TAXATION ASPECTS OF THE OLD-AGE SECURITY PROGRAM IN THE UNITED STATES
A Memorandum Submitted to the Treasury
I. Introductory The Present System of Payments Classes of Aged Some General Implications for the Tax System "Extension of Coverage" equivalent to Extension of Semi-Contributory System Non-Contributory Taxation Within the Semi-Contributory System "Extension of Coverage" Also Possibly Equivalent to Increase in General Revenues Devoted to Old-Age Payments Three-Way Tax System: European versus United States Methods II. Tax Implications of the Reserves Problem Effects Judged by Comparison Other Assumptions Four Extreme Types Plan I. Reserve: Contributory Plan II. No Reserve: Contributory Plan III. Reserve: Non-Contributory Plan IV. No Reserve: Non-Contributory Implicit Assumptions Present System in United States Contributory Aspects Reserves Accounts "Reserve" Problem a General-Budget Problem III. That Is a "Contributory" *** Individual-Sacrifice Principle Emphasis on the In Not to Pay Factors Influencing the Choice of a Contributory Tax Under the Individual-Sacrifice Principle Incidence of the contributory tax Groups who are to receive old-age benefits Share of benefit to be contributed by one beneficiary compared with another beneficiary Variation of total benefit among individual beneficiaries Choices assumed in present analysis Present Payroll Taxes Under the Individual-Sacrifice Principle Incidence: "Income Tax" part of payroll taxes Incidence: "Excise Tax" part of payroll taxes Scope of benefits Relative share of benefits to be contributed by individual beneficiary, and variation of total benefit among individual beneficiaries Alternatives to Payroll Taxes under Individual-Sacrifice Principle Net income tax Expenditures tax Summary General Summary Making Each Business Pay Its Way Checking Undue Growth of Old-Age Benefits Maintaining Morale of Recipients IV. Conclusions Appendix One: Minor Economic Aspects of Old-Age Payroll Taxes Appendix Two: Conflict Between Cyclical and Secular Aspects
TAXATION ASPECTS OF THE OLD-AGE SECURITY PROGRAM IN THE UNITED STATES
The taxation aspects of the present and prospective programs for old-age pensions in the United States form the subject of the present discussion.
Throughout, the following terms are given the following meanings:
a) "Old-age payments" or "pensions": any payments made to any person because he is aged, by any governmental unit in the United States. They are either (1) "assistance," that is, payments given only if the aged person satisfies a means test to show that he is "needy" or (11) "benefits," that is, payments given without a means test and because the individual has been under a contributory system or a semi-contributory system. A third class, payments given without a means test to individuals who were never under a contributory system or a semi-contributory system does not, in principle at least, /1/ exist in the United States.
b) "Contributory system"; a legally distinct system in which the contributory payments in the aggregate, over a long period of time (say, 40 years or more) are adequate, with the interest they earn, to cover the old-age payments made under the system. If they are not thus adequate, the system is a semi-contributory system.
c) "Earned benefit"; a benefit to a given individual who has, by his own contributory taxes, covered the actuarial cost of the benefit (though not necessarily including in actuarial cost certain costs of administration).
d) "Contributory tax": a sacrifice, through taxation, made by a person who is expected to derive a direct benefit that does not go to others who do not undergo the sacrifice.
e) "General tax": any tax other than a contributory tax.
f) "Reserve plan": a plan whereby: (a) the Government becomes committed to certain expenditures whose dollar volume can be forecast with some degree of assurance and (b) the increase, in the yield of the entire tax system, /2/ designed to most those expenditures is, in whole or in part, carried through earlier, and is smaller in total amount, than if it were carried through simultaneously with the expenditure /3/ -- the decrease in total amount being exactly made up by the interest earned on the increase collected prior to expenditure. Under this definition a reserve can of course be of varying sizes. It might average the tax payments over the years, removing the peak from the later years, or it might instead be so large as to move the whole peak forward.
This definition of reserve is framed with a view to a discussion of the fiscal and economic effects of the old-age plan. It is quite different from the conception of a reserve as a statement of a net liability incurred. The latter conception, which may be termed the actuarial reserve, is the necessary one if the discussion concerns questions of public honesty, realization of commitments, etc. The two conceptions are not contradictory: they simply serve different purposes. A system that did not increase the tax yield in the manner indicated in the preceding paragraph could still be an actuarial reserve system, simply by the computation and publication (in the proper place in the accounts) of the net commitment incurred. /4/ Whether this commitment in turn resulted in a change in the tax system, and if so, what kind of change, involves the conception of the reserve as defined here - the tax reserve.
Throughout the present analysis the term reserve is used in the tax-reserve sense, not the actuarial-reserve sense. It is around the problem of the tax reserve, not the actuarial reserve, that most of the public discussion has turned - discussion, for instance, of "inflationary" or "deflationary" tendencies, of effect on public debt and the banking system, and of temptation to extravagance or pressure for penury.
