An easy way to reduce wealth inequality — but Democrats won't like it

An easy way to reduce wealth inequality — but Democrats won't like it
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The country could take a major step toward reducing wealth inequality, not by raising taxes but by letting workers save the taxes they are already paying. Yet Democrats have long opposed this option.

Listening to the Democratic presidential candidates, you don’t have to wait very long before they turn to the issue of wealth inequality. For example, Sen. Bernie Sanders (I-Vt.) claimed in the last debate, “we cannot afford to continue this level of income and wealth inequality.” 

Note that Sanders cites both wealth and income inequality. The terms are often used interchangeably, but income (the money a person makes) and wealth (the total value of one’s assets) aren’t the same. 

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A person could have a very high income — former President Barack Obama’s threshold for high-income earners was $250,000 for a family — but spend it all and therefore have very few assets (i.e., wealth). Conversely, many people have significant assets but little reported income — perhaps because they inherited wealth or have retired with substantial savings. 

Although many economists believe wealth and income inequality concerns are overblown, Democrats keep decrying it and then propose their favorite solution to virtually every public policy problem: raise taxes on the rich.

Both Sanders and Sen. Elizabeth Warren (D-Mass.) have proposed a “wealth tax” to reduce wealth inequality and to help pay for their many other spending programs.

A simpler solution would let workers keep — and save — a particular tax they are already paying.

Currently, 12.4 percent of workers’ income — half of which is paid by the employer and half by the employee — is handed over to the federal government to pay for Social Security. But the government doesn’t put that money in a special account for the worker until retirement; it immediately redistributes that money to current retirees, in what’s known as a pay-as-you-go (paygo) system.

The U.S. Supreme Court has ruled that no one has a private property right to that money. Congress can raise benefits or reduce them, or end the program altogether. And because workers have no property right to those funds, they cannot count them as assets. 

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How much money are we talking about?

Economists Eugene Steuerle and Caleb Quakenbush of the Urban Institute track what workers at various incomes and family status pay into Social Security and Medicare over their working lives and how much they can expect to receive.

In their 2018 update of “Social Security and Medicare Lifetime Benefits and Taxes,” the authors state that a two-earner family retiring in 2020, who earned the average income over their lifetimes, will have paid into Social Security about $600,000.

Had that money been deposited in a personal retirement account — similar to an IRA but with limited access and investment options — and invested it in a broad-based fund that mirrored the S&P 500, it would have grown on average about 8 percent per year, according to Investopedia. Thus, even average workers making those deposits, goosed by compound interest, over 40 or 50 working years would have significant assets at retirement.

And, of course, this personal retirement account would be separate from, and in addition to, an employer-provided 401(k) account, pension plan or a personal IRA. 

To reiterate, this is a tax that every worker already pays. This proposal simply gives workers control over the money they have made.

One of the barriers to adopting this approach has been finding the money the government would need to pay current retirees’ benefits.

One option is a transitional approach that would allow people just entering the workforce to choose either a personal account or traditional Social Security. Those who stay with traditional Social Security would continue paying into the system. 

Whether the government makes the transition slowly or quickly, it would need to borrow a lot of money to pay some or all current retirees’ Social Security benefits.

But more federal debt apparently isn’t a restraining factor anymore — at least for Democrats. Sanders and Warren are proposing programs like “Medicare for All” that would cost an estimated $3 trillion a year, as would Democratic candidate Andrew Yang’s universal basic income proposal.

Allowing workers to keep their Social Security payroll tax would be a huge tax cut for everyone, while dramatically increasing average workers’ wealth over time. If Democrats are willing to spend a lot of money reducing wealth inequality — as they say they are — personal retirement accounts are the most efficient, least costly and least disruptive solution.

Merrill Matthews is a resident scholar with the free-market think tank the Institute for Policy Innovation. Follow him on Twitter @MerrillMatthews.