Asymmetrical Information

Assume you have spent your life saving your money and buying government bonds. Assume further, that despite your obvious obtuseness and unwillingness to listen, you live to the age of retirement.

And what if that assumption turns out to be false and you die before reaching retirement? Under Social Security, you get exactly $255 as a one-time death benefit, regardless of how much you paid in over your lifetime.

Your spouse might get a special "spousal benefit" assuming that he did not also work and pay into Social Security, in which case the spousal benefit is worthless.

The surviving member of a gay couple, meanwhile, gets an official Social Security middle-finger, courtesy of DOMA.

IIRC, the plan that was adopted in 1983/4 to "fix" Social Security by pumping up the trust fund in anticipation of the Boomers' retirement had two parts. One was to raise the tax rate and create the surplus; the other was for the rest of the government to run a balanced budget and over 30 years transfer the entire national debt (then about $1.5T) from the public to the trust fund. Then over the 30 years after that, the national debt would be transfered from the trust fund back to the public. If Congress had held up their end of the bargain, the credit shuffle would be easily performed over the years and no big deal.

Unfortunately, the increased taxes and the trust fund assumption of government debt had the force of law behind them. No such limitation was applied to the Congress, who spent the next 20 years maxing out the credit cards. Krugman had an interesting pair of numbers the other day. At no point in the next 40 years will the dedicated SS tax cover less than 81% of the promised outlays; today, the general fund is only covering about 68% of its outlays; why is the SS situation a crisis and the general fund not?

"It's a perennial favourite of the AARP. I confess, I don't understand why it works. Are people really unable to understand the difference between lending money to a third party, with a promise to repay in the future, and 'lending' money from your future self to your current self to spend now?"
~~~

It would seem so. The key seems to be the words "government bonds" -- these people tend to put great emotional faith in the government.

So if you explain the logic of the situation to them in my experience they come back: "Full faith and credit! Full faith and credit! If the government defaults on those bonds it will be the end of the world!" Missing the point entirely.

But there is a remedy ... I quote the government to them.

Analytical Perspectives on the 2005 Budget
http://www.whitehouse.gov/omb/budget/fy2005/pdf/spec.pdf

"At the time Social Security ... redeems these instruments to pay future benefits not covered by future income, the Treasury will have to turn to the public capital markets to raise the funds to finance the benefits just as if the trust funds had never existed. From the standpoint of overall Government finances, the trust funds do not reduce the future burden of financing Social Security."

[p. 199, my emphasis]

I find they have a much harder time dealing with the government telling them the trust fund is worth $0 than my telling them ;-)

If a business tried to fund its retirement plan exclusively with its own bonds, the execs would go to jail. When the U.S. does the same thing with Social Security, AARP says it's a rock-solid investment. Too bad businesses can't tap the magical money tree AARP must know about.

The AARP knows there's a difference between a corporation and a government of a large industrial economy.

"At no point in the next 40 years will the dedicated SS tax cover less than 81% of the promised outlays; today, the general fund is only covering about 68% of its outlays; why is the SS situation a crisis and the general fund not?"

Geeze.

(1) Krugman is comparing the general fund balance *today* -- which is supplemented by the SS surplus (with Krugman being he first person to argue the budget should be judged on a unified basis) and which can be changed at will by Congress at any time -- to a 40-year deficiency in SS that is locked in and can't be changed without fundamentally altering the program??

(2) Is Krugman being disingenious at stopping his tally at 40 years. That's when the trust fund runs out. What happens then?

Perhaps Krugman should try to remember who wrote this:

"Social Security ... has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over..."

-- Paul Krugman, Boston Review, January 1996-97 issue.

"The AARP knows there's a difference between a corporation and a government of a large industrial economy."

Maybe they should rememeber what the difference is.

A corporation has to fund retirement obligations with real assets in a real trust -- not one that when called upon leaves the situation "just as if the trust funds had never existed". And because the trust is beyond its control, it can't reduce funded benefits later.

A government is run by self-interested politicians subject to the whims of voters, funds nothing, and can cut benefits at any time (as SS has already done *twice*, the prior two times it ran out of money).

Also, *only* a government can set up a defined-benefit retirement plan with a benefit schedule that gives back every annual cohort of retirees into the future *less* than they paid into it!

Try to imagine a corportion doing that!

I'll make a prediction though: when today's young get old enough to start moving into AARP, AARP will begin to remember.

B, there sure is a difference. One is a perpetual entity with opaque finances run by an barely-accountable group of self-selecting insiders. The other is just a corporation.

Jim, is just isn't fair to actually quote the Perfesser!

Another way to explain it is to ask oneself what would happen to Joe Taxpayer if he decided to default on the bonds sold to the government of China, as opposed to defaulting on the bonds held in the trust fund. The first default makes things very, very, very, painful for Joe, in many, many, ways, no matter what stage of life he is in. The second default, if Joe isn't too old, will actually, in all likelihood, be somewhat beneficial to him.

To think of these bonds as being similar, in terms of the risk of default, is to ignore fundamental aspects of borrower behavior.

