Working Paper: NBER ID: w1645
Authors: Alan J. Auerbach; Laurence J. Kotlikoff
Abstract: This paper examines the efficiency gains from linking marginal Social Security benefits to marginal Social Security payroll taxes. In the U.S. the current combined employer-employee OASI payroll tax rate is 10.4 percent. Recent estimates suggest that the average marginal income tax rate is roughly 27 percent (Barro and Sahaskul (1983)). If marginal OASI payroll taxes provided no marginal Social Security benefits or were incorrectly perceived to provide nomarginal benefits, the effective marginal federal government taxation of labor supply would average roughly 38 percent. Since the efficiency costs of distortionary taxation rise as roughly the square of the tax rate, the Social Security payroll tax may be more than doubling the dead weight loss of labor income taxation.The findings of this paper suggest that there may be very significant efficiency gains available from tightening the connection between marginal Social Security taxes paid and marginal Social Security benefits received. Indeed,the simulated efficiency gains are very large in comparison with those obtained from analyses of the gains from structural tax reform. Restructuring Social Security to greatly enhance marginal benefit-tax linkage may be infeasible, at least in the short run. However, simply providing annual Social Security reports indicating how a worker's projected benefits are affected by his or her tax contributions could provide substantial increases in economic efficiency. Such efficiency gains are potentially as large as increasing GNP by 1 percent this year and every year in the future.
Keywords: Social Security; Economic Efficiency; Taxation
JEL Codes: H55; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal OASI payroll taxes providing no marginal social security benefits (H55) | effective marginal taxation of labor supply averages around 38% (H31) |
| higher payroll taxes without corresponding benefits (J32) | greater inefficiencies (D61) |
| tightening the connection between marginal taxes paid and benefits received (H29) | significant efficiency gains (D61) |
| significant efficiency gains (D61) | increase GNP by 1% each year (E20) |
| marginal linkage can be greater than one for certain groups (C34) | those groups receive more in benefits than they contribute in taxes (H29) |
| better linkage of benefits and taxes (J68) | improved economic efficiency (D61) |
| efficiency gains of 13% of full lifetime resources (J17) | improved economic efficiency (D61) |