Funds for the Future
FAR more heat than light has been engendered by recent public discussion of the old-age insurance system established by the Social Security Act. A leading newspaper speaks of its provisions as ‘financial hocus-pocus.’ One commentator says that misrepresentation of the Act to the wage earners has been ‘shocking’; another, that the statute itself is a ‘crime.’ On the other side, we find one rather conservative journal condemning adverse criticism of the system as ‘diabolical propaganda.’ We hear on the radio such terms as ‘huge reserve fund’ and ‘pay-as-you-go,’ and these phrases bring into our minds pictures that have only a tenuous connection with reality. It is high time that we looked calmly into the real facts.
The old-age insurance provisions of the Social Security Act came into active operation on January 1, 1937. Beginning then, taxes were levied on the payrolls of employers and the wages of employees — taxes equally heavy on employer and employee. The rate of tax on each is 1 per cent to-day. At three-year intervals it will rise, until in 1949 it will be 3 per cent of employer’s pay roll and 3 per cent of employee’s wage. Some employments — farm labor and domestic service, for instance — are not included by the Act; but the wages of over 30,000,000 workingmen are now being taxed.
Those workingmen will get old-age benefits from the Federal Government. The benefits will come to them in the form of checks, if they retire from regular employment and have reached the age of sixty-five. The amount of their monthly checks will be anywhere from $10 to $85, depending upon the total wages which they have earned since the system began on January 1, 1937. The larger the total wages, the larger will be the old-age benefit. Thus, if there are two men continuously at work and earning exactly the same wages, the one who becomes sixty-five and retires in 1950 will get a smaller old-age benefit than the younger man who does not reach the retirement age until 1960.
Obviously, we can expect generally larger benefits to be paid out in 19600 than in 1950. The annual burden on the government for the payment of these benefits is comparatively small at first, but it will increase steadily for many years.
Right now that annual burden is hardly discernible. Regular benefits will not begin until 1942. The only payments now being made are small lumpsum benefits to wage earners who have paid the new tax but are celebrating their sixty-fifth birthday this year, too soon to be eligible for regular monthly benefits, and to widows or estates of other wage earners who, having begun to pay the tax, have died. These lump-sum benefits pay to the employee or his family more than he has paid in in taxes — but the total cost to the government today is negligible.
Let us disregard, then, the lump-sum payments and concentrate on the methods of financing the huge future load of old-age benefits. The Social Security Act embodies a policy of collecting more to-day in payroll and wage taxes than is being paid out to-day in old-age benefits. It provides that this excess of income over outgo shall be used in buying government bonds. The framers of the Act determined upon these policies with their eyes open. But they never believed that their choice was necessarily perfect and final.
It would take a book to discuss every question of policy. We cannot here ask whether it would have been better to pay pensions at a flat rate to every elderly person, regardless of his previous wages. Lack of space likewise prevents a discussion of the means test’s place in a pension system. Let us simply take the benefit structure of the Act as it is. We have promised to pay benefits, of from $10 to $85 a month, without imposing any test of need. We seek the wisest possible method of carrying out that promise.
First, why should there be payroll taxes to-day, and for years to come, which will produce revenue far in excess of what is being paid out in old-age benefits? Why not have a ‘pay-as-yougo’ system, raising in 1960 what we need to spend in 1960?
I think we can find one answer to that question if we suddenly shift the scene and amuse ourselves with a bit of imaginary ancient history: —
We are ancient Athenians, and we know that the Persians will attack us in thirty years. Of that we are certain. We have just had a war with them, which has killed off most of our fighting men. But there are lots of little children in Athens. By the time the Persians come again, we shall have to have an army, and to-day’s children will be to-morrow’s soldiers.
The financial affairs of Athens are in some disorder to-day. It cost a great deal to defend the city against the Persians’ last attack. The invaders burned some of the outlying sections, and we have to rebuild those sections. Furthermore, in deep gratitude to the gods on Olympus, the people have demanded that the city erect several new temples and statues on the Acropolis. All this has cost money. Athens has had to raise taxes a little, and has had to borrow heavily. Its debt is large. Certain moneylenders in the city hold its bonds.