"One is a perpetual entity with opaque finances run by an barely-accountable group of self-selecting insiders. The other is just a corporation."

Ha! I'll remember that. ;-)

Hey it's me. The commenter who "nailed it"! Getting quoted (typos and all) on this fine site makes my day (thanks, Jane). Can I get a job at The Economist? I'll do anything -- I'll even make photocopies and fetch everyone's coffee at Starbucks.
(-:

hi megan,
"Payroll taxes are, of course, all ultimately paid by all but minimum wage employees, not their firms. Firms have an upper limit on the cost they are willing to incur to hire an employee; any money taken by the government in tax represents salary they could have negotiated for themselves."

i am wondering if you have some implicit assumptions about the elasticity of supply and demand of labor. i say this because the economic imposition of a tax is not always the same as the legal incidence of taxation (which i think is the point of this comment above, right?). who actually gets to pay the tax depends on the elasticities involved. the more inelastic the schedule involved, the more of the tax folks on that schedule actually pay. correct me if i am wrong, but when i read what you are saying above, i understand you to be saying that the elasticity of supply of labour is completely inelastic. but if that is the case, that would seem to suggest that the payroll tax will have no impact on bodies hired, since the only effect is a lower wage for those workers who are hired. is that what you are arguing? if so, i would like to follow up on the evidence you have for such a completely inelastic supply curve of labour (as i would like to share that link with my students)?

Dittoes to what cas said. My impression was that the elasticities for supply and demand of labor are roughly equal, which would mean the naive assumption that workers only bear "their" half of the payroll tax would turn out, by sheer accident, to be approximately true. (This is assuming that the workers, in their capacity as consumers, do not also bear too much of the ultimate incidence of that portion of the tax whose proximate incidence falls on the employer.)

Cas and Paul are exactly right--the distribution of the burden of the payroll tax depends on the relative elasticities of demand for and supply of labor. This is standard wedge analysis which anyone as literate in economics as you should be aware of. The only way for 100% of the burden to be borne by employees if is labor supply is perfectly inelastic, or labor demand is perfectly elastic (in both cases the reference is to the long run, of course). While estimating elasticities of labor demand and supply tends to be a bit dicey, I know of no empirical support whatever for either possibility. Daniel Hamermesh's "best guess" about the elasticity of demand for labor, published a few years back, was 0.30. Most of the estimates of labor supply elasticity that I have seen put it at below 1.0, but clearly greater than zero. So it is not the case that "Payroll taxes are, of course, all ultimately paid by all but minimum wage employees, not their firms. "

(Joe Kristan) "Too bad businesses can't tap the magical money tree AARP must know about."

(Boonton) "The AARP knows there's a difference between a corporation and a government of a large industrial economy."

Yes, the difference between a government and a corporation is that the government can do all kinds of things a corporation can't, including among others: print reams of money to "make up" the shortfall (and screwing people through inflation), or as long as the elderly are a big enough voting bloc, taxing hell out of younger people to pay off their more organized elderly constituents. Might doesn't necessarily make right, though.

On the question of how much tax the employee pays:

How about "The employee pays just as much of the tax on the employer as he does of the tax on himself"?

By the analysis you're using (which I believe is correct), the employee will wind up actually paying a certain percentage of the tax levied on himself, and a (probably identical) percentage of the tax levied on his employer. So levying the tax half on the employer and half on the employee is functionally equivalent to levying the whole thing on the employee (which is functionally equivalent to levying the whole thing on the employer, which is the whole point of that analysis in the first place). So while the employee may not bear all the costs of the taxation, claiming we spare him half by making the employer pay it instead is disingenuous at best.

A corporation has to fund retirement obligations with real assets in a real trust -- not one that when called upon leaves the situation "just as if the trust funds had never existed". And because the trust is beyond its control, it can't reduce funded benefits later.

A corporation must produce revenue to pay its bills from the assets it owns. Unlike a corporation, the assets a gov't owns are almost always irrelevant to its budget. A gov't derives its revenue from taxes which come from the underlying economy.

Even with regular debt, the assets of the corporation are implicitly 'funding' their borrowing since their assets are the only thing that can produce the revenue to pay off the debt in the usual course of things. This is why the corporation's balance sheet is an essential financial statement.

A gov't, though, almost never uses its assets to generate revenue to pay its debts. In fact, its usually pretty bad when that happens. That happens in countries where the government owns some type of major industry (such as the nationalized oil companies of the Middle East or the UK's coal mines in the 70's). Ideally a government's balance sheet should be made up of 'worthless' items like national parks, a few office buildings and military bases. It should not have productive assets like factories, capital and other things.

Like it or not you cannot apply the same tools analyzing companies as you do to gov'ts.

So levying the tax half on the employer and half on the employee is functionally equivalent to levying the whole thing on the employee (which is functionally equivalent to levying the whole thing on the employer, which is the whole point of that analysis in the first place). So while the employee may not bear all the costs of the taxation, claiming we spare him half by making the employer pay it instead is disingenuous at best.

