A few major conclusions may be drawn from the analysis above, but even these must be regarded as somewhat tentative, owing to lack of intensive research in this part of the tax field.

1. The employer's part of the payroll tax should be replaced by some other tax: by an addition to the employee's tax, if the employer's tax in to be justified under the individual-sacrifice principle; otherwise, by an increase somewhere in the general-tax structure.

2. Any contributory tax, either the present employee's payroll tax or any tax substituting for it or complementing it, should allow a specific exemption, probably somewhere between $300 and $500 a year, at a level below which it is deemed impossible or impracticable to ask an individual to save for his old age.

3. The existing benefit program is far from self-supporting. The reserve will be, at its peak, far less than the $50 billion (or $48 billions) figure commonly cited -- possibly no more than half that -- and will eventually disappear unless supported substantially from general revenues. If coverage is extended on the existing basis to domestic workers and farm laborers, the reserve may reach a higher or lower peak depending on certain data largely unknown. If the present old-age system is considered as a whole, including the assistance program, which is probably on a deficit basis, the system may never build up a reserve much larger than the "contingent" reserve advocated by some, and even this relatively small reserve will eventually disappear unless supported from general revenues.

4. In view of the present and prospective state of the Federal Government's finances, the old-age benefit program should be based on the building of a substantial reserve (in the tax sense, as defined at the start of this analysis), at least as large as the reserve that will accumulate under the existing program.

5. Part of the reserve should be built up from general taxes, not contributory taxes.

6. There is much to recommend the use of a net income tax, possibly in place of the employee's payroll tax, and, more likely, as the best available contributory tax for the self-employed and the RENTIERS.



An analysis of the major economic aspects of the old-age payroll taxes is a tank too formidable for the present study, but it may be useful to note certain minor pressures that are being exerted by the taxes. It is not known to the writer whether these pressures have in fact been strong enough to change business practices and consumer reactions. For that matter, it is not even certain A PRIORI in which direction the pressure works: some employers and employees may strive to get under the system rather than out of it. But the possibility that some pressure may be exerted in one way or the other, particularly if the payroll taxes over total 9 per cent, is worth considering. The instances below have all been inferred from rulings of the Internal Revenue Bureau as reproduced in the Commerce Clearing House "Unemployment Insurance Service." Numbers in parentheses refer to paragraph numbers in C.C.H.:

1. Since a pension payment is not a wage payment, while a payment into a pension fund or, instead, payments from the fund (depending on the circumstances) may be considered a wage payment and hence taxable, there may be a pressure on employers to substitute non-contractual pensions for contractual pensions (1355, 5130, 87).

2. The exemption of national banks and of State banks that are numbers of the Federal Reserve System may be exerting pressure on State banks to because numbers of the System -- or, possibly, the pressure works in the other direction, if coverage under the old-age benefit plan is regarded an desirable (1357).

3. The benefits to be obtained by a business firm, whatever they may be, by giving a traveling salesman a flat amount for expenses and net demanding an accounting are destroyed. In covered ***, since the *** requires an accounting of actual expenses, in order to uncertain actual remuneration (1810).

4. Since *** compensation payments are not wages, but additional voluntary payments by the employer to supplement such payments are wages, and a salary paid after an employee has become *** disabled in also wages, there may be some *** to extend and intensify the workmen's *** *** (1225, 1260).

b. Members of a Pennsylvania "partnership association," who are employed full-time by the association, are paid weekly wages, and share squally in profits, are "employees," and the association is the "employer": hence, there may be pressure to take less use of this form of organization, and revert to the simpler partnership types (8362).

6. Since tips are not taxable as wages, but a surcharge on the bill (commonly 10 per cent) in lieu of tips is taxable as wages, the latter method may be put at some disadvantage (123, 8338, 8632).

7. Premiums paid by a company on a sick benefit insurance contract covering its employees are not wages when the employee has no option in the matter and no equity in the policy; hence this form of compensation may appear more attractive to the employer (8356).

8. Apparently the impact of the tax, at least as the tax is interpreted by the Government, may influence the terms of the contracts between taxi-car drivers and the cab companies, and may also influence the competition between fleet cabs and individual-owned and -operated cabs. (8382, 8457, 8516).

