It appears that Barack Obama intends on following through with his campaign promise to issue refundable income tax credits so that people who pay no income taxes will get “refund” checks from the federal government. Obama justifies these payments as being a refund of payroll taxes. While many people have referred to such refunds as "welfare" or "handouts," such criticism misses the biggest problem. Obama’s proposals undermine the foundation of social security by divorcing contributions from benefits and permitting a large percentage of the population to "double dip" on benefits.
In order to understand the threat Obama's plan poses to the social security system, it is necessary to understand two key concepts. First, social security is not designed as a tax on income, but a contributory system based on wages. Second, because social security trust funds have been loaned to the government and then spent, social security depends upon a new supply of wage contributors to pay for benefits for people who no longer earn wages. Obama's plan undermines both these elements.
Social security, which includes unemployment assistance, aid to dependent children, and disability and death benefits, is not truly a "benefit" bestowed by government. Rather, workers pay into the system through Federal Insurance Contributions Act (FICA) payments on wages. Employers "match" these worker contributions.
While often referred to as FICA "taxes," these "taxes" really are contributions to a system -- contributions which a worker is supposed to "get back" when the worker qualifies for benefits (usually at retirement age, but possibly earlier in cases such as disability). FICA is a "tax" on wages, not income; you pay FICA on wages regardless of your taxable income. There are other sources of revenue, such as the contributions made by self-employed individuals, but FICA is by far the largest source of funding for our social security system.
Social security revenues go into the social security "trust fund," but there is no bank account holding such trust funds. Most of the funds have been "loaned" to the federal government to cover government expenses. The social security system is owed a massive "IOU" by the federal government, and it is federal income tax revenues that ultimately are used to pay back this IOU and thereby to pay social security benefits.
FICA is the heart of the social security system. Yet it is that very heart that is at risk from Obama's plan. Obama's plan amounts to double dipping. Approximately 40% of taxpayers who pay no federal income taxes get a refund now of their FICA contributions through refundable income tax credits. These same people get those FICA contributions back a second time when they collect social security.
Equally important, Obama's plan changes the very nature of social security. No longer will social security be a system in which workers contribute now in order to "get back" the contributions at retirement. For a large percentage of the population, there will be no real contribution to the social security system; those contributions will have been "refunded" through "income tax credits" long ago.
As a nation we are struggling to meet the social security obligations to workers who pay into the system. Obama has yet to explain how we will meet those obligations in the future when a large percentage of contributions already will have been refunded once before. Either taxes will become even more repressive than even Obama contemplates, or the government will simply print more money with all the negative consequences.
The social security bubble is fragile enough; Obama's plan to give tax refunds to people who pay no taxes may cause the bubble to burst.