Another Way to Do the Math for Social Security Reform

Phillip Swagel is a professor at the School of Public Policy at the University of Maryland and was assistant secretary for economic policy at the Treasury Department from 2006 to 2009.

Social Security is a hot button political issue, but there is actually more agreement on the matter than might meet the eye. Consider a potential Social Security reform that increases benefits for low income retirees and raises taxes on workers with relatively high incomes. This sounds a lot like what Democratic members of Congress might favor.

Now compare this to an alternative that maintains current taxes on the rich but lowers their benefits, while again raising benefits for those with low incomes. In broad strokes, this is the Republican proposal. It turns out that those are the same, once assessed from a perspective that looks at the net of lifetime contributions and benefits. Too bad, though, that President Obama, who once upon a time spoke about making tough decisions to ensure the sustainability of vital entitlement programs such as Social Security, is stepping back from the issue.

The Obama budget released on Tuesday leaves out the President’s previous proposal to modify the formula by which Social Security benefits are adjusted for inflation, a change meant to improve the financial condition of the retirement program.  This is even though last year’s budget documents noted that “most economists agree that the chained CPI provides a more accurate measure of the average change in the cost of living than the standard CPI.”

News reports indicated that Mr. Obama is still actually open to the idea in principle. But proposals favored by the president are put in the budget, even if like his various suggestions for higher taxes and more spending, they stand little chance of enactment.

The omission, which was explained to the press, is not surprising.  Neither side in Congress seems eager to address Social Security’s financing gap, whether through higher revenues or slow benefit growth. Even putting forward the proposal last year caused problems for Mr. Obama within his party. Doing so again would make it awkward for Democratic candidates in this fall’s Congressional election to accuse their opponents of wanting to hurt seniors.

While understandable, the budget change is disappointing because it steps away from a proposal that would begin to address the gap between the future revenues available to Social Security and the promised benefits that cannot be sustained under current law. Consider, for example, a potential Social Security reform that makes no changes to payroll taxes but increases benefits for retirees with low lifetime incomes and reduces benefits for retirees with high lifetime incomes.

Projections from the Social Security Administration’s actuary indicate that the disability system faces a financing crunch in 2016, while the old age retirement program will be able to pay promised retirement benefits until 2035. If retirement and disability funds are considered together, system reserves will be depleted in 2033, with revenues in that year sufficient to pay 77 percent of scheduled benefits, a figure that declines to 72 percent of scheduled benefits in 2078. With no change in the law, then, changes to Social Security will still take place, with current projections indicating that this would involve a reduction in benefits of 23 percent and rising for all retirees, both high- and low-earners.

The arithmetic of these projections is straightforward, but my sense is that discussion of the available policy options is often confused in the public debate. The adjustment to Social Security will eventually come through either revenues or benefits, or some combination of the two. With this in mind, a useful way to analyze the burden of adjustment is to consider the net impact of changes to revenues and benefits over workers’ lifetimes.

The assertion that increased benefits for retirees with low lifetime incomes and reduced benefits for retirees with high lifetime incomes are similar on net leaves aside the vagaries of individual mortality. This is an important topic but considering it does not reverse the points made here, since the proposed reform is to increase benefits for those with low earnings who tend to have shorter life spans than high earners.

For a given improvement in the system’s financial condition, then, the two alternatives are to maintain current benefits and have higher taxes or to keep taxes the same but slow benefit growth from what is now promised, but not payable.

Either way, the net impact is the same, with the burden of the adjustment falling on high earners in both instances. The plan with higher revenues does provide greater assurance to one group: people who made lots of money while working and then spent it all. 

But it seems hard to imagine that protecting this group with higher benefits would be a strong reason to prefer for a plan that raises taxes on people with relatively high earnings and thus runs more money into the government merely in order to pay out higher benefits to the people with relatively high earnings. And again, under both reform proposals, people with low lifetime earnings would have higher benefits and not higher taxes than in the current system.

The idea that people at the bottom should do better on net while the burden of adjustment falls on those with high lifetime incomes is common to Social Security reform proposals, including those previously put forward by Congressman Paul Ryan, the Republican from Wisconsin, and President George W. Bush.  Senator Tom Harkin, an Iowa Democrat, and Senator Elizabeth Warren, the Democrat from Massachusetts, among others, have proposed expanding Social Security benefits.

Implicit in the Harkin-Warren proposal to avoid benefit reductions is to eventually increase system revenues, (since otherwise benefits would be cut once system funding is inadequate.) And presumably Senators Harkin and Warren would do this in a progressive fashion by having the burden of higher taxes fall on people with relatively high lifetime incomes. This means that on net their proposal is broadly similar to that from the other side, with an improved outcome for low-income retirees and the net burden of adjustment falling on those with greater lifetime earnings. This is clear with a lifetime perspective.

I realize that it is uncommon to see this group of policymakers as sharing common ground on Social Security reform, but that is the implication of viewing changes to the system through the lens of the net burden of adjustment.

President Obama could have adopted the idea of Senators Harkin and Warren to increase benefits for retirees with low lifetime incomes, which would have left the impact of slower benefit growth focused on those with higher lifetime earnings. Mr. Obama had already proposed safeguards to protect vulnerable retirees who most depend on Social Security and others who depend on government assistance programs such as food stamps. Higher benefits for low earners would have been a natural expansion of his proposal, rather than simply striking it from the budget.

Other changes to Social Security would be desirable, such as to improve incentives for people to work; the former deputy commissioner of the Social Security Administration, Andrew Biggs, provides a useful discussion. It should be expected that there will be different views between the two parties on many aspects of reform. The point here is that on the burden of adjustment there is broad consensus.

The timing of reform matters. If progressive changes to revenues or benefits are made in 2033 rather than sooner, up to twenty years’ worth of rich people get both higher benefits and lower taxes and thus do not share in the burden of adjustment (and again, in all cases, people with low lifetime incomes would have higher benefits and not higher taxes).  This means that a larger adjustment will be borne by others, including in future generations.

Social Security reform is off the political discussion table for now, but the eventual burden of adjustment will fall on someone-this is the implication of the actuarial figures listed above.

A few days before releasing his first budget in 2009, President Obama hosted a fiscal responsibility summit at the White House at which he noted that “tough choices” would be needed to address the long-term fiscal challenge facing the United States, including to ensure the solvency of Social Security. The necessary adjustment should take place slowly and take hold after the economic recovery is further along.  But developing a societal consensus around reform will take time and require political leadership. In this regard, President Obama’s budget is a step in the opposite direction.

Postscript:  More information on a range of topics relating to Social Security reform can be found a set of background papers on the issue written while I was Assistant Secretary for Economic Policy at the Treasury Department, which can be found here. These papers do not represent the view of the Obama administration (though I suspect that their economists would agree with much of the contents-the reports were drafted by the talented career economists at the Treasury). I am glad, however, that the Treasury under Secretary Geithner and Secretary Lew has continued the tradition of ensuring that such reports are available on the Treasury website, just as the reports written and speeches given in the Clinton administration and before remained online during the Bush administration.