We face now the certainty that, beginning in about fifteen years, we must shoulder a huge new financial burden. We shall have to equip a mighty fighting force. To-day our army costs us little, because it is very small; when our children grow up, it will cost enormously.
We look to the future with worry in our hearts. With the debt already so large, how will Athens pay for the future army? The moneylenders are already wondering if they are ever going to be paid back. It won’t be easy to borrow much more from them. We cannot cut down much on our present expenditures. How shall we pay for that army?
Our elders argue in this wise. ‘We shall have to buy grain from Macedonia to feed our army. And we’ll find it very hard to get the money to buy the grain. In a famine year, our revenues will certainly shrink and the moneylenders will be reluctant to lend us money. No, if we let things slide, there’ll come a time when we suddenly can’t keep our army supplied. The Persians will crush them in the mountain passes, and then will burn our city.
‘So,’ they continue, ‘we must begin — now. We will impose new taxes — now. We will explain that these new taxes are necessary because we shall need a great army in the future. Of course, the money that comes to us through these new taxes won’t be buried for fifteen years in a cave overlooking Salamis. We’ll use that money. We can’t use much of it for the army right away, because there is n’t much of an army to-day. Instead, we’ll use it to make our financial position stronger, so that during the famine fifteen years hence we shan’t find it hard to raise the necessary funds. We’ll make it as certain as we can that it will be possible to maintain that standing army.
‘We’ll keep our city’s debt from growing larger. And then if general expenditures are cut down, or our old customary taxes bring in more revenue, we can use the new tax money to pay back part of what we owe the moneylenders. Instead of getting nearer and nearer the brink of financial chaos, we’ll back away from that precipice. Should misfortune make us expand again — make us move forward — we’ll be able to move without toppling over the edge.’
But certain critics cry out vehemently: ‘Well, to levy an “army tax” and use it, for fifteen years, in building temples and paying back moneylenders is what we call financial hocus-pocus. It’s misleading the people. It’s shocking.’
And our leaders answer: ‘Why is it shocking? Without this tax — beginning now — we should run a great risk of having our future army die of starvation. With this tax — beginning now — we can feel reasonably sure that our army will always be well equipped and able to defend us. Therefore it seems to us perfectly fair, and realistic too, to call this an “army tax.” ’
And so we have an army tax. It seems the least we can do to make Athens secure against the Persians.
Put the future cost of old-age benefits in the place of the expense of maintaining an army in future years. Assume that the repair of outlying districts and the building of temples represent usual governmental activities. There seems to be a good deal of soundness in beginning at once to collect new taxes, so that the government may with the least possible difficulty meet the old-age benefit costs in the years to come.
Even the most ardent advocates of ‘pay-as-you-go’ realize that it would be folly to let the future take care of itself completely. They realize that there must be some advance provision made — some ‘contingent reserve’ created. Otherwise, in years of depression (or ‘famine’), the government might find it virtually impossible to meet its obligations to the aged people.
It has been estimated that in 1960, say, the cost of old-age benefits would be 9 1/2 per cent of the total payroll — 4 3/4 per cent on employer and employee, instead of the 3 per cent on each which will then be levied under the present law. But that estimate assumes 1960 to be a normal year. If it were a year of business recession, however, the payroll tax rate would have to be much higher. Should unemployment spread so widely that the nation’s total payrolls were diminished by one half, the payroll tax rate would have to be set at 9 1/2 per cent apiece if the necessary revenue were to be forthcoming. Such a prospect gives the ‘pay-asyou-go’ advocate pause. The need for some contingent reserve to tide over such bad years is apparent.
But is it necessary to begin at once taking in revenue so greatly in excess of outgo? When the Social Security Act was passed, it was indicated that over a stretch of about forty years there would be an excess of as much as fourteen billion dollars. Granting that the Greek leaders were wise to begin their preparations promptly, would they collect such vast sums before they had any army? Granting that there was common sense in starting the payroll taxes in 1937, was it wise to set their rates so high that for many years the government will be taking in much more than it is paying out?
To answer this question, we must look to the use to which this excess of revenue is to be put.
We have heard it said that the money from payroll taxes will go into an ‘oldage reserve fund’ and that the fund, earning interest each year, will some day amount to forty-seven billion dollars. But, as a matter of fact, the Social Security Act does not even mention any old-age ‘fund,’ and the excess revenue from payroll taxes will probably not amount to anything like forty-seven billion dollars.
