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Answering Common Questions About Social Security: Part 2
By Charles Blahous
Social Security is the largest federal program, affecting Americans’ individual economic lives more than any other. The prominence of Social Security naturally gives rise to many questions from Americans who are trying to plan their economic futures. The questions and answers that follow are among those most commonly asked about the implications of Social Security reform. This article is part two of two; part one can be found here.
Will my benefits be cut by Social Security reform?
Almost certainly not, if you are already receiving retirement benefits. Historically, federal lawmakers have been strongly disinclined to cut benefits for those already receiving them. If you are not yet receiving benefits, you should know that it is highly likely that the scheduled rate of benefit growth will need to change if Social Security is to remain solvent. This is unlikely to require a decrease from today’s Social Security benefit levels, but it could mean future benefits will grow somewhat more slowly than currently scheduled.
Will Social Security be solvent if politicians pay back the money they took from it to finance other government spending?
No. The Social Security financing shortfall exists despite the Treasury bonds in its trust funds that reflect Social Security’s past surpluses. In other words, whenever Social Security collected payroll taxes that were not immediately spent on benefits, this surplus revenue was invested in Treasury bonds. Social Security is authorized by law to cash in these bonds whenever necessary to pay benefits, and it receives principal and interest back in full whenever it does so.
Social Security has been relying in part on Treasury bond income to pay benefits ever since worker payroll taxes began to fall short of benefit obligations in 2010. Social Security is thus given full credit for any surpluses it previously ran. The shortfall exists not because politicians have stolen the money and refused to pay it back but because scheduled benefits far exceed the payroll taxes workers contribute.
Would requiring the rich to pay the same payroll tax rate as everyone else solve the Social Security problem?
No. Applying the payroll tax to more wage income would partly reduce the Social Security financing shortfall because higher-income people receive smaller benefit returns on their payroll taxes than lower-income people do. However, exposing more income to tax would not be sufficient to place Social Security on a financially sustainable path. According to recent estimates, eliminating the tax cap and thereby taxing all employment earnings in the U.S. would eliminate roughly 32% of the program’s long-term annual deficits. If a more radical step were taken—applying the tax to all earnings but denying any benefits based on the new contributions—this would still eliminate only 55% of long-term deficits. To render Social Security permanently sustainable, additional measures would be needed to slow the growth of benefit obligations.
Why should we care about Social Security solvency? Why not just give the program whatever revenues it needs, like any other government program? Why can’t Social Security be financed with other taxes (capital gains taxes, wealth taxes, carbon taxes, value-added taxes, etc.)?
In theory, federal lawmakers could change Social Security’s financing structure at any time, to be financed with any taxes lawmakers choose. Historically, however, the program reflects the vision of President Franklin D. Roosevelt that Social Security be a contributory insurance program, in which workers’ payroll taxes create their entitlement to benefits. By contrast, in so-called welfare programs, benefits are often conditioned on need and funded by those who are better off financially. Individuals who pay for welfare programs are not usually the same ones who receive benefits from them, setting up a persistent competition of interests that results in frequent revisions of benefit levels and eligibility rules.
Social Security’s historical earned-benefit design could be changed at any time—that is, changed to be funded with progressive taxes that do not result in benefit accruals for those taxpayers. This, however, would mean abandoning the philosophy of an earned-benefit system. If Americans wish to preserve Social Security as an earned-benefit program, then its benefit and payroll tax schedules will need to be realigned.
Are all generations treated equally by Social Security? If not, can this be fixed?
Different generations are treated very differently by Social Security. In general, younger generations receive poorer returns, while the first generation of Social Security beneficiaries received windfall returns—benefits for which they themselves did not pay. This unequal treatment across generations can be mitigated but not completely fixed. There is no way to undo the windfall returns paid to the first generation of participants. This “legacy debt” means that later generations, as a whole, must contribute more to Social Security in present-value terms than they receive.
A critical challenge facing policymakers is to spread these net income losses among later generations as fairly as possible. Unfortunately, under current law the distribution of income gains and losses would be substantially unequal, with individuals born just before and after the 1960s making no net contribution to fixing the problem, while those just entering the workforce today would have their lifetime income lowered by more than 3% due to Social Security. The only way to ameliorate this situation is for today’s older workers to make a contribution to lessening the program’s financing shortfall. It should be noted that any across-the-board benefit expansion would worsen these generational inequities because it would give today’s participants additional benefits for which they did not pay, compounding the income losses facing young workers.
Isn’t increasing Social Security’s eligibility ages unfair to low-wage manual workers?
No. This is a myth borne of misunderstandings about how Social Security’s benefit formula and eligibility ages interact. Under Social Security, individuals can choose their age-of-benefit claim to suit their individual circumstances, receiving smaller monthly benefits if they claim earlier and larger benefits if they claim later. The benefits provided at a given age of claim are a function of multiple variables, including not only where the Full Retirement Age (FRA) is set, but also the degree of progressivity in the Social Security benefit formula. Consequently, low-income individuals can be assisted by making the benefit formula more progressive even as the FRA is adjusted to reflect demographic realities.