It's been said that the employee bears the full cost of the SSI tax. If you have self-employment income you certainly do. If this is the case you would think that people would be totally indifferent between taking regular wages or self-employment income (which should be higher just enough to compensate for the higher tax the individual pays). My gut feeling is that many people demand a higher premium for working as an independent contractor than would be justified by simply the employers share of the SSI tax.

I suspect that the market is such that employers are in fact bearing a portion of the cost of their share of the SSI tax. Therefore in order for a person to take a position as an independent contractor they would need compensation beyond just both sides of the tax.

Regarding the issue of just who is paying the employers' portion of the payroll tax; to the employer there is a cost of employment which includes wages, benefits, and taxes. It doesn't really matter to the employer to whom it writes the checks, only if the employees produce enough to cover those costs plus a normal profit.

So, looking from that viewpoint, the employee does pay all the p/r tax.

No, I'd think that the elasticity of demand determines whether or not employers fire workers in response to higher costs. Who pays the payroll tax should be determined by the elasticity of the supply of labor, which most economists agree is pretty inelastic, other than for very high, and very low, wage workers. When you impose a new cost collectively, the employee has no additional bargaining power with which to induce the employer to take on a share of the cost. Since the cost is more likely to run into the employer's ceiling than the employee's floor (which, given that we all must continue to eat, is pretty low), the employee bears the cost.

That's a micro argument, of course; on a macro level, I'll go back to what I said before: if the employer (i.e. the shareholders) were bearing the cost, then we should have see a net transfer of resources from capital to labour (since AFAIK SS payments would be registered as a labour share of national income). Given that we haven't, I'd say that macroeconomically speaking, it's simply not possible that anyone but hte employees are paying the tax.

I tend to agree but it also seems sensible then that the premium workers demand for being 'independent contractors' should equal the employers share of the tax plus the value of fringe benefits (including an element of job security). If workers demand even more than that, that would be an indication that employers are somehow bearing at least part of the employer tax.

How you can measure this without some heavy duty statistical analysis is beyond me. True labor's share of income has remained relatively steady historically but what does that really tell us? How do we know it wouldn't have deteriorated over the years?

I don't understand. Why does it matter if the EMPLOYEE pays part, all, or none of the SS tax?

In the end the company must break even (over the long run) and so either charge higher prices, employ fewer workers, lower wages, or lower dividends to cover ANY extra expense (like the SS tax) that the company pays. So in the end, some person is paying the corporate part of the SS tax.

It's relevant as an academic question. If the SSI tax was abolished what would happen to wages? What would happen to corporate profits (capital income)? Would corporate profits go up even by $1 or would wages increase exactly enough to offset the eliminated tax?

If its the latter then indeed the whole burden of the tax is born by the employee, if it is the former then a portion of the tax is born by 'capital' (those that own companies).

No, I'd think that the elasticity of demand determines whether or not employers fire workers in response to higher costs. Who pays the payroll tax should be determined by the elasticity of the supply of labor, which most economists agree is pretty inelastic, other than for very high, and very low, wage workers.

If that is what you think, you are wrong. It is the relative elasticities of demand and supply that determine the incidence of a tax. The burden falls more heavily on the less elastic side of the market. This is standard wedge analysis--you should be able to turn up some online treatments of the subject with a bit of googling if the word of one economist who teaches the topic regularly isn't enough for you. You are correct that most empirical estimates of labor supply elasticity show it to be fairly inelastic, even in the long run--but as I noted above, labor demand is also fairly inelastic, so it is likely that the actual incidence of the payroll tax is pretty close to the 50-50 statutory split.

I can dutifully, factually, report that the economists and actuaries of the SS Adminsistration and various outside Advisory Committees are pretty unanimous in saying employees pay all the cost of Social Security, and that the "elasticity" considerations are spurious.

The reason is that, until now at least, payments into the SS program functionally have not been a tax but a favorable way of financing benefits -- so "tax" considerations no more apply than they do to wage reductions that finance regular pensions, educational benefits, cafeteria benefit plans whatever.

A tax is a *cost*, and that cost is divided among affected parties in line with their relative elasticities. But financing an employee benefit that provides full value (or more) for the expenditure is *not* a cost. It is is just a reshuffling of various parts of the total wage bill, which may even be advantagous. (As when employers provide tax-favored benefits instead of taxable salary.)

As a clear example re SS, a "tax" as big as the total of the employer part of SS contributions is a cost that industries try hard to avoid, employing battalions of lobbyists and tax lawyers if necessary.

But historically businesses quickly embraced SS and lobbied *for* it -- because as long as it paid above-market returns it reduced their pension bills. So it was no "tax" to them, it let them meet workers' demand for market-level pension benefits at less cost, through SS contributions rather than contributions to normal pension plans providing only market returns. (If anything, there was a *gain* to which the elasticities applied, divvying it up between companies and workers. And a gain is the opposite of a tax).

So the SSA's economists and acutaries consider the wage level that employers face to be set by the market, with SS coming for all practical purposes fully out of the workers' side as one form of compensation rather than another, leaving the total basically unchanged.

