President Joe Biden, in his State of the Union address last week, scored a moral victory over the Republicans by accusing them of wanting to cut the Social Security and Medicare entitlement programs, thereby forcing them to deny any such intention. However, the actuarial reality is clear: Medicare will become insolvent around 2027 and Social Security around 2035. New funding will have to be found; I have one suggestion: to abolish the tax deductions and exemptions enjoyed by charities.
If you believe the actuaries, the deficits on Social Security and Medicare are gigantic, tens of trillions of dollars over the next 75 years. However, that is a “scare” figure; the actuarial deficit is only 1.5% of the period’s Gross Domestic Product. That suggests the reality: that most of the annual deficit over the next few decades results from the retirement and prolonged life of the bulge “baby boom” generation, born in 1946-64.
Some way must be found to pay for this bulge. However, following the Baby Boom’s passing, the remaining deficit can be handled fairly easily by continuing the process set in motion by the 1983 reforms: of increasing the social security retirement age. That rose from 65 before 2003 to 67 from 2026; it needs to continue rising at about the same pace, to 68 in 2038, 69 in 2050 and 70 in 2062, to reflect increasing longevity.
We cannot however “assume away” the baby boomer pensions problem. For decades, we have been told that Social Security is out of whack because of its tendency to increase payments with wages, which until the last two years rose significantly more rapidly than prices. In a sense, the actuarial problem of Social Security was a problem of success in growing the economy; we could thus assume that our considerably richer successors would deal with it.
We can no longer assume that to be the case. For one thing, we are now little more than a decade from the exhaustion of the Social Security trust fund (and much closer than that to the exhaustion of the Medicare trust fund) at which point, if nothing is done, social security payments to retirees will have to drop by 20%. For another thing, the possible slowdown in innovation, and certain plethora of leftist regulation and “climate change” madness have slowed productivity growth more or less to zero, so we can no longer assume our successors to be richer than ourselves. The disastrous “open borders” policies of the Biden administration, allowing hordes of wealth-sucking illegal immigrants to enter the country, have made it likely that our successors will be poorer, not richer than ourselves.
A sharp fall in Social Security payments in the mid-2030s would cause exceptional hardship. The Baby Boomers were in their middle years plunged into a new retirement system, without the security that the previous “final salary” pension system offered, but instead were forced to assume the market risk of their retirement savings, as well as the “longevity risk” that they might survive into their 90s or beyond. Generally, the “funny money” policies of the 2010s, that have artificially inflated house and stock prices have cushioned the effect of this. Stock portfolio values and house values are higher than the Baby Boomers had any right to expect.
However, this is just the beginning. The oldest Baby Boomers, born in 1946, are still only 77, young enough to become WalMart greeters if necessary to top up their incomes, and the youngest ones, born in 1964, have not yet turned 60. This has two implications. First, the negative cash flow in the Social Security system is going to get more severe, as younger baby boomers leave the workforce and start drawing pensions – this cash flow worsening will begin to reverse lessen only from about 2030, when the youngest Baby Boomers are 66. Second, the retired Baby Boomers drawing on their savings, being 70 or so, have still mostly got a fair quantity of savings left.
In 2034, the Baby Boomers will all be retired, and the majority of them will have passed 80, while only a minority will have left us. Moreover, most forecasts of stock returns over the next decade are very low, perhaps 1-2% annually – which is most likely to involve a massive drawdown sometime in the next few years and a modest recovery later. Thus by 2034, the now old and infirm Baby Boomers, who had not saved enough in the first place and have seen their savings eaten away by a dreary stock market, will have mostly exhausted their savings. That is the worst possible time to hit them with an unexpected (to them) 20% drop in their Social Security payments.
Since just adding the additional Social Security deficit to the national credit card will by that time have become impossible, debt having spiraled to 150% of GDP or more and the government doubtless still running large deficits, additional revenue will have to be found to cover the gap. Ideally, that revenue should be found several years before 2034, to cushion the effect of Baby Boomer elderhood.
There is one best way to find this revenue, that would have positive effects both economic and social, and that is to eliminate or sharply restrict the tax benefits available to charities. Those include freedom from property taxes on their real estate and freedom from income taxes on their endowments, as well as the deduction from individual income taxation for charitable donations. To the limited extent that the charitable income tax deduction increases contributions to genuine charities benefiting impoverished people in the United States, eliminating it and applying that revenue to Social Security would mostly have a like-for-like benefit, reducing charitable funding for poor people and increasing it for other poor people.
To the extent (far greater) that at the top income levels the charitable tax deduction subsidizes rich people’s vanity projects in the cultural arena, there would be a moderate social benefit from its removal. To the extent (even greater) that it subsidizes political activities of environmentalists or leftist trial lawyers, eliminating it would have an immense economic benefit and a considerable social benefit. I accept that for some small percentage of the total, the charitable tax deduction subsidizes non-leftist policy activities or churches, but I would suggest that the economic and social losses here would be a very small percentage of the overall picture.
Charitable tax deductions totaled $215 billion in 2020, which given an average tax rate of 40% (including state and local taxes) implies a revenue cost of some $86 billion for those deductions. The 2017 tax changes reduced the overall amount of charitable deductions taken but skewed them very heavily towards the highest income levels, with charitable tax deductions for those with taxable income over $10 million increasing by 39% between 2016 and 2020 (we can safely assume that deductions at these very high income levels have a higher percentage of political and vanity projects than at lower levels). To minimize the losses of genuine charities from eliminating the deductions, we could instead cap deductibility at a modest figure of say $10,000, thereby preserving the deduction for middle-class alms and church giving while eliminating most abuses of the taxpayer. Such a cap would eliminate the egregious scams by which the ultra-rich pay lower tax rates than the middle classes.
A net benefit of $86 billion per annum, 0.42% of GDP, from eliminating the charitable tax deduction would not completely eliminate the 1.5% of GDP deficit in the Social Security system. However, it would substantially alleviate it, and together with increases in the retirement age could reduce the problem to a manageable level. In any case, the economic benefit of eliminating the deduction for abusive political and vanity charities would itself increase GDP growth, as environmental and trial-lawyer obstacles to new projects were done away with or at least greatly reduced.
If further revenue was desired, a drastic tightening of tax exemptions for non-profit activities could be instituted, so that only those organizations clearly religious, educational or aimed at the poorest would be granted such exemptions from income and especially property taxes – perhaps with a cap, so that multiple-billion college endowments would pay a fair tax rate. Again, eliminating tax exemptions for entities whose purpose is to delay and add cost to economically valuable projects would be wholly beneficial as well as morally more than justified.
Fixing Social Security and Medicare are an urgent problem, that should not be a matter of partisan politicking, so that nobody dares to do it until it is too late. Doing so by eliminating charitable tax exemptions would be socially and economically highly beneficial and would lose the votes only of under-taxed multi-millionaires – who might usefully then turn their enormous abilities to more productive activities.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)