July 7, 2016

New Entitlement Bigger than Social Security

With the federal debt exceeding GDP, a predictable return to trillion-dollar deficits and two credit downgrades, the last thing Congress should do is expand the welfare state in the United States. Yet that is exactly what Hillary Clinton hopes they will do if she is elected president in November. It is her ambition to add three new, major entitlement programs to the American welfare state. 

One of her new programs is a federal paid-family-leave program, also known as general income security. Nobody should be surprised at this: as I explained in my 2010 book Remaking America, Democrats in Congress have been pushing for general income security programs for many years. 

To find out what a federal paid-leave program might look like and what it would cost, it is a good idea to study the state-level programs that are popping up around the country. The best study object is the federal pilot program in the District of Columbia, which, if implemented at the federal level, would cost American taxpayers more than Social Security.

To recap, the basic architecture of the DC paid-leave program is as follows:
  • Every employer in the District will be mandated to pay a paid-leave entitlement tax on the payroll of their employees; 
  • To guarantee all DC residents the same entitlement, employers outside of the District who have District residents on their payroll will have to pay the tax for those employees;
  • The tax is progressive, up to one percent of payroll for incomes above $150,000 per year;
  • Anyone who has been employed at an "included" employer for at least part of a year, or is unemployed with previous eligible employment, is eligible for the entitlement;
  • The program replaces income for a number of specific events, such as but not limited to bonding with a newborn child or various forms of medical leave;
  • Income is replaced for a maximum of 16 weeks for every 24-month period;
  • The weekly replacement rate is 100 percent for the first $1,000 of weekly income and 50 percent there above, up to a cap of a total replacement amount of $3,000 per week.
As I explained in my analysis of this program, the finances of this architecture simply do not work out. The tax base as defined in the bill proposing the program will not even pay for nine percent of the defined entitlement value of the program. In actual numbers, the defined entitlement value is $6.5 billion, but the tax that is supposed to fund the program can only pull in $534 million - and this is under the assumption that the tax is one percent for all income brackets. 

In reality, the revenue that the tax will generate will be much smaller. Here are the actual tax rates:

Individual annual salary Paid-leave tax
$0 $10,000 0%
$10,000 $20,000 0.5%
$20,000 $50,000 0.6%
$50,000 $150,000 0.8%
$150,000 and up 1.0%

Unlike the across-the-board one-percent tax that was used in the revenue calculation earlier, these rates will not even generate the first $500 million in revenue.

This is an urgent question: as defined now, the program will run into the red if every eligible person takes five sick days per year.

At the national level, this program would produce some truly staggering numbers. Let us find out exactly how staggering. 

To begin with we make the simplified assumption that the paid-leave program only applies to private-sector employees. The DC program is supposed to cover government workers as well, though there are potential conflicts between this program and existing law, such as the Federal Medical Leave Act, that apparently have not yet been sorted out. Therefore, we exempt government employees.

In 2014 there were 117,180,000 employees in the private sector nationwide. In total they earned $6.24 trillion in wages and salaries, averaging $53,256 per employee. Add to that 8.5 million unemployed individuals, who are also eligible under the DC federal pilot program.

Since the paid-leave program calculates its income reimbursement on a weekly basis, we divide the per-employee earnings by 52 and get $1,024. Given that every worker is eligible for 16 weeks of income replacement per 24 months of employment, we multiply the weekly earnings by eight; each private-sector employee is entitled to $8,097 in income replacement per year. 

The defined entitlement value, which again is calculated as the maximum monetary value of the entitlement per individual, times the entitled population (117 million employed plus 8.5 million unemployed), comes out to almost exactly $1 trillion. This is the maximum amount that eligible Americans would take out of the entitlement program; in order to guarantee funding of every individual claim the federal government must be able to fund the defined entitlement value in its entirety.

Are they? Well, let us assume, again, that the tax rate is one percent for all income brackets, and that the tax will not be so costly that it destroys a single job. Under these assumptions the total revenue would be $62.4 billion.

Or, to be more precise:

Based on 2014 numbers
Defined total entitlement value
Revenue from 1-pct payroll tax
Funding deficit

To put this program in perspective, in 2014 the federal government paid out $857 billion in Social Security benefits. This means that the funding deficit alone is bigger than Social Security. 

But is it really realistic to assume that every eligible person would actually use the maximum monetary value of what he or she is eligible for?

This is a moot question. There are enough benefits covered to very quickly use up the revenues of the program. In the DC pilot-study case, the money is gone if every eligible person takes five sick days in one year. It is not beyond the realm of the imaginable that the average working DC resident takes five sick days in one year.

Not to mention the fact that this sick-day example implicitly assumes that nobody claims any income replacement due to any other factor whatsoever. 

Another example illustrates the poor architecture of the national program. One of the benefits covered is child birth and a "bonding" period. Suppose that only half of all mothers giving birth in the United States in one year (that would be half of four million) apply. Suppose also that they all take the maximum of eight weeks. 

Based on the fact that women's earnings are 80 percent of what men make, we use the aforementioned average earnings number of $53,256 to estimate an annual women's earning. Since our current number is an average for men and women, the women's average is 90 percent, or $47,930.

On average, women thus make $922 per week, an amount covered to 100 percent according to the DC paid-leave program. If a woman takes eight weeks to bond with her newborn, she is on average eligible for $7,374 in one year.

If all four million women who give birth in one year uses this entitlement program to its full extent, they will use up $29.5 billion of the $62.4 billion in total tax revenue for the program. 

The remaining balance, $32.9 billion, is enough to grant every man and woman in the program a total of one and a half day's worth of sick leave per year.

As admirable as the cause behind this program might be, this hypothetical application shows very clearly how detached from real-life economic facts the program happens to be. America cannot afford this program, plain and simple.

Instead of expanding the welfare state, its proponents should focus their efforts on distinguishing essential entitlements from non-essential ones. That would be a good step toward helping save America's fiscal future.  

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