BTW, big businesses' rapid powerful embrace of SS was a big part of it becoming universal quickly -- and it shows the importance of *positive returns* on contributions in the politics and history of SS.

As SS becomes a *real* tax by providing negative returns, this dynamic will go into reverse.

Boonton - The premium employers pay independent contractors is due, largely, to the flexibility employers gain in managing the size of their workforce. It is far easier to terminate a contract than to fire an employee. Yes, workers "demand" extra pay to, in part, compensate them for the extra taxes (and lack of benefits) being an independent contractor entails, but they also demand extra pay to compensate them for the risk they'll be out of work more frequently.

Having helped analyze this question for both clients and my own firm, I can say we NEVER consider salary, payroll taxes, and benefits as separate items. Determining whether to add headcount is always a total cost determination (payroll plus benefits plus taxes). Determining whether to hire (employee) or rent (contractor or temp) is based on the question of how sure we are there will be a long term need for the position.

"While [automation] makes sense as a macroeconomic solution to the demographic crisis, it will not make the Social Security system itself stable."

Higher productivity means that income taxes can be raised without affecting the standard of living. This effect is what has allowed taxes to be raised to their current breathtaking levels; in earlier lower-productivity eras, this would have caused a civil war.

Boonton - The premium employers pay independent contractors is due, largely, to the flexibility employers gain in managing the size of their workforce.

I agree with that but I wonder if we are looking at two sides of the same coin. You're paying the premium because the flexibility is worth it to you....or are they demanding the premium because your flexibility is a huge cost to them? Regardless I would say flexibility is an indirect benefit that is all part of the process.

Jim writes:

I can dutifully, factually, report that the economists and actuaries of the SS Adminsistration and various outside Advisory Committees are pretty unanimous in saying employees pay all the cost of Social Security, and that the "elasticity" considerations are spurious.

Spurious elasticity! The horror! Jim's right to be a bit frantic here. If SSI's tax cost is born entirely by the employee his numbers for 'typical returns' look bad, if the employee is only bearing half of the SSI tax then the cost basis for calculating a 'typical return' drops in half.

Sadly for Jim you can't dismiss something with a bit of name calling. Why should we assume that labor demand is highly elastic when that doesn't pan out by emperical evidence?

If this was true then employees would typically be totally at the mercy of employers. Labor would supply pretty much the same amount of labor regardless of compensation AND employers demand would vary a lot with compensation. Yet Jim also paints a picture of employers passionately supporting SSI because it relieved them of funding expensive pension plans. Elastic demand would imply that employers wouldn't care about employee pension plans.

A tax is a *cost*, and that cost is divided among affected parties in line with their relative elasticities. But financing an employee benefit that provides full value (or more) for the expenditure is *not* a cost. It is is just a reshuffling of various parts of the total wage bill, which may even be advantagous. (As when employers provide tax-favored benefits instead of taxable salary.)

I'm not even sure what this means but take note that the 'wage bill' is indeed a cost for the employer regardless of whether the benefit provides 'full value'. Take an employee whose health insurance cost the employer $5000 a year. This is a cost to the employer even if it turns out the health insurance was horribly overpriced and the employee didn't even use it!

"I'm not even sure what this means..."

Let me help you; you don't.

"Take an employee whose health insurance cost the employer $5000 a year."

It's costing the employee $5,000, not the employer. The employer is merely writing the check on behalf of the employee.

We employers look at the TOTAL cost of employing someone, not the individual components of these costs. It's the employees who should be concerned with their health insurance costs.

Jadagul, it does in fact make a difference that half the tax is nominally paid by the employer and half is nominally paid by the employee. This is because the employee portion is paid with after tax dollars and the employer portion is paid with pretax dollars. It used to be the case that employers could voluntarily pay the whole thing. Eventually employers figured out by doing so (with a corresponding cut in wages) both employee and employer could benefit at the expense of the government and the government stopped allowing this. This is also why the self employment tax rate is less than twice the employee tax rate.

As for Jane Galt's claim that 100% of the tax is borne by the employee this seems to be wrong for a pure tax (with no corresponding individual benefit) for the reasons others have stated (a portion will be borne by the employer who will be able to pass some of it on to his customers). The fact that there is an associated individual benefit complicates the analysis but I don't think it changes anything.

Now that I look at it again I think the existence of the associated benefit does change everything. I don't know that it changes everything completely-- participation is presumably mandatory for a reason-- but close enough to completely that it becomes essentially true that the employee pays for it all.

If you are correct that the employer pays 50% of the SS tax, rather than the employee paying 100%----then doesn't this same argument apply to the income tax?

I never get my hands on the withheld amount for one instant---the employer cuts a check to Uncle Sam, in exactly the same way that he cuts a check for the "employer share" of the SS tax. In fact, he cuts a check for the "employee share", too. How could it be that one of these three identical checks is paid by the employer, yet the other two are paid by the employee.

Come to think of it, my employer also cuts a check to my Credit Union every payday. Who pays this---me or my employer?

"Spurious elasticity! The horror! Jim's right to be a bit frantic here. If SSI's tax cost is born entirely by the employee his numbers for 'typical returns' look bad,"

Not at all. Why in the world would you think that?