Social Security’s earliest eligibility age (EEA) is currently 62, three years earlier than it was when the program began. Thus, even if the EEA were to rise by three years, Americans would be able to claim Social Security as early as its first participants could. A failure to adjust eligibility ages is on balance harmful to working-class Americans because it means a costly diversion of resources to pay able-bodied, higher-income Americans to leave the workforce prematurely.
How does the Delayed Retirement Credit work? Can we make it more effective?
The Delayed Retirement Credit (DRC) is an increase in monthly benefits when individuals delay old-age benefit claims past the Full Retirement Age. For every year beyond FRA that an individual delays a benefit claim, up to age 70, the monthly benefit is increased by 8%. Scholars have noted that relatively few individuals claim the DRC, and some have proposed ways to make it more attractive. Some have suggested offering the DRC as a lump sum, since academic research shows that individuals would be more likely to claim it in that form. Others have proposed slightly increasing the DRC to reimburse individuals for the additional payroll taxes they contribute if they delay their benefit claims while continuing to work.
How can we reform Social Security to better reward Americans’ workforce participation?
Social Security as currently designed pays very low returns (just a few cents on the dollar) for payroll taxes contributed by working seniors. A number of strategies have been suggested to maintain work incentives when participants reach late middle age. One is to redesign the benefit formula so that benefits are accrued proportionally with each year of work, rather than accruals dropping suddenly after 35 years of earnings as occurs under the current formula.
Others have suggested steepening the actuarial penalties for early benefit claims and increasing the rewards for delayed retirement claims. Others have suggested repealing the retirement earnings test. Some have suggested lowering payroll taxes for working seniors, perhaps by exempting them from the disability insurance tax or by exempting them entirely from Social Security taxes once they have contributed them for 45 years. These tax decreases could improve work incentives, though they would also worsen Social Security’s financial shortfall unless paired with other measures to cut spending growth.
Can we make Social Security more progressive without destroying work incentives?
Yes, but it’s difficult. The Social Security benefit formula is already substantially progressive, with returns on work declining as one’s income increases. Simply making the benefit formula more progressive would further reduce returns on individual participants’ additional work. A similar challenge affects proposals to create new special minimum benefit provisions within Social Security; if designed the wrong way, they would reduce labor force participation.
However, these challenges can be overcome. A more progressive Social Security benefit formula could be combined with reforms that would tie benefit accruals to annual earnings rather than lifetime average earnings, thereby maintaining incentives for individuals to work every year. Minimum benefit protections can also be designed to scale up with years of employment, to reward low-income people for their continued work.
How can we modernize Social Security to reflect the diversity of 21st-century American families?
Social Security’s design largely reflects early 20th century assumptions about family structure and labor force composition. For example, although nonworking spouse benefits are now available regardless of gender, they were originally “wife’s insurance” benefits and paid only based on the earnings of a man. Their design reflects earlier assumptions that the norm for participating worker households would be a husband with earnings outside the home, married to a stay-at-home spouse. Through this benefit, Social Security transfers income away from two-earner couples and single heads of household toward one-earner couples, including higher-income one-earner couples. Social Security could be better adapted to 21st century needs by paring back some of these income transfers, thereby preserving program resources for other types of families with different employment patterns.
Can personal accounts fix Social Security?
No. Personal accounts—retirement accounts in which a portion of workers’ payroll tax contributions could be saved—were frequently proposed in previous decades when Social Security was running a surplus of payroll tax revenue, and many academic analysts noted then that surplus revenues were not being saved to finance future benefit obligations. Personal accounts were suggested as one means of ensuring that a portion of payroll taxes would be saved, a portion of future benefits would be pre-funded, and younger workers would not suffer poor returns from shouldering the entire burden of financing benefits for the historically large baby-boom generation.
However, in 2010 annual benefit obligations began to exceed annual payroll tax contributions, meaning that there are no longer any surplus revenues to save. Unfortunately for younger generations, the opportunity has passed to lessen their income losses by pre-funding a portion of the baby boomers’ Social Security benefits, so creating personal accounts at this stage would not eliminate that problem.
Is anyone trying to privatize Social Security?
Although there are always a few individuals who advocate true privatization of Social Security as with any federal activity, actual privatization is not supported by significant numbers of elected Republicans or Democrats. “Privatization” was a term coined as a means of criticizing earlier proposals to save a portion of surplus Social Security payroll tax revenues in personal accounts, when such surpluses existed before 2010. However, the legislative proposals introduced even then did not envision actual privatization, and Social Security (including any personal account component) would have remained a publicly administered program of the federal government.