This list does not purport to be exhaustive up to date, but it probably covers a wide enough range to give a fair idea of the types of business practice that may be affected by the payroll tax.



It may appear that the attitude expressed above (p. 34), in favor of a reserve plan, and based on a dislike of the prospective rapid growth in the publicly-held public debt, is essentially a minority attitude. Thus, if the Government decides that there should be a certain gap between revenues and expenditures, say $4 billions, in order to stimulate business recovery, the existence of a reserve plan (tax reserve) simply makes it necessary to increase current expenditures by that much - otherwise the $4 billion gap diminishes. The money is taken from one pocket by the tax-reserve plan and put into another by increasing expenditures, and all this is presumably a waste of effort. Any observer who does not believe the gap should be as big as $4 billions, and who cannot get the Government to close the gap directly by decreasing expenditures or increasing general taxes, may favor the reserve type of old-age plan as an indirect any of getting what he wants. This, it might be argued, may be a sensible minority attitude, but it is by the anne token on inconsistent attitude for those in power to take. /38/

The conflict, however, may not be so much between majority and minority as between cyclical policies and secular (long-term) policies. Even those who urge deliberate deficits in depressions will usually urge budget balancing over a long period of years, or at least in the prosperous years. An old-age plan without a reserve may, in times to come, demand such high tax rates (either general taxes or contributory taxes) that the political effects force a resort, in those future years, to a SECULAR deficit in order to escape those rates. The fiscal engineer who wants to create deficits of a certain size in depression periods (and possibly surpluses of a certain size - probably smaller - in prosperity) then faces a dilemma. The political repercussions of a tremendous long-term growth in total average yearly expenditures may endanger, in future years, the prosperity-period part of his cyclical-control program.

The present writer would agree that his own attitude is essentially a minority one. He dislikes the size of the prospective growth in the amount of publicly-held public debt for the next few years, and is willing to urge the reserve method of old-age financing as a way of keeping that debt smaller than it would otherwise be. However, the time might conceivably come when the Government itself would feel constrained to adopt a minority position against the expenditure pressure groups, and would be willing to use the reserve method as an offset to a current expenditure total that had grown larger than the Government liked.


/1/ The definition of "need" may be so lax in some states that in effect this third type of payment is made.

/2/ Including in taxes any contributions by the beneficiaries, whether officially designated as taxes or not.

/3/ It does not follow, of course, that on every occasion where (a) is present, a reserve plan is called for. Probably such a plan is called for only when "the annual intake or outlay will vary widely over a period of time" ("The Old-Age Reserve Account - A Problem in Government Finance" (unsigned), Quarterly Journal of Economics, May, 1937, p. 452. Items (1), (2) and (4), accompanying this quotation, which is item (3), may be regarded, perhaps, as essential conditions for the existence of a reserve, while the quoted item is the reason for the reserve).

/4/ Thus Alanson W. Willcox, Assistant General Counsel of the Social Security Board, says that "a reduction of payroll taxes levied by the present act - whether or not other tax levies were substituted - would not affect the necessity for a reserve and would not greatly affect its ultimate size," in "Why the Old-Age Reserve Account is Indispensable, Apart from Tax Problems," Annalist, Aug. 17, 1938, p. 237.

/5/ The tax is 2 per cent on 1937, 1938, and 1939 payrolls; 3 per cent for 1940-42; 4 per cent for 1943-45; 5 per cent for 1946-48; and 6 per cent thereafter. Half is legally due from the employee ("income tax") and half from the employer ("excise tax"): the employer pays the former to the Government on behalf of the employee, deducting it from his wages.

/6/ The proportion of gainfully employed adults reached is much greater, since there is a considerable amount of shifting into and out of these positions. For example, a factory position may be filled part of the year by a farm laborer and part of the year by a regular factory worker.

/7/ Certain lump-sum payments are being made before 1942.

/8/ "Such evidence as exists today" indicates a probability that the old-age benefit system is "underfinanced," Willcox, "Social Security Taxation, Annual Appropriations and Anticipated Tax Receipts," Annalist, Aug. 24, 1938, p. 271. In "Funds for the Future," in Atlantic Monthly, August, 1938, p. 230, Thomas H. ***, General Counsel of the Social Security Board, says that the reserve may not be more than half of $47 billions, and may possibly be no more than a "contingent" reserve.