The Social Security Act does establish an old-age reserve ‘account.’ This, as the word ‘account’ implies, is a bookkeeping mechanism whereby the increasing liability of the United States is shown in the annual budget.
It is not true that social security taxes are being used ‘to balance the budget.’ The existence of the Old Age Reserve Account prevents that. If the payroll taxes were simply covered in to the Treasury like any other taxes, they would help to balance the budget. But that would be budget balancing by blindfolding our eyes to our future liabilities. That would be treating the payroll taxes as net revenue, and forgetting all about the steadily increasing obligation for old-age benefits.
Honest bookkeeping seems to require that this increasing obligation be shown on the books of the United States. Hence, each year, the administration recommends that an amount roughly equal to payroll tax proceeds be appropriated to the Old-Age Reserve Account. The money thus appropriated is then borrowed by the government. Instead of the tax proceeds being covered into the Treasury in the beginning, and left there for general expenditures, they pass through the Old-Age Reserve Account, and finally come back to the Treasury as a loan. Thus the books show that the government owes a debt to millions of its people, payable in the future. We are kept from ‘balancing the budget’ fictitiously, because we are not allowed to shut our eyes to the cost of old-age benefits.
We have, then, the proceeds of the payroll taxes in the hands of the Treasury, not as revenue but as borrowed money. It will be used, presumably, just like money which the government borrows from you and me. When we buy a bond, we don’t expect our cash to be hidden away in a safe place, held for us until the bond falls due. We assume that it will be mingled with other funds, and spent in meeting the cost of running the government. We do expect to get paid in full when the time comes, because when we bought the bond we knew it was the safest investment we could make.
So with the money borrowed from the Old-Age Reserve Account. The Account — representing the wage earners whose rights to future benefits are accruing — buys bonds. No one expects the money to be put in a vault, to be used only for repaying the loan. The wage earners do expect, however, that they will get their old-age benefits. The payroll taxes which they have paid are, in effect, the safest investment they could make.
The money borrowed from the OldAge Reserve Account can be used, with some limitations, in the way other government funds are used: for current expenses, or for paying off the present national debt. Certain critics have said that it is a bad thing to spend this money for current expenses. Others have said that it is a bad thing to pay the national debt with it. Let us examine their arguments.
First, using the money for current expenses: relief, national parks, suppression of the narcotic trade, or — to use Mr. Walter Lippmann’s carefully chosen examples — refurbishing the White House and buying Mr. Justice Black a telephone. Some people have tried to scare labor by saying that such use of the money means that labor’s ‘old-age fund’ is being squandered.
I doubt if the average employee is much impressed by the argument that the money should be buried in the ground for thirty years. He realizes that benefits in 1960 will, of course, have to be paid out of funds raised in 1960. But he also realizes that benefits are much more likely to be paid in full in 1960 if payroll taxes are levied now, and the proceeds wisely spent.
More straightforward is the criticism that, being able to borrow from the OldAge Reserve Account, the government will find it easier to be extravagant. The Old-Age Reserve Account provides, through compulsion upon taxpayers, a ready source of funds.
The man who makes such a criticism assumes that it is a bad thing to have Congress decide how to spend public money, even though Congress represents the people. He assumes that it is a good thing to have the heads of large banking houses, who frequently lend money to the government, exert some kind of check on the purposes and amount of government spending, even though they are not public officials.
Whoever makes such assumptions will make a further argument against spending the old-age money for current expenses. He will point out that the government must pay 3 per cent interest on the money it borrows from the OldAge Reserve Account. Current expenses don’t bring in any return like that— they are money spent, often without any visible cash return. But have n’t we been relieved of borrowing further from the banks, and are n’t we therefore relieved of paying interest to them? Does n’t what we save in interest, on what we should have otherwise borrowed from banks, more or less cancel our 3 per cent obligation to the Old-Age Reserve Account? No, says the critic, because the government would not have borrowed from the banks. It would have spent less. The Account tempted it, and it did spend.
This idea of the Old-Age Reserve Account playing the rôle of serpent to Congress’s Eve may or may not have something in it. In a democracy, the government presumably spends money when the people want it spent, and refrains from spending when the people insist on balancing the budget without higher taxes.