And they aren't *my* numbers, they are the numbers published by the Social Security Adminstration actuaries, who base their calculations on the cost of all SS taxes falling on employees.

Because that's what Social Security's actuaries and economists consider to be the case.

"if the employee is only bearing half of the SSI tax then the cost basis for calculating a 'typical return' drops in half."

Well, *then* the SSA Actuaries' calculations would look bad, because financial return to workers on their contributions would be much higher.

Of course, that increase would be exactly offset by also calculating a finacial return to employers on their taxes of exactly zero (0).

"Sadly for Jim you can't dismiss something with a bit of name calling"

Name calling? Dismiss something?? I Am sad??? ;-)

Hey, I just reported what the SSA and SS Advisory Commissions' economists and actuaries say. It's all published, you could look it up.

If you think that's "name calling" then I'd say you have a beef with them, not me. Take it to them!

Spurious elasticity! The horror! Jim's right to be a bit frantic here. If SSI's tax cost is born entirely by the employee his numbers for 'typical returns' look bad,"

Not at all. Why in the world would you think that?

Quite simple. If I pay $100 into something and get a benefit check of $90 and then drop dead, my return was -10%. If I only paid $50 into that thing then my return was 80%.

We employers look at the TOTAL cost of employing someone, not the individual components of these costs. It's the employees who should be concerned with their health insurance costs.

True but it doesn't follow that the employee is bearing the burden of the cost. Imagine the insurance company cut premiums in half. Will you immediately give all your employees a raise of $2500 per year?

Of course, that increase would be exactly offset by also calculating a finacial return to employers on their taxes of exactly zero (0).

Return on their taxes? If the employer does bear part of the tax (or all of it) then that money would not have gone to the worker to begin with. The return would properly increase the workers return on his benefits. It's nonsensical to calculate a return on employers tax expense, neither SSI nor pensions are set up to generate a return to employers but provide a benefit to employees.

Name calling? Dismiss something?? I Am sad??? ;-)

Hey, I just reported what the SSA and SS Advisory Commissions' economists and actuaries say. It's all published, you could look it up.

While we're at it, argument from authority is only a bit less grating as a fallacy.

hi all,
its an interesting debate that consideration of the tax-benefit issue of sstaxes has brought up. i must confess i have no idea why the ssa economists and acturaries are saying what they are saying. really, i don't.

is the payroll deduction a tax or not? one argument is that it is actually a benefit (a subsidy maybe? :)) and thus something the worker treats in exactly the same way as any other benefit (i get the health insurance, etc).

respectfully, i don't buy it. why? i get health insurance and it gives me benefits for right NOW. ss is a long way off (usually). unless i have some really small pitiful discount rate of future consumption, i am hardly hanging out for the promised benefits now; unless i am reasonably old, i suppose... if that is not so, it seems like a tax to me, since i don't get the benefits, NOW. just the costs. if one speaks to folks in the street, the answer they have to that distinction (cost or benefit?) is going to heavily depend on whether or not they are under or over 40 years of age... (hypothesis: compare rates of savings in ira's for those pre and post 40; i suspect that holding income constant, the rate would be higher for post 40s. is that right or am i just blowing smoke?)

also, megan, relying on what ssa actuaries and economists think? i enjoy your blog because you don't normally make arguements based on appeals to authority (i like that you question received wisdom and that is the space in your blog where my learning takes place). so that felt a bit strange to me.

is the payroll deduction a tax or not? one argument is that it is actually a benefit (a subsidy maybe? :)) and thus something the worker treats in exactly the same way as any other benefit (i get the health insurance, etc).

Whether its a net benefit is indeterminate. If you die before you turn 65 SSI is not much of a benefit. If you become disabled and/or live a very long time it is a benefit. The question of who is paying the tax is much simplier.

Jim is wrong, the elasticities do matter. Take health insurance that costs $5000 per year for an employee. If the cost drops to $2500 will the employees instantly get a $2500 raise? If not then at least a portion of the cost is being born by employers. Likewise if the cost goes up to $7500 wll the company cut everyone's pay by $2500?

The legal incidenceof the tax doesn't really matter here. In a tight labor market workers can actually pass along all the costs of the SSI tax to their employers by demanding wages high enough to offset their share of the SSI tax. Likewise in a weak market employers can pass along their share of the tax by cutting wages enough to make up their share.

Since our economist friend said that both supply and labor are inelastic I'll go along with the 50-50 split as rather reasonable.

"Imagine the insurance company cut premiums in half. Will you immediately give all your employees a raise of $2500 per year?"

In a competitive labor market, with all insurance companies cutting premiums, yes.

Paul Zrimsek, the associated individual benefit means the employee bears all the cost only if the value the employee places on the benefit is exactly the same as the cost. Otherwise the difference represents a tax (or subsidy) which is shared between employee and employer. Suppose for example employees place no value on the benefit. Then the existence of the benefit becomes irrelevant and the analysis is the same as for a pure tax. In reality of course employees will place varying values on the benefit with employees who value it highly being in effect subsidized by employees who don't.

