Incentives and the Social Security tax

April 11, 2010

Incentives and the Social Security tax.

This is one example where government action is nullified by the incentives of the market. The answer to the question of who really pays for Social Security is not the obvious one. In the end, all of the cost is paid by the one who benefits: the worker.

The obvious answer is what the government has decreed: The employer and employee each pay half of the part of the payroll tax which goes to Social Security. The incentives of the market, in time, worked it out differently, and I believe, more fairly.

Paying half of the SS tax is to the employer an increase in the cost of labor. Employers are very reluctant to visibly reduce wages. By holding back or reducing the usual cost of living pay increases, in time, with assistance from inflation, he will reduce real wages enough to repay his share of the SS tax. Does this sound unfair? The employer is competing with other employers who are doing the same. He’s not operating a charity.

The employee will probably feel that entering the Social Security program is worth all that he and his employer pay into it. He sees the employer’s contribution as a raise in pay. Before the introduction of Social Security, he found his job and pay acceptable and the best deal he’d find on the jobs market. After SS, he will still feel the same, even though his real take-home pay is diminishing to the extent that he is paying the full SS tax himself.

“Fringe benefits” to augment wages came into the workplace after World War 2, when the government imposed a wage freeze in a vain hope of controlling price inflation. Employers, in order to compete for scarce labor started to add fringe benefits such as Employer-paid medical insurance and pension plans to the frozen wages. The employer and the employee both saw this as additional pay and bargained accordingly. This actually defeated the government’s pay freeze.

The same effect defeats the government’s mandate to force the employer to pay half of the SS tax, and will similarly defeat the mandate of Employer paid Health insurance which is now working its way through Congress. The worker, who gets the benefit, will in reality be paying the full cost of the benefit.


2 Responses to “Incentives and the Social Security tax”

  1. Bill Harding Says:

    Glen. I’m not sure about this one. “Workers” who take home money from their workplace are not all the same. $12 million take home is not the same as $22,000 take home yet they both work for Allstate. Does general systems theory rely on exact measures? Hope to see you soon.

    • glennodell Says:

      Bill: I’m not familiar with General Systems Theory. The millionaire doesn’t pay the Social security tax beyond some income threshold- I think about $100,000 per year. Likewise, his SS pension when he collects it is limited accordingly. So out of $12 million a year, neither employer nor employee is likely to care about who pays for such small change.

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