The term "reserve" is popularly used in still a third sense: that of an aggregate of bank deposits, securities other than those of the Government, or even tangible property such as gold, commodities, etc. - in short, an aggregate of claims to wealth. This conception is narrower than the one used in the present discussion: the latter locks at the net financial position of the Government and thus counts as a "reserve" the amount by which the Government's own obligations have been reduced (compared to what they would have been otherwise).
Later on in this discussion, "reserve" will be given an economic connotation by asking whether the tax reserve really makes it easier to pay the benefits when they come due than it would be if there had been no such tax reserve. A reserve in this economic sense is built up only if the community saves and invests (profitably) more than it otherwise would have done. Then when the benefits come due, they can be paid in part out of the yield of capital equipment that would otherwise not have existed. It will be seen that a tax-reserve plan may or may not create a reserve in this economic sense; the crucial factors are the saving and spending propensities of the taxpayers in question and the bondholders.
However, a tax reserve will presumably create a reserve in still a fifth sense - a "political" reserve. Levying the tax earlier than otherwise diminishes the amount of tax money and the tax rate that need to be obtained or imposed when the benefits come due. If the community has not been saving and investing, there will be no economic reserve, and the effort required to pay the benefits when they come due will not be decreased, but superficially the tax burden will be less, and this fact will be important politically.
Of the five conceptions of "reserve" - tax reserve, actuarial reserve, claim-on-wealth reserve, economic reserve, and political reserve - the tax-reserve conception is, as noted above, used throughout this discussion; and since the tax-reserve produces also the political reserve, it follows that the present discussion deals more (by implication, at least) with the political aspects than the economic aspects. This fact does not imply an opinion that the economic effects are the loss important; it does imply a relative lack of knowledge of what the economic effects of any given plan will be, and a feeling that the political *** of tax-revenue aggregates and of tax rates are very important.
The Present System of Payments
Before studying the tax questions proper, it is desirable to describe briefly the existing system of old-age payments.
The program of care for the aged to which the Federal and state governments are at the present time committed includes both a non-contributory system and a semi-contributory system (commonly but mistakenly supposed to be a fully contributory system).
The semi-contributory system, financed entirely by a Federal tax on payrolls, /5/ reaches about half of the positions occupied by gainfully employed adults. /6/ This system will not produce pensions ("benefits") until 1942. /7/ Even then and for many years thereafter the monthly pension will be very low, judged by prevailing standards, since the amount of an individual's pension depends on (though it does not vary in precise proportion with) the total wages he has earned in covered employment after December 31, 1936, to his 65th birthday.
Even on the common but erroneous assumption that the payroll tax as a whole (plus interest on the tax payments) is adequate to cover the benefit payments in the aggregate, the system is only partly contributory in the sense of imposing a corresponding sacrifice on the direct beneficiary; half of the tax is levied on the employer and is in many cases likely to come out of profits, higher prices, and in other ways that do not directly affect the beneficiary as such. Moreover, so far as concerns percentage return (in benefits) on payroll tax payments, the system is weighted in favor of those contributors whose aggregate earnings in covered occupations are low, those whose earnings come in the later years of life, and those who are earnings now rather than later when the payroll taxes will be higher. Thus, even if the payroll taxes were high enough (plus interest) to cover the benefits in the aggregate, and even if the employers' half of the payroll tax were considered "contributory," some part of the benefits of certain individuals would be on a non-contributory basis.
In fact, however, it appears, from discussions that the present writer has had with those who are studying this problem intensively, that the payroll taxes, as scheduled, are far from being high enough to build up a reserve large enough so that by 1980 or thereabouts the payroll taxes plus interest received (or interest saved) will equal the benefit payments. On the contrary, the prospect seems to be that a reserve, possibly half as big as the $48 billion or $50 billion reserve commonly anticipated, will be built up some time before 1980 and then will begin to dwindle and ultimately disappear, /8/ the Government having to come to the aid of the benefit system from general revenues. This prospect results from the fact that a large number of persons are working and will work only occasionally in the covered occupations. Thus their lifetime earnings in covered occupations will be low (per worker), and, because of the weighting noted above, they will draw out of the system much more than their payroll taxes (both halves) plus interest put in. Instead of the 26,000,000 or so workers who, it was supposed, would be in covered occupations, 40,000,000 have applied for old-age security account numbers. Many, probably most, of the increase seems to be accounted for by those employed only irregularly in covered occupations - those who drain the reserve, on balance, rather than build it up.