ray, a portion of income tax is paid by the employer. This is particularly apparent when comparing jurisdictions with different tax rates. For example different state and national (US vrs Canada) income tax rates are sometimes a consideration with baseball free agent signings with teams in high tax jurisdictions having to pay a bit more pretax to stay competitive. Some MLB contracts provide for adjustments if the player is traded to a high tax team.

Jane Galt's speculation about massive inflation in goods consumed by the elderly shows a bizarre lack of faith in the free market's ability to adjust to shifts in demand, especially shifts readily predictable decades in advance.

"Imagine the insurance company cut premiums in half. Will you immediately give all your employees a raise of $2500 per year?"

In a competitive labor market, with all insurance companies cutting premiums, yes.

Those of us working in the real world know the answer to this is no. A company will, in most cases, not give all their employees an immediate $2500 raise if they are able to score a better deal on health insurance. Likewise a company won't immediately cut pay if insurance costs go up. Over the longer term, where both demand and supply become more elastic, the case may be different.

Then the existence of the benefit becomes irrelevant and the analysis is the same as for a pure tax. In reality of course employees will place varying values on the benefit with employees who value it highly being in effect subsidized by employees who don't.

The type of problem with this type of analysis is that it is often impossible to even measure these things in theory. It's better to take a step back and simplify something. If the insurance or tax or whatever costs $5000 a year then the cost is $5000 a year. The question is who pays that? Do employers cut pay $5000 thereby making employees pay it all? Do employers keep pay the same and let their labor costs simply grow by $5000? Or a combination of both?

Once you figure that out then you can address the question of how much the $5000 benefit/tax is worth to the employee. Social Security, though, is more complicated because it is both a benefit AND a tax. Everyone acknowledges that SSI has a progressive tilt built into it giving lower income workers more of a bit than higher income workers relatively speaking. That element is going to complicate return calculations because you will overstate your cost basis if you include 100% of the tax payments.

Boonton, you can't decide who effectively pays the tax until you know where it goes. Suppose for example the government imposes a payroll tax on employers and immediately returns it to the same employers as a benefit. This is equivalent to having no tax or benefit. So wage rates will not change and the employer will be paying the entire tax. Suppose on the other hand the entire benefit is paid to the workers (each receiving the amount of tax paid on his wages). Then wages can be expected to fall by the amount of the tax as this will make the situation equivalent to the prior equilibrium with no tax or benefit. So in this case the tax falls entirely on the employee.

As to the relative perceived benefit of social security to low paid and high paid workers, it is true that the monthly payment amounts are relatively greater for low paid workers. However high paid workers tend to live longer. Furthermore high paid workers tend to have lower discount rates. A high paid worker may own tax free bonds paying 5% which means he has a discount rate of 5% or less while a low paid worker may be carrying credit card debt at 20% which means he has a discount rate of at least 20%. In other words low paid workers tend to need cash now more than high paid workers. Now $1 discounted for 20 years at 5% is worth $.37689 but discounted at 20% is only worth $.02608 a ratio of 14.5. So many poorly workers will feel social security is a bad deal for them even though they are being subsidized. This is why they will often choose to work "off the books" for quite trivial increases in after tax pay.

Boonton,

You have really elevated this discussion. However I'll throw myself in with Jim and Jane. I think all your arguments are valid in the short run. However, over time competition will cancel out the short run effect of various elasticities.

As someone who has studied economics and run a business the reasons are obvious. A cut in my costs through lower insurance premiums? I'll certainly try and pocket it. Can I over time? Only if I have a tremendous competitive advantage which allows me to simultaneously outbid my competition for the relevant workers without raising pay despite my competitors and potential competitors greater ability to enter the marketplace and bid for them. That is why over time labors share of income is so constant (though not perfectly so.) Undoubtedly a cut in the payroll tax on the employer side would be a short term windfall for employers. Within a few years it would fade away. There would be anomalies, but they would cut both ways.

Of course this is true when SS taxes are increased. I think it would be interesting to see if when the SS Tax has in the past been increased if there was a short term increase in labor's share of total income? Obviously long term there hasn't been. I suspect short term it has been a tax on employers which could be demonstrated.

In the end employers look at total cost of an employee in deciding what they can pay. Employees want what they can get. Inelastic demand and supply schedules eventually give in to that in an economy as a whole(I always included on my employee stubs the emplyer SS cost to show what SS was costing them. My little blow against hidden taxes my employees pay. It was a nice economic lesson for many who were surprised at how much of what I paid them went to the government.) An interesting question is what is the policy implication of that short term inelastic stickiness (I always liked Keynes's use of the term sticky rather than economic jargon.) If the tax were ever disclosed and recast honestly as a tax on workers, should we also require that companies give a corresponding one time raise?

You have really elevated this discussion. However I'll throw myself in with Jim and Jane. I think all your arguments are valid in the short run. However, over time competition will cancel out the short run effect of various elasticities.