Another argument against spending the money now is usually put in the form of a question: ‘Where’ll we get the money to pay the benefits in 1960?' The answer is that we shall get it through taxation in 1960, and, if necessary, through borrowing in 1960. Levying taxes now merely makes it much more likely that we shall be able to raise the necessary money in 1960.
Finally, there are those who question using this money for government spending because, when the government refrains from borrowing from the public and instead levies taxes, the result is at least comparatively deflationary. When money is borrowed from banks, the effect may be inflationary; new money, in the form of deposits, is created. When we don’t borrow, we avoid this inflationary tendency. If, simultaneously, we levy payroll taxes and thus cut private spending, we not only avoid going in an inflationary direction, but move in a deflationary one. The deflationary effect would be small, of course, if the tax proceeds were used at once for such activities as housing.
If the money is not used for current expenses, it might be used directly to reduce the present debt. If you and I are in debt, and have some extra money, we could do worse than get out of debt. The government’s debt is very large: why not reduce it?
Reduction of the present debt would lower the annual interest burden on the general taxpayer. To-day we must meet the interest annually on over thirty billions of dollars. If we reduce that principal sum, we shall be reducing the total interest also. This seems especially desirable when we remember that we are going to have to pay interest on the money borrowed from the Old-Age Reserve Account.
But there are times when debt reduction is not a good thing. It would seem rather silly to retire the debt when goveminent expenditures exceed revenue, for at the same time that we paid back our loans with our right hand we should have to be borrowing some more with our left. It would seem more sensible, at such a time, to borrow the money directly from the Account and use the proceeds for current expenses, thus eliminating the need for more borrowing from the banks.
In periods of business recession, debt reduction is of questionable value. In so far as the government’s debt is in the form of bank deposits, retiring that debt means that deposits are canceled. This is a deflationary process. More and more deflation may be bad medicine in a depression.
Of course, in a depression there would probably be less objection to spending the money for current expenses. The need for funds would be apparent, because in a depression revenues diminish and relief burdens increase. Some people have therefore suggested that the money borrowed from the Old-Age Reserve Account should be spent in debt reduction in times of prosperity, and for current expenses in days of depression.
In any event there is no likelihood that the Old-Age Reserve Account will wholly supplant the present outstanding national debt. Although in 1935 the actuarial estimates indicated a possible huge surplus of payroll tax proceeds, further study and a brief experience under the Act show that those estimates may well need drastic revision. The 1935 estimates frankly included a large amount of guesswork — without more facts, any estimate to-day would be chiefly conjecture. Right now, some of our best guessers think hardly half, if that much, of the supposed forty-seven billions is likely ever to be piled up, and quite possibly the excess will turn out to be very small — no more than the amount needed as a ‘contingent reserve’ to tide the Account over bad years. Further information must be gathered before more reliable estimates can be given.
Thus far we have been thinking of the money appropriated to the Old-Age Reserve Account as the proceeds of payroll taxes. But that is not necessarily so. If we disliked payroll taxes, we might impose other taxes, or increase existing ones, and still have an Old-Age Reserve Account. Our mythical Athenians imposed an ‘army tax,’ of uncertain nature. We could, if we wanted, impose an ‘oldage tax’ in the nature of a drastically increased income tax. The payroll tax and the Old-Age Reserve Account are not indissoluble. We might reduce the payroll tax, and still, with future obligations steadily accruing, the Treasury might insist on the usual appropriation to the Account, and Congress might make it.
Payroll taxes, rather than other taxes, are imposed chiefly because it is thought socially desirable to tax the employee who is going to get a cash benefit later on, and to insist that his employer take heed of the depreciation of the man power in his plant as well as of the machinery.
The idea of a ‘contributory system’ was overwhelmingly approved by Congress in 1935. And, so far as the tax on the employee is concerned, ‘contributory system ’ is not a bad name for it. A dime or a quarter is taken out of his pay envelope, and sent to Washington. That is his ‘contribution.’ He bears the cost himself. He will get back, in benefits, much more than he pays in ‘contributions.’
