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This is the fourth in a series of articles on Social Security reform, and the third of three discussing the "FairTax Plan."

Previous columns discussed both the benefits of the "FairTax Plan" and the manner in which it would block critical Social Security reform. Today's discusses a far more serious problem: the way in which it destroys the underlying "social contract" of Social Security.

Social Security was sold to the American people as a plan in which we would pay in during our working years and would in turn receive payment in our retirement. It removed the risk of outliving private savings that could be made instead, at the cost of no or little return to those who died before or during the early years of retirement. All along, the premise has been that the worker is receiving repayment for his contributions, rather than any type of "gift" from society.

This, of course, has never been quite true. In fact, the system was sold by fraud from the start: there was no possibility that the early premiums could fund the promised benefits. Additionally, the connection between contributions and benefits has always had a redistributive element: payments have always been used to calculate benefits, but lower income workers received disproportionately large payments.

In spite of these issues, the social contract has always been that workers would receive benefits in return for their payments. In today's system, and in the variously proposed privatization plans, workers have a moral claim to receive benefits. This would no longer be the case under FairTax plan.

Under FairTax, Social Security would be funded under the general sales tax. Raising the same amount of funds is not the problem; with a properly calculated tax rate, that will happen. The problems is that this would completely divorce the fact of contribution, and the amount of contribution, from the receipt of benefits.

Today, the Social Security Administration monitors earnings and payments by each worker over the working life. This occurs through the regular payroll tax collection and reporting. Under FairTax, the collection would no longer be made, but employers would still file reports on the income made. This could, at least in principle, tie benefits to earnings. It would not, however, tie them to payments made.

One of the reasons—and an excellent one—that a sales tax is a better policy than an income tax is the very fact that it breaks the connection between income and taxation. Those who consume less (and therefor save more) than others with similar incomes are rewarded with lower current taxes. Similarly, wealthy individuals with modest "income" under the current code will be taxed upon the spending involved in a luxurious lifestyle. But the connection between contributions to and benefits from Social Security gets broken.

Breaking the direct link breaks the moral claim to benefits. Rather than making a claim for benefits based upon his contributions to the system, a retiree would make his claim based upon the fact that he had earnings in the past: the moral basis is gone.

Even today, there are proposals to "means-test" Social Security, paying it only to those who "need" it more. In practice, this will transfer benefits from those who prudently save for their retirement to those who do not. Today, that claim is resisted based upon the moral claim of the retiree and the social contract. With the link broken, however, the benefits are no longer repayment for contributions. The benefits do become a payment from society to support the elderly—no longer repayment in any sense, but instead a welfare payment based upon society's willingness to give.

And that is the best case. Today income only up to an earnings cap has social security deducted. Amounts above the cap are used neither for the initial tax nor for calculation of benefits. This, too, breaks under FairTax—there is no upper limit to the amounts paid in taxes for Social Security, nor can there be.

But we have yet to reach bottom. Without the moral claim, society has no reason to pay benefits in relation to income. When the payments (or even contributions to private accounts) come from general revenues, those who had higher incomes in their working years no longer have any claim to greater benefits than those with lower incomes. In fact, with the connection to contribution to income broken, those who go into "underpaid" jobs such as teaching and daycare, or who spend much of their lives as volunteers, or housewives, might even have a moral claim to greater benefits than others, as they gave up the chance to earn in a way that benefited society.

This is not to say that there is not a case to be made to reward these groups. If we are going to make these subsides, though, they should be done explicitly, rather than through a "back door."

Switching from a tax on income to a tax on consumption would be an excellent idea. Social Security, while collected in the form of a tax, is not a general tax, but part of a social contract in which contributions are exchanged for benefits. Paying for Social Security out of general revenue breaks this contract. It replaces a system in which workers have a moral claim on benefits that they have earned with one in which retirement is payed for by government largess—a massive welfare program. This alone is enough reason to oppose the FairTax plan. If, however, it were modified so that the consumption tax was lowered and Social Security contributions taken from workers' wages, I would support it wholeheartedly—after a reform and privatization of Social Security occurs.

© Richard Edmund Hawkins, MMV

Related Columns

Why I didn't sign the FairTax letter :

Social Security is indeed a Ponzi operation--but that is not a problem :

The "FairTax Plan" would block critical Social Security reform :

Links of interest

FairTax Plan home page

The homepage for the FairTax Plan, which explains the proposal in far more detail. Read

Social Security Administration Benefits Calculators

The Social Security Administration provides a number of ways to estimate retirement benefits.Read

Dr. Hawkins is a statistician, antitrust attorney, and Assistant Professor of Economics at the Pennsylvania State University.

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