As someone who has studied economics and run a business the reasons are obvious. A cut in my costs through lower insurance premiums? I'll certainly try and pocket it. Can I over time? Only if I have a tremendous competitive advantage which allows me to simultaneously outbid my competition for the relevant workers without raising pay despite my competitors and potential competitors greater ability to enter the marketplace and bid for them. That is why over time labors share of income is so constant (though not perfectly so.) Undoubtedly a cut in the payroll tax on the employer side would be a short term windfall for employers. Within a few years it would fade away. There would be anomalies, but they would cut both ways.

Thank you for the compliment Lance. I believe (correct me if I'm wrong) labor's share of income has been about 70% and capital 30%. If this remains constant then in the long run a decline in health insurance cost of $1000 per year will translate into $700 going to labor in the form of increased wages/benefits and $300 going to you as a business owner. If this wasn't the case, if all the savings gets passed onto the workers over time, then labors portion of income would not remain constant.

In that case 30% of SSI taxes fall upon employers and not 100%. Any estimate of SSI's return has to reduce the cost basis by 30%. Time does change the elasticities but it does so for both demand and supply.

Boonton, you can't decide who effectively pays the tax until you know where it goes. Suppose for example the government imposes a payroll tax on employers and immediately returns it to the same employers as a benefit. This is equivalent to having no tax or benefit. So wage rates will not change and the employer will be paying the entire tax.

After 9/11 the gov't passed a $12B bailout bill for the airline industry. Let's imagine this bill was financed not with deficit spending but with a payroll tax. So airline workers, let's say, paid $1B in payroll taxes but their employers got $12B. Would this really be equilivant to either have 'no tax' or a net benefit of $11B for the airline workers? Only if the airlines increased pay for their workers by $1B or more.

But, depending on market conditions, the airlines could tell their employees that they need the full $12B and won't give them any pay increase. After all, where are the airline workers going to go since the payroll tax was accross all jobs????

So even in your example where the gov't passes a tax but also provides a benefit that is exactly equal it isn't clear who will really pay the tax and who will really pay the benefit.

If the tax were ever disclosed and recast honestly as a tax on workers, should we also require that companies give a corresponding one time raise?

Economics acts behind the scenes as often as front and center. A 'required one time raised' can be subverted in a host of ways. Employers may take it back by reducing future increases, they can cut benefits, they can cut 'quality of work' benefits and so on. In the end the employers will share the tax cut or increase in the proportion that the market decides.

"I believe (correct me if I'm wrong) labor's share of income has been about 70% and capital 30%. If this remains constant then in the long run a decline in health insurance cost of $1000 per year will translate into $700 going to labor in the form of increased wages/benefits and $300 going to you as a business owner."

Huh? That would increase capital's share and reduce labor's, when they are specified as constant.

Health benefits are 100% income to labor. If labor's health-benefit income reduces by $1,000 -- employers pay less for it by $1,000 -- then to keep labor's income *constant* other benefits or cash salary must increase by $1,000. Mere arithmetic.

100 income: 30 to capital, and 70 to labor -- of which 20 is health benefits and 50 other stuff.

Then total income remains constant at 100: 30 stays with capital and 70 stays with labor. If what capitalists pay for health drops from 20 to 10 and they keep *any* of that 10 in savings their share goes up -- which it *doesn't* -- so they must pay *all* the 10 of savings to labor in some other form to keep labor's share constant.

QED. Arithmetic.

I can see why your regressions were different than Smetters'.

"In that case 30% of SSI taxes fall upon employers and not 100%."

Huh? Instead of 100% of SS tax falling on employers? Typo?

"Any estimate of SSI's return has to reduce the cost basis by 30%."

Any estimate of return on SS tax must omit some of the tax?

Basis=cost. Return is computed on cost, not by omitting cost.

If you want to use your strange math above to argue with the SSA's actuaries and economists, and say only 50% of the cost of SS tax is borne by employees, and the other 50% is by employers, so return to employees is doubled, fine and dandy.

Then when you compute your total financial return on all SS taxes paid, how do you factor in the 0% return on 50% of tax paid by employers. By ignoring it?

One other thing: "SSI" is Supplemental Security Income, *not* Social Security, and is not paid with Social Security taxes but general revenue.

If you want to use your strange math above to argue with the SSA's actuaries and economists, and say only 50% of the cost of SS tax is borne by employees, and the other 50% is by employers, so return to employees is doubled, fine and dandy.

Then when you compute your total financial return on all SS taxes paid, how do you factor in the 0% return on 50% of tax paid by employers. By ignoring it?

Quite frankly if employers bear a portion of the tax (30% or 50%) then they are literally generating some of the return. Your reasoning would force us to conclude that all bonds have zero return since we would no only include the price you pay to purchase the bond as part of its cost but the cost to the taxpayer of the interest & principal payments!

Health benefits are 100% income to labor. If labor's health-benefit income reduces by $1,000 -- employers pay less for it by $1,000 -- then to keep labor's income *constant* other benefits or cash salary must increase by $1,000. Mere arithmetic.