But the tax on the employer, though of identical amount, is not quite the same thing. When he digs into his pocket for a dime or quarter to send to Washington, the matter docs not end there. He does not want to bear the cost himself, and frequently does not have to. Often he will raise the price of the product he sells, and thus pass the cost along to the consuming public. It is not so easy, therefore, to say that he has paid a ‘contribution.’ He has paid a tax, and he is passing the tax along.
Society as a whole pays a large portion of the payroll tax on employers.
Now it can be seen that a payroll tax, in so far as it is passed on in the form of higher prices, imposes an equal burden on people regardless of their capacity to pay. It cannot be graduated, like an income tax. It cannot hit the man who is wealthy and can afford it, and miss the poor man to whom a one-cent price rise is a calamity. The higher the payroll tax, the higher the rise in prices, and the more apparent the regressive nature of the tax.
The people who follow the gleam of social justice are therefore sore beset. It is just — it is proper social accounting — to charge the employer with the cost of depreciation of his working force, yet it may not be just to impose regressive taxation. If you feel strongly about ‘social accounting,’ you will put up with the regressive tax; if you feel that regressive taxation is altogether evil, you will forgo ‘social accounting.’
There are, I think, a good many people who are conscious of this dilemma, and who feel that it can be solved by compromise. They feel that the contributory principle and the idea of social accounting can be maintained, and that at the same time a large portion of the total cost can be borne by further graduated taxes on income and inheritances. But they should go slow about insisting that the present payroll schedule in the Social Security Act be reduced. As has been pointed out, the present tax rates may bring in less excess revenue, in the early years, than had at first been thought. And anyone who demands a reduction of payroll tax rates should be ready to say, at once and specifically, how he would raise the money needed to meet the steadily increasing obligation.
Before the present tax rates of 1 per cent apiece rise to 1 1/2 per cent apiece — in 1940 — we can expect to have a somewhat better basis upon which to estimate future receipts and total benefits. There is, therefore, ample time to make up our minds as to the social desirability of higher income taxes for old-age benefit purposes, while the experts assemble the necessary data.
We find, then, that the ‘financial hocus-pocus’ in the Social Security Act is not an arrangement designed to fool the people, but to assure that the people are not fooled. It makes plain that we owe an increasing obligation, payable in the future, to the wage earners of America. It is ‘shocking’ to Mr. Lippmann, but it is common honesty to Mr. Morgen thau.
We find that ‘pay-as-you-go’ is not as attractive as it sounds. The opposite programme — the common-sense programme of our friends the Athenians — does lead to the possibility of government spending unchecked by the need to borrow from private banks. It also has deflationary tendencies, although drastic deflationary action when deflation is not desirable seems unlikely.
We find that the Old-Age Reserve Account, and the amount appropriated to it, have no necessary connection with payroll taxes. The Account might still exist even though different forms of taxation were selected in connection with oldage benefits. Payroll taxes were chosen simply because they seemed practical and just . Some people feel, however, that the payroll tax has undesirable features and should be kept at a low rate, with greater dependence on more progressive forms of taxation.
We find, finally, that any decision today on the questions we have discussed would probably be both unnecessary and premature. The present tax rates of 1 per cent on employer and employee do not increase to 1 1/2 per cent until 1940. The amount collected in these first three years will hardly be enough even for that ‘contingent reserve’ which the pay-asyou-go advocates now recognize as a necessity. We do not really know, today, whether the taxes imposed by the Act will in fact bring in much more money in the next twenty or thirty years than will be paid out in benefits.
During the next year or two, the wage records of the Social Security Board should bring to light some of the facts upon which reliable estimates can be based. The public, meanwhile, will have a chance to discuss the real issues: first, the desirability of a large excess of income from old-age taxes over outgo for old-age benefits; second, the advantages or dangers of using such an excess for current expenditures; and third, the kind of tax that an old-age tax should be.
The discussion of these problems can be useful and enlightening, if words like ‘shocking’ and ‘crime’ and ‘financial hocus-pocus’ are cast to one side. Sincere and informed men, having at heart the security of the aged people and the welfare of the nation, may differ and do differ. Their considered opinions can be of great, value if they will but proceed dispassionately to a discussion of the issues.
(Mr. M. A. Linton, ’president of the Provident Mutual Life Insurance Company, will reply to Mr. Eliot in the September Atlantic)