There are taxes and then there are taxes: solving the Social Security and other problems: what compromise looks like

Writing for Bloomberg.com Whitney Tilson, managing partner of T2 Partners LLC, the hedge fund, and a member of Patriotic Millionaires and Anthony Scaramucci, managing partner of SkyBridge Capital LLC, formerly one of the national finance chairmen for Mitt Romney’s presidential campaign explain the need for higher taxes especially on the wealthy. Their ideas may gain traction as the talks to deal with the fiscal cliff continue. Below are some of their ideas.

There are two main issues related to all this as I see it. Do we want to change our basic social programs into income based welfare type entitlements thereby leaving the fundamental design of these programs forever behind? And two, are we willing to simply send more money to Washington to be poured into the massive pot of spending at the will of Congress? We seem to forget that is how we got into this mess in the first place. What happens if we raise taxes and the President and Congress just keep spending for an array of “progressive” goals? What happens if we send more money now and at the end of four years the debt is even higher? How is this different than an unmotivated person on food stamps and welfare seeing their benefits rise, but not seeing the need to change what they are doing in our society?

If we want major entitlements such as Social Security and Medicare, we should pay for them, all of us. What we pay should increase immediately as our Congress sees fit to increase those benefits as opposed to increasing benefits and passing costs to generations not born. Note below that the cap on Social Security taxes is described as highly regressive. Given the maximum benefit is based on the same limit, it is not regressive. The lower income person always receives a greater portion of pre-retirement earnings replaced by Social Security. What the Bloomberg writers propose is that eventually anyone earning more than $110,100 (as adjusted under current law) subsidizes growing benefits for everyone else. Later they suggest that Social Security be means tested and state “The government can no longer afford to provide a safety net to people who don’t need it.” The government can no longer provide you say? Really?

It seems to me the government doesn’t provide anything, except the mismanagement of these programs.

Here is a brief history of major Social Security changes:

A significant change to the SSA occurred in 1950, when the first cost of living adjustment (COLA) was added the program. This was a one-time increase in benefits of 7.7%; the next COLA occurred in 1952, a 12.5% increase. In 1954, a stipulation was added that would freeze a worker’s record during the years he was disabled and unable to work. This amendment avoided a worker’s receiving reduced or no benefits in the event of a disability.

In 1961, the retirement age for men was reduced to 62, with a reduced monthly benefit for those choosing to retire early. Several major changes to Social Security occurred with the 1972 amendment: automatic COLAs were instituted, a minimum monthly benefit was established, monthly benefits were significantly increased to those individuals waiting until age 65 to retire, and a system for automatic increases in the amount of earnings subject to Social Security taxation was developed.

All good stuff, right?

Is that how you see Social Security working? Keep making improvements and not pay for them or perhaps have only some Americans pay?. Here is the reality as stated in the 2012 Social Security Trustees Report:

For the combined OASI and DI Trust Funds to remain solvent throughout the 75-year projection period, lawmakers could: (1) increase the combined pay- roll tax rate for the period in a manner equivalent to an immediate and per- manent increase of 2.61 percentage points (from its current level of 12.40 percent to 15.01 percent);1 (2) reduce scheduled benefits for the period in a manner equivalent to an immediate and permanent reduction of 16.2 percent; (3) draw on alternative sources of revenue; or (4) adopt some combination of these approaches. Lawmakers would have to make significantly larger changes for future beneficiaries if they decide to avoid changes for current beneficiaries and those close to retirement age.

You see, none of this is a surprise, the trustees have been saying similar things for years and yet here we are looking for a solution that can be found, but which only affects 1% of our citizens … It ain’t gonna happen.

From Bloomberg column:

We don’t favor raising tax rates, but believe that Social Security taxes, which are currently levied on income only up to $110,100, making them highly regressive, should also be paid on all income (including unearned income) above $1 million, starting in 2013. The limit would go down by $100,000 each year such that there would be no cap whatsoever after 10 years.

In addition, we believe the tax rate for capital gains and dividends, currently 15 percent, should be raised to 20-25 percent.

Some argue that even if these tax increases are carried out, they won’t be enough to eliminate the budget deficit. True, but think of the math this way: For every $1 billion not raised from the wealthy, that’s equal to having 1 million average American families each pay an extra $1,000 in taxes.

Sacred Cows

As for deductions, rather than trying to tackle sacred cows such as the mortgage-interest deduction one by one, we endorse the proposal by Governor Romney to put a hard cap on income-tax deductions at, say, $35,000.

Finally, we need to address entitlements, especially Social Security and health care, which consume more than half of the federal budget. Regarding the former, in addition to raising more revenue by removing the income cap, we need to gradually raise the age of eligibility to 70 years old; after all, people who reach age 65 today live, on average, five years longer than they did when Social Security was created in 1935.

Lastly, Social Security has to be means-tested. Everyone who paid into the system should get something back, but the amount should be based on need. The government can no longer afford to provide a safety net to people who don’t need it.