Social Security: A Macroeconomic Issue

Article excerpt

The issue of how to save Social security crosses the fields of accountancy, economics, and sociology. With the first batch of baby boomers starting to retire within the next five years, and for 20 years thereafter, tremendous demographic changes will affect all aspects of life within the United States, including how we provide for retirees and disabled workers.

Why Social Security?

As a result of the stock market crash of 1929 and the subsequent bank failures, especially during the period 1932-1934, tremendous wealth was lost in the United States. While this affected many Americans, it affected older Americans more because they would not have a long time horizon to recover this lost wealth before retirement. Social security was originally set up as an immediate response to this loss of wealth to retired and soon-to-be-retired people. Having a "government pension" financed by a tax was of utmost concern in 1935; it was an immediate response to this huge "evaporation" of wealth.

The Social Security payment itself is a transfer payment. The recipient does not have to do anything currently to receive this check (e.g., perform a service); all recipient must do is reach the retirement age of 65. In this sense, therefore, it is no different from unemployment insurance or income maintenance.

The Social Security tax was set up in a cumbersome way, however, because the tax is shared by both the employer and the employee. Currently it is 6.2% each on the first $90,000 worth of income; selfemployed individuals pay both portions, for a total of 12.4%. In a sole proprietorship, there is a deduction for adjusted gross income (AGI) of one-half of the Social Security tax remitted. Corporations can deduct Social Security taxes as an operating expense. In 2005, the maximum amount that can be withheld per employee is $5,580 ($11,160, including the employer portion ).

Regressive Versus Progressive

The Social Security tax is inherently a regressive tax. For example, A earns $25,000 per year, B earns $90,000 per year, and C earns $350,000 per year. The marginal tax rates based on disposable income are as shown in the Exhibit. For convenience, the example uses a 10% marginal tax rate for A, a 25% marginal tax rate for B, and a 40% tax rate for C.

Above the $90,000 cap, the tax becomes very regressive. Therefore, the Social Security burden is heavier for middle-income people than for upper-income people. Also, A is probably not saving that much for retirement, and B and C are saving a great deal more. In this scenario, B and C would probably rely more on their 401 (k) and other retirement accounts than on Social Security. …