The American aversion to taxes is not helping… to fix Social Security

I have a solution here, as well. However, because it is practical and intergenerationally-savvy, no one will support it. Americans only want the best benefits YOUR taxes will buy.

Here’s a recent post from Andy Biggs, he’s getting closer and closer to my solution all the time …

Fixing Social Security without raising taxes, cutting earned benefits or endangering the poor It’s possible, if we think differently.

Andrew Biggs

Policymakers are in a box: Social Security is $25 trillion out of whack, the only way in-whack it is to raise taxes or cut benefits, and Americans oppose both. Pretty much all Americans oppose raising taxes, on themselves, at least, but eliminating the Social Security payroll tax ceiling – which will be $184,500 in 2026 – would fix only around half the funding gap. But politicians from both parties also oppose cutting what they call Americans “earned benefits” from Social Security. On top of this, low-income seniors rely heavily on Social Security for income in old age, meaning that solvency-via-benefit-cuts seemingly would throw millions into poverty.

But what if there were a different way? [Foreshadowing: there is.]

Thanks for reading Little-Known Facts! Subscribe for free to receive new posts and support my work.

The key piece of data is this, courtesy of the Congressional Budget Office: Americans born in the 1960s and hitting age 65 over the next decade are promised an average of 33% more in Social Security benefits than they paid over their lifetimes in taxes, including interest on those taxes.

Ratio of lifetime Social Security benefits to lifetime taxes (including interest on taxes) by earnings quintile, 1960s birth cohorts.

These Americans will retire precisely when the Social Security trust fund will be exhausted and the need for tax increases or benefit cuts becomes critical. And they’re being promised benefits far, far in excess of the taxes they paid into Social Security. It’s one thing for Social Security to be a welfare program for the poor, but when the middle class are promised 47% more in benefits than they paid in taxes that’s when financial sustainability becomes a real issue.

But imagine that Social Security reform honored earned benefits – that is, benefits that Americans actually paid for – but simply reduced the unearned bonus benefits that retirees are slated to received but didn’t actually pay for.

Reducing unpaid-for benefits alone would restore Social Security to solvency: come 2032, Social Security will be about 24% short of the revenues it needs to pay full scheduled benefits, but at the same time beneficiaries are being promised benefits about 33% greater than their taxes. Simply eliminate these unearned benefits and the Social Security funding gap is resolved.

In fact, according to the CBO, even if we balanced Social Security’s finances simply by cutting benefits when the trust fund ran out, Americans born in the 1960s would still receive 13% more in benefits than they paid in taxes!

But Social Security is designed as a safety net to reduce poverty in old age. If low earners received back only what they paid into Social Security, wouldn’t that undermine the program’s effectiveness?

That’s a reasonable point. But there’s also a reasonable response.

Low earners receive the best return from Social Security in percentage terms: they receive benefits equal to 2.66 times their taxes-plus-interest, while a middle earner receives benefits equal to only 1.47 times what they paid in, and a high earner only 1.01 times their taxes.

But in dollar terms, the big transfers go to the middle class: low earners, in the lowest lifetime earnings quintile, receive $111,000 more in taxes than they paid in benefits. The next three quintiles up receive $130,000, $125,000 and $103,000 in unearned benefits, respectively. And Social Security’s $25 trillion funding gap has to be balanced in dollars.

If Social Security reform merely eliminated unearned benefits for the top four quintiles, who are at zero risk of poverty in old age, that would generate 83% of the savings needed to achieve solvency without increasing taxes.

Lifetime Social Security benefits net of lifetime taxes (plus interest), by lifetime earnings quintile; 1960s birth cohorts.

Okay, but we can’t simply cut people’s benefits overnight. Whether they paid for those benefits or not, they participated in Social Security in good faith and we can’t pull the rug out from under them.

That’s a perfectly reasonable objection to making changes overnight, but not against phasing those changes in over time. The fact that retirees in the 2030s are promised far more in benefits than they paid in taxes isn’t a one-off: it’s true for people retiring today and it will remain true for people retiring in the 2040s and beyond.

Lifetime ratio of Social Security benefits to Social Security taxes, by year of birth.

Social Security’s underlying demographics and economics simply don’t make it possible to keep paying people more in benefits than those people paid in taxes. This doesn’t mean that the tax-benefit imbalance has to be resolved on the benefit side, though for middle- and high-income households I think there are compelling reasons to do so.

But it’s generationally immoral to keep expecting future generations to inherit trillions of dollars in unfunded Social Security liabilities simply because we – by which I mean both Americans and their elected representatives – don’t want to act like adults.

Now, there is a good argument against this approach, one that forms the foundation of the discussion of Social Security in my book The Real Retirement Crisis:

That objection is that Social Security reform should aim to produce the best, most cost-effective social insurance program possible, not merely a reform proposal – like the one I’ve outlined above – that overcomes common objections to reducing Social Security benefits. My approach in the book was to start from scratch, designing a Social Security program for 21st Century realities, to which the current program would transition over a period of several decades to give people time to adjust.

How might an idealized Social Security program differ from the reform plan I outlined above?

Well, to start, consider the one group that did earn its Social Security benefits, in the sense of paying taxes that are proportional to their benefits: high-earning households, in the top fifth of the distribution. By my previous logic, reducing their benefits would not make sense.

But neither does having high-earning households continue to accrue new retirement benefits that don’t increase their retirement incomes so much as displace money that they would saved for retirement on their own. Even if high earners fully paid for their benefits, it doesn’t make sense for a high-income couple to get $100,000 annual benefits from the government. No other country that I’m aware of pays this level of benefits or anything close to it. So, over time, reform should scale down the maximum benefit.

But we also may want to increase the minimum benefit. That may sound odd, given that low-earners already receive far more in benefits than they paid in taxes. But if we have other social insurance goals – say, guaranteeing that no American would retire into poverty – then setting a true minimum benefit makes policy sense. Despite Social Security being a very good deal to low earners in a rate-of-return sense, there remain many seniors with Social Security benefits that leave them below the poverty threshold.

The point remains that the key to Social Security solvency without record-breaking tax increases isn’t about cutting Americans earned benefits. It’s about reducing benefits they didn’t earn, or at least didn’t pay for.

LikeLike