/9/ In the sense simply of prevailing standards.

/10/ Plus 5 per cent of its share, as a contribution toward administrative expense.

/11/ A third sub-group, of insignificant numbers, consists of those whose earned plus unearned payments exactly equal the inadequacy of private resources.

/12/ Note that in this paragraph the term "general revenue" does not cover the non-contributory elements in the employees' tax.

/13/ Thus the contributory tax revenue currently collected cannot, for the purposes of the present discussion, be said to be invested in the current public works program of the United States, since this program would apparently have been undertaken anyway.

/14/ It will be recalled that throughout this analysis the term reserve is used in what has been called above the tax-reserve sense, not in the actuarial-reserve sense.

/15/ In the broadest sense of spent in such a way that future net income will be larger than otherwise, no matter how indirect the connection between the two.

/16/ To put it another way: the tax rates on such private income as does not include the part *** to the government's investment need be no higher than if the investment had been self-liquidating, but then the rest of private income would have to be taxed 100 per cent. The average rate on all private income would however still be lower than if no investment at all had been made.

/17/ The level they would be at if there were no old-age system.

/18/ Note that if it is instead assumed that some old-age payments would have to be made in any case, and would in fact be financed out of general revenues if there were no contributory system, general taxes stabilize at a point not so far above the normal level.

/19/ See definition of "earned benefit" at the beginning of this analysis. In an unsigned article in the Quarterly Journal of Economics, May, 1937, p. 447, it is said that Congress' decision to levy payroll taxes for old-age benefits and "to make them the taxes . . . sufficient to equal over an indefinite period of time the whole cost of old-age benefits" rendered "impracticable 'pay-as-you-go' financing of benefits on the scale contemplated by the Act. For while it would be very easy to levy payroll taxes which for a generation would be just adequate to pay currently the benefits fixed by Title II, the percentage of pay rolls required would ultimately rise to a figure considered to be out of the question." But such a plan would allow the payroll taxpayer of today to draw (tomorrow) much more than he had put in, plus interest. Correspondingly, it would force the payroll taxpayer of tomorrow to overpay for his (day after tomorrow) benefit; in effect, part of his payroll tax would be a general tax. He would get back only what he put in (assuming the system had stabilized), without interest. Hence this system would not be financed solely by contributory taxes, in the sense in which "contributory" is used in the text above. Congress' decision did indeed render impracticable this particular kind of "pay-as-you-go" financing, but did not render impracticable a strictly contributory pay-as-you-go (non-reserve) type of financing.

/20/ It is probably a reasonable assumption that old-age payments do not result, even indirectly, in an appreciable amount of investment.

/21/ Excluding debt retirement and the incurring of debt.

/22/ It is often - perhaps, almost always - impossible to discover in practice just which these taxes are, but, conceptually, at least, they exist.

/23/ The market rate is influenced by the tax-exemption feature, but only to a negligible extent in the case of the long-term issues (which are perhaps the best to compare with the 3 per cent bonds), since these issues are exempt only from the Federal normal tax and the State income taxes, not the Federal surtax: and even with the wholly exempt short-term issues, the influence on the interest rate is probably not important, since most of these issues are probably held by legal persons not subject to the surtax or indeed, in some cases, to any tax.

/24/ See "The Old-Age Reserve Account -- A Problem in Government Finance", (unsigned) Quarterly Journal of Economics, May, 1937, p. 434.

/25/ Admittedly, if one wishes to study the old-age problem in detachment from government finance as a whole, the contributory feature on an insurance basis does inevitably lead to the building up, of a reserve. This appears to be the approach taken by K. *** in "The Functions of Reserves in Old-Age Benefit Plans", Quarterly Journal of Economics, August, 1930, especially top of p. 633 and top of p. 634. In the present analysis, on the other hand, the chief effort is to examine the possible reactions of the old-age program on the rest of the budget, and vice *** . Thus it is assumed for example, that the reserve built up under the insurance principle can be eliminated, for all practical purposes for the economy as a whole, by lowering GENERAL taxes (Plan III) in the GENERAL budget.