Hats off Jim, this one really thru me for a loop this Monday morning. But looking at this again I can see this question is anything but simple. Assuming the same quality health insurance can be purchased for $1000 less, labor's real income by your reasoning will grow by $1000 (they will still have their health insurance plus $1000 more in their checks) while capital's will grow by $0. If we assume that the 70-30 split between capital and labor is constant (which, let's remember, is just a historical observation, there's no law of ecnomics that says it must remain like that) then this cannot hold.

What's happening is that if the cost of a health insurance policy falls from $3000 to $2000 it would appear in accounting terms like a drop in employer compensation of $1000. Why? Because accounting entries are done at cost so a policy that costs $2000 is $1000 less than a $3000 one, even if it is of the same quality! So if our ratio remains constant we will want to see an increase in employer compensation to keep things even.

Accounting wise, however, the SS tax does not have this problem in analysis. The employers share is distinct from the employees share. So let us imagine that Congress passed a $1000 rebate on the *employers* portion of SS payroll taxes. What will happen?

A: If this $1000 windfall is passed onto employers in the form of a raise of $1000 then labor's share of income will rise. This is because business was reporting the $1000 tax as a business expense and now that expense is gone but there will be no increase in business income. All of it went to labor therefore the 70-30 split cannot beheld.

B: If this $1000 windfall is kept by business owners then labors share of income will fall as business owners enjoy larger profits. {note that my hypothetical is only a $1000 cut in the employers SS tax, no cut is made in benefits for employees}.

C: If the windfall is divided between labor and business owners $700 to $300 then the ratio of will remain unharmed. However this implication of this is that 30% of the payroll tax is falling not on labor but capital! After all, if Congress changes its mind and decides to remove the $1000 rebate labor's income will fall by only $700. Who is paying the remaining $300!~

So if capital is paying 30% of the SS tax then the cost to the employee is 30% less. You should present your return on investment figures with this taken into account.

Any estimate of return on SS tax must omit some of the tax?

Basis=cost. Return is computed on cost, not by omitting cost.

Frankly, return is computed on your actual cost. If someone else pays 30% of your cost then you do not include that cost in computing your return.

Example, you employer allows you to purchase company stock for 10% less than the market price. Market price on 12/31/03 was $100 and $110 on 12/31/04. Compute the return if you brought one share on 12/31/03 and sold it on 12/31/04:

Cost $100 - $10 = $90
Return = ($110 - $90) / $90 = 22.22%

Jim's method:

Cost $110
Return = ($110-$100) / $100 = 10%

Notice how the actual return is more than twice the return you would get if you forgot that the employee did not pay the entire cost of buying the share? The difference in Social Securities expected return can be quite dramatic if Jim is even slightly off in his assertion that 100% of the tax is paid by the employee.

The BEA "Gross Domestic Income by Type of Income" table seems to be the relevant one:

http://www.bea.doc.gov/bea/dn/nipaweb/SelectTable.asp?Selected=N

Labor's share of income:

1929 49.7
1930 51.2
1931 52.6
1932 53.3
1933 53.0
1934 52.3
1935 50.9
1936 51.9
1937 52.2
1938 52.7
1939 52.9
1940 52.0
1941 51.3
1942 52.4
1943 54.7
1944 55.8
1945 56.3
1946 54.1
1947 53.7
1948 52.6
1949 53.4
1950 53.1
1951 54.0
1952 55.2
1953 56.0
1954 55.5
1955 54.8
1956 55.7
1957 55.9
1958 55.7
1959 55.5
1960 56.2
1961 56.0
1962 55.9
1963 55.8
1964 55.9
1965 55.7
1966 56.6
1967 57.4
1968 57.9
1969 58.9
1970 59.9
1971 59.1
1972 59.0
1973 59.0
1974 59.8
1975 58.6
1976 58.9
1977 58.8
1978 58.9
1979 59.6
1980 60.1
1981 59.0
1982 59.2
1983 58.5
1984 57.6
1985 57.7
1986 58.2
1987 58.3
1988 57.9
1989 57.8
1990 58.2
1991 58.2
1992 58.4
1993 58.4
1994 57.7
1995 57.5
1996 56.9
1997 56.7
1998 57.3
1999 57.6
2000 58.2
2001 58.2
2002 57.8
2003 57.3

Looks like a pretty significant long-run gain in labor's share of income to me.

Apropos of nothing, it sure is interesing that the peak was in 1980.....

Oh, one technical criticism:

"Problem: ultimately, unless labor's share of national income falls (something it shows no sign of doing over the long run), productivity growth translates into wage growth. And social security benefits are indexed to wage growth (rather than inflation). Thus, the cost of social security will grow right along with productivity. While this argument makes sense as a macroeconomic solution to the demographic crisis, it will not make the Social Security system itself stable."

Actually, since there's a one-generation lag between payment & collection, there should be a one-generation productivity difference. Basically today's more productive workers pay in at 6.25% on their wages, but yesterday's workers collect at their old, lower pay rates.

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Even without the one generation lag labor's share of income is between 50-60% in the long term (with the recent past closer to 60% than 50%). That means 40% or so of productivity growth will NOT go to labor in the form of higher wages.

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