the sales tax receipts) only the benefits now owed current retirees and current workers. Part 3 sets up an individual account system, but one Democrats as well as Republicans can support.

Kerry should love Part 1. The payroll tax is highly regressive. It taxes only wages, and only up to $87,900. For Bill Gates, who makes $87,900 in minutes, payroll taxes are a pittance. But with a retail sales tax, Gates would pay taxes on every dollar he earns, as well as on his entire $61 billion in wealth, the minute he spends these funds.

Mathematically speaking, a retail sales tax is equivalent to taxing all wages plus all wealth because both are ultimately spent on goods and services. Hence, 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. What more could a Democrat want?

But what if Gates saves his earnings and his wealth and spends it later? This delays, but doesn’t reduce, his tax payments since the interest earned on this saving is also taxed when spent. What if Gates gives his money to his kids? Again, there’s no tax avoidance; the kids pay the tax when they spend the gifts or inheritance.

How about the elderly who live off Social Security? Won’t they be hurt by having to pay higher sales taxes at the store? No, because their Social Security benefits are adjusted annually for price increases, including those arising from higher sales taxes. The same would hold for other transfer recipients were their benefits adjusted for inflation. Congress could go even further and rebate all sales taxes up to the poverty level.

Part 2 phases out the existing Social Security system, which served us well for decades but is well past its prime. Why keep in place a retirement system with 2,528 rules that no one understands, that discriminates against working women, that redistributes income capriciously, that is two-fifths underfunded, and that requires highly regressive payroll tax hikes to sustain?

Part 3 replaces the current Social Security system with a fully funded modern alternative. Specifically, the contributions workers formerly made to Social Security are split 50-50 between spouses and invested in individual accounts. The government provides matching contributions for low earners.

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, PSS balances are gradually sold off and converted to inflation-indexed pensions. The Social Security Administration handles all paper work, investing and pension conversions. Wall Street plays no role and collects no fees.

This plan gives Democrats and Republicans most of what they seek via tax and Social Security reform and provides a great boost to the economy. Most important, it gives our children a transparent, efficient and equitable retirement system that won’t drive them broke.

-------------------------------------------------------------------------------- Laurence J. Kotlikoff is chairman of the Department of Economics at Boston University. He wrote this on behalf of the non-profit organization Americans for Fair Taxation to distribute to newspapers.

This fits in with the Kotlikoff dream.

Statement of Laurence J. Kotlikoff,
Professor of Economics, Boston University, and
Research Associate, National Bureau of Economic Research
Testimony Before the House Committee on Ways and Means
Hearing on Fundamental Tax Reform
April 11, 2000
Chairman Archer and other distinguished members of the Committee on Ways and Means:
I'm honored by this opportunity to discuss with you the nation's need for tax reform and the role that consumption taxation, particularly a federal retail sales tax, could play in enhancing the economy's economic performance and improving its distribution of resources.
Our nation's economy has been performing remarkably well in recent years, but our economic success is no reason to be complacent about a tax system that is extraordinarily complex and highly distortionary and that plays a critical role in an overall fiscal system that is likely to visit enormous burdens on our children and grandchildren.
The complexity of the tax code doesn't just drive taxpayers crazy. It also costs them a significant amount of time - time that could be spent working or time that could be spent enjoying life. Having just spent three days doing my taxes, I have a refreshed sense of the substantial costs to the man in the street and the nation as a whole of complying with the federal income tax code.
The distortions of our tax system also diminish the nation's well being, but in ways that are less transparent. Today, almost all American households are in combined federal, state, and local marginal income tax brackets of roughly 50 percent. Because governments are collectively confiscating half of every dollar most workers earn, most workers work many fewer hours than they would were their tax payments independent of their labor earnings. And since the government is confiscating half of every dollar of income most savers earn on their non tax-favored retirement accounts, many Americans choose to spend today rather than save for tomorrow.
Tax Reform's Importance for Fiscal Sustainability and Generational Equity
Eliminating complexity and distortions would be cause enough for reforming the federal income tax, but there is a much more pressing reason: notwithstanding recent wishful projections about future government surpluses, our fiscal house is not in order. Indeed, getting it in order would require not cutting federal income taxes, as some in this chamber advocate, but immediately and permanently raising them by over 25 percent. That assessment comes not from academia, but from the Congressional Budget Office and the Federal Reserve Bank of Cleveland. A joint CBO-Cleveland Fed generational accounting study, to be published next month in the American Economic Review, shows that such a tax hike is needed to achieve generational balance - a situation in which our children and grandchildren will face tax rates that are no higher than those we face.
The 25 percent or greater requisite tax hike is derived under the assumption that growth in federal purchases of goods and services keeps pace with growth in the overall economy. This responsible assumption can be contrasted with the irresponsible one underlying the projection of very large surpluses over the next few decades. The irresponsible projection, whose surpluses are routinely cited by advocates of tax cuts and spending hikes, assumes that, as a share of GDP, federal spending will decline by 20 percent by the end of this decade and by 30 percent by roughly 2040.....

Go to THOMAS to read the rest.

Having just spent three days doing my taxes, I have a refreshed sense of the substantial costs to the man in the street and the nation as a whole of complying with the federal income tax code

Funny thing is, even with this latest payroll tax to sales tax scam he'd still have to fill out those income tax forms.

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