WHEN PRESIDENT BUSH HINTED LAST week that he might be willing to raise the payroll tax cap to "pay for" Social Security reform, he opened the door to the largest federal tax increase endorsed by a Republican since George Bush Sr.'s "read my lips" debacle 15 years ago.
The 12.4 percent Social Security payroll tax is now levied only on the first $90,000 a worker makes each year. What President Bush said was that raising the cap (to perhaps $125,000 or even $200,000) was "on the table." This was a strategic blunder of the first order. Now even the strongest advocates of Social Security personal accounts are wondering what hefty price will have to be paid to enact them. And while this move was seen as a tactical device by the White House to keep the Social Security debate moving forward, in fact it is a serious setback. House majority leader Tom DeLay and others in the Republican leadership in Congress have rightly declared that any tax hike to "pay for" Social Security reform is dead on arrival, especially in the more conservative House.
Bush may gain a few Democratic votes by agreeing to raise taxes, but it appears he would lose far more Republicans in the bargain. In other words, this proposal is a net subtraction of votes for personal accounts.
Worse yet, by talking of higher taxes in exchange for Social Security reform, the White House is only reinforcing the concern among House Republicans in tough districts that this debate could become a Republican version of HillaryCare, with its subsequent decimation of Democrats in the 1994 midterm elections. Tinkering with Social Security is a tough enough vote for Republicans, let alone doing so while raising taxes at the same time.
A quick glance at George W. Bush's governing style during his first term reveals that whenever he reaches out to congressional Democrats, the result has been legislation that maims taxpayers and divides the Republican party down the middle. That is what happened with the ill-fated $1 trillion Medicare prescription drug fight of 2003. Conservatives split off from the president, and enough moderate Democrats gave Bush the margin for "victory." The term "victory" is in quotation marks because it is now universally acknowledged that the prescription drug bill is a fiscal time bomb, with the costs already exploding in the 18 months since it was passed.
An even more ominous analogy is the No Child Left Behind education bill. This passed in 2001 with lots of Democratic votes, including support from Ted Kennedy. The education bill ended up massively expanding education spending, and it sanctified the federal presence in school policy. Worst of all, the one desired conservative feature, school choice, was excised in the process.
The danger now is that Bush, who wants a legacy "victory" on Social Security, will ultimately sign a Social Security bill that raises taxes and drops or guts personal accounts. On Social Security, Bush is arguing for less bureaucracy and more individual financial choice, and those are attractive concepts, particularly to young voters. Polls reveal consistently that the public understands that the Social Security system needs to be modernized (though they reject the term "crisis") and that those who argue for doing nothing (most of the Democratic party leadership) are the enemies of progress. Bush got a huge boost this week from Alan Greenspan, who acknowledged (1) that Social Security's finances are in desperately poor condition, and (2) that private accounts can be very beneficial to young workers. But Bush's talk of higher taxes stepped on that helpful headline.
Talk of raising taxes as part of a pro-freedom reform scrambles the underlying message and divides the natural allies of personal accounts. Self-employed workers are big winners under any private investment account system, because currently 12.6 percent of what they earn up to $90,000 is sliced right off the top of their take-home pay. That's roughly $11,000 a year if they make $90,000 or more. If the cap were raised, say, to $125,000, these same workers would be big losers, with their Social Security tax rising to some $15,500 a year (and this doesn't even count the $3,700 a year they pay in the Medicare payroll tax).
Raising the cap would have two effects. First, the payments of higher-income workers would be so out of proportion to any eventual benefits as to make a mockery of the long-held notion that Social Security is an insurance program and that the tax payments are individual "contributions" into a trust fund for one's own retirement. Ironically, it has been liberal Democrats, arguing against the creation of personal accounts, who have made this case most vociferously.
Raising the payroll cap would convert Social Security into an overt income redistribution program. Higher income people would pay an inordinate amount of payroll tax in order to subsidize the pensions of low income workers. If Social Security is to be made into a welfare program, then it should be done on an honest and much less economically destructive basis simply by cutting the benefits of wealthy seniors, rather than hiking marginal tax rates while they are still working, which destroy economic incentives to work and invest.
It may seem fair to raise payroll taxes on higher income workers. But in many high-cost states, an income of between $90,000 and $150,000 a year is anything but rich. In states like California and New York, many school teachers, computer technicians, construction contractors, and medical assistants earn more than $90,000 a year, especially if they log overtime.
The rich already do pay the lion's share of federal taxes through the personal income tax. The latest Tax Foundation data reveal that the wealthiest 10 percent of earners already pay almost two-thirds of the income tax. And because we have an Earned Income Tax Credit that essentially refunds to low-income families the money they pay in payroll taxes, even the payroll tax system is much more progressive than is commonly understood.
The suggested payroll tax hike is politically perverse, given that its principal impact would be to cancel out one of George W. Bush's primary policy victories in his first term, namely, the income tax cuts. Bush went to the mattresses to reduce income tax rates by about 5 percentage points on average. This, in combination with the capital gains and dividend tax cuts, helped spur growth, a stock market rally, and now a jobs boom. But for those in the upper middle income range, lifting the payroll tax would transform a 5 percentage point reduction in tax rates into a net 7 percent hike.
The strongest selling point of a personal account system for Social Security is that the current system is a rotten deal for young workers. For workers with incomes of more than $90,000 a year, the program already offers a poor return on the money they pay in to Social Security. The typical worker with earnings of more than $90,000 gets a rate of return from Social Security that is around 1 percent. Raising the payroll tax cap tells these workers that they would now get an even tinier rate of return, because they would be forced to pay more in for the same promised payout. Republicans should be arguing for a better deal for all workers.
George W. Bush is desperate to secure at least token Democratic party support for his historic Social Security modernization plan. He wants Social Security reform--and especially the implementation of personal accounts--to be the crown jewel of his domestic policy legacy. But any reform bill that raises taxes to win the support of Ted Kennedy or Nancy Pelosi likely will be much worse than no bill at all.
Stephen Moore is president of the Free Enterprise Fund.