The aged who are not adequately /9/ cared for by this semi-contributory system are or apparently will be cared for by public assistance, if the aged person's private resources are inadequate. This public assistance is now chiefly of two kinds:
1) Non-contributory pensions for old age (old-age "assistance") paid by states and financed roughly 50 per cent from general revenues of the Federal Government. The Federal Government pays half of the cost of approved systems of caring for those over 65, up to a total (Federal plus state) cost of $30 a month. /10/ At the present time all the states except Virginia are active in this manner, but the level of payments is very low in many of them.
2) Federal, state and local payments to those on relief. Possibly in come $cases the relief rolls or the W.P.A. or F.S.A. rolls are carrying persons over 65.
CLASSES OF AGED. The program may be described in terms of the various classes of aged that fall under it. These classes, and the extent to which they are covered, are:
1) Everyone who reaches 65 is guaranteed that he will get, either from his own resources or those of the Government, a minimum monthly income. In this sense, old-age coverage can be said to be complete. The also of the minimum, however, varies greatly from state to state, and is not always specified.
2) Some of those in Group (1) above will in fact receive no old-age payments at all. They will be those individuals (a) whose private resources (including, in some states, the resources of certain of their relatives) are adequate, in the sense of prevailing legal or administrative standards of adequacy, and who also (b) have not earned a sufficient amount of wages and worked over a long enough period in covered employments to qualify under the semi-contributory system. In general, those persons will be the thrifty and fortunate among these self-employed (farmers, professional men, business men, etc.), farm laborers, domestic laborers, casual laborers, and governmental and institutional employees who work little or not at all, throughout their lifetimes, in covered employments.
3) Another part of those in Group (1) will, although their private resources are adequate, receive an old-age payment that is wholly an earned benefit.
4) Another part, likewise with adequate private resources, will receive an old-age payment that is only partly an earned benefit. The rest of the payment is therefore an unearned pension given without need. Groups (3) and (4) will consist of those who have been employed sufficiently in the covered employments - chiefly manufacturing, transportation, trade, and the extractive industries - and who have also been thrifty and fortunate. How they will divide between Group (3) and Group (4) depends upon one's interpretation of a "contributory tax." If the employers' part of the payroll tax is not regarded as a true contributory tax, nobody will be found in Group (3). Even if it is so regarded, an appreciable number will be found in Group (4). They will consist largely of those who have had low earning power during their lives or who have spent only a few years under the semi-contributory system, especially before the payroll tax rates reach their maximum. (Of course one whose earning power has been low is more likely to be in one of the groups below, the needy aged).
5) Corresponding to Group (3) above is a group whose private resources are not adequate, but whose earned benefit overcomes or surpasses the inadequacy.
6) Corresponding to Group (4) are two sub-groups, whose private resources are not adequate, but who either
(i) Receive payments in which the earned element is large enough to overcome or surpass the inadequacy: here, the unearned element is still, as in (4), an unearned pension given without need; or
(ii) Receive earned payments in which the earned element overcomes only part of the inadequacy, the unearned element overcoming or surpassing the rest of the inadequacy; here, the unearned element is partly as it is in (i) above, and partly an unearned pension given without an actual means test but in fact given to a needy person. /11/
7) The rest in group (1) receive old-age payments because they prove that they are needy, in the sense that the aged person's private resources plus his benefit payment, if any, is inadequate. The assistance payment presumably makes up the difference.
The precise extent to which the assistance payments will in fact be granted to supplement inadequate benefits cannot be known before 1942, when the benefits start. For example, if a state's assistance law sets the minimum per person at $30 a month, and if the husband is receiving $45 a month in benefits, will the state grant the wife $15? There seems to be nothing in the philosophy of the assistance plan to preclude such a grant, but one may well hesitate to forecast.
Some General Implications for the Tax System
Some general observations of particular interest to the tax student may be made on the basis of these facts:
"EXTENSION OF COVERAGE" EQUIVALENT TO EXTENSION OF SEMI-CONTRIBUTORY SYSTEM. - Since the old-age system as a whole already covers everyone with a guarantee, or, rather, geographically varying guarantees, the extension-of-coverage question is really a question of an increase in the volume of payments under the semi-contributory system with an accompanying, but smaller, contraction in the volume of means-test free payments. The contraction would be smaller than the expansion because (a) some of the new semi-contributory-system payments would go to non-needy aged and thus not be effective in reducing the means-test free payments, and (b) in some areas the new payments going to those who had been considered needy would be larger than the amount payable under the assistance system. Neither the contraction nor the expansion would start until several years had passed, and the net expansion would not become a major factor until one or more decades had passed.
If the semi-contributory system is to remain on a reserves basis, extension of the system will result in an increase in the absolute total of the reserve -- i.e., a further decrease in the publicly held public debt (compared, that is, to what it would be otherwise).
The grand total of free ("unearned") payments, including both those to the needy and those to the non-needy, might increase rather than contract, as the present semi-contributory system was extended: as pointed out above, this system carries a large unearned element, especially if the employers' half of the payroll tax is not counted as a true contributory tax.