/26/ To repeat, this self-liquidating aspect is important only from a political point of view.

/27/ For instance: if of two individuals, A and B, each earns $40,000 wages during his lifetime, but A has a total net income of $30,000 during that period as against $60,000 for B, and if the benefits are to very in direct proportion with wages earned, and each beneficiary is supposed to meet half the cost of the benefit, a flat-rate wages tax is suitable, whereas a net income tax would have to be *** at twice the rate on A as on B, and at various other rates on other individuals.

/28/ Analyses based on other principles follow in other sections.

/29/ Throughout this analysis, the "income tax" part of the payroll tax is put in quotation marks to distinguish it from the general income tax.

/30/ Compared, that is, to what they would have been otherwise.

/31/ "Wages" as used in this section includes "salaries."

/32/ Moreover, the existing system in fact also excludes those in the service of the Federal Government and of charitable, etc., institutions. These exclusions represent a concession to specific circumstances, not an inherent disability in the wages tax. The constitutional restriction, too, might be placed in this group.

/33/ About the only other possibility seems to be equal (annual) dollar benefits.

/34/ Cf. J. Frederic Dewhurst, "Old-Age Security Financing in Relation to Income Tax Reform," Bulletin of the National Tax Association, May, 1938, pp. 240-45. Under this plan the additional net income taxation would be primarily for old-age payments, but the size of the payments (above a basic minimum) to any given person would depend on payments under a low-rate gross income tax.

/35/ Some expressions of this view were given in the hearings on the Social Security Act in 1935. The following extracts are from the HEARINGS . . . COMMITTEE ON WAYS AND MEANS . . . ON H.R. 4120, 1935:

The employers' contribution is "very similar to the revenues which they regularly set aside for depreciation on capital equipment." (p. 39) (Report of the Committee on Economic Security)

The employer's contribution provides "an automatic method of meeting the depreciation charges on the human factor cooperating in production similar to the usual accounting charges for depreciation of plant and equipment." (p. 242) (J. Douglas Brown)

The employer's contribution "spreads the cost of old-age protection uniformly over concerns that employ older workers /and therefore feel obliged to grant pension systems/ and those that employ younger workers . . . and lay them off long before they are susceptible to pressure to have a pension plan." (p. 242) (J. Douglas Brown)

"It is inequitable for an employer, while protecting his investment in buildings, machinery, fixtures, and so forth, by charging as an item of the cost of doing business, an amount for depreciation and obsolescence, to not provide for his employees' sustenance during a period of enforced idleness and a pension upon being retired."3 "The customer should pay . . . " (p. 856) (William P. McGerved)

/36/ Thus the old-age problem has a direct connection with the minimum-wage problem.

/37/ Thus the Twentieth Century Fund's Committee on Old-Age Security dislike the use of assistance payments as supplements to inadequate benefit payments to married couples, since "this would still subject the couple to the means test, the avoidance of which is one of the primary purposes of the contributory plan. MORE SECURITY FOR OLD AGE, p. 133. The Committee on Economic Security (HEARINGS . . . COMMITTEE ON WAYS AND MEANS . . . ON H. R. 4120, 1936. p. 39) Characterized the employee contribution as "a self-respecting method."

/38/ This argument is implicit in Alvin Hausen's analysis: "There is, however, one matter . . . which is sufficiently serious to warrant abandonment of the reserve plan and the adoption in its place of a pay-as-you-go policy. The old-age benefit law as it now stands operates UNNECESSARILY to accentuate any tendency OTHERWISE PRESENT toward deflation italics supplied . . . Assume, on the other hand, that the Government deficit is exactly equal to the amount of the Old-Age Security taxes. In this event it is of course true that the funds derived from these taxes will be used by the Government to cover the deficit. PRESUMABLY, HOWEVER, SUCH DEFICIT-CREATING EXPENDITURES WOULD HAVE BEEN UNDERTAKEN IN ANY EVENT, with or without an Old-Age Reserve Account italics supplied. What must be clearly recognized is that by drawing in tax funds in a period of recession, deflation is accentuated, thereby calling for still heavier governmental expenditures to check the downward movement." FULL RECOVERY OR ***, pp. 190-92