More on Social Security Math

As I noted in my post last Wednesday, Social Security is inherently a hot button topic.  It struck me in looking through the comments that the topic perhaps was so sensitive that my point was missed in some readers’ reaction to a discussion of changes to Social Security benefits.  I thought it would be worthwhile to elaborate.

Several commenters wondered why I do not consider as a policy option increasing the cap on Social Security wages that are subject to tax.

The answer is that changes to the wage cap are among the list of possible tax changes one could make to shore up the financial condition of Social Security..

Under current Social Security rules, wages are subject to a 12.4 percent tax up to a cap, currently set at $117,000 a year.  Wages above this level are not subject to Social Security taxes and do not result in the accrual of additional of benefits. The wage cap applies only to Social Security; all wages are subject to the Medicare tax, plus an additional tax levied in the Affordable Care Act above $200,000.

Raising the Social Security wage cap would be a reform of Social Security that improves the financial condition of the system through a progressive increase in taxes. The change could be made with or without accrual of additional benefits corresponding to the tax paid on wages above the existing cap.

There are two main policy levers available for Social Security reform: revenues and benefits (Andrew Biggs in his article linked in my original post discusses changes to work incentives as well).  In writing that raising taxes is one of the two options, this encompasses every variety of tax increase, including higher tax rates and a higher wage cap. Raising the cap is an increase in taxes from current law.  President Obama’s now-discarded proposal last year to change the way in which benefit growth is calculated is a reduction in future benefits from what is now promised under current law.  That is a change in benefits.

With this in mind, let me reaffirm what I have written: there is more agreement on an important aspect of Social Security reform than meets the eye.  Broadly speaking, the Democratic proposal to close the financial gap is to increase benefits for people with low lifetime incomes and collect more revenue from people with high incomes. The Republican approach is also to increase benefits for people with low lifetime incomes and provide lower future benefits than is now currently promised for high earners.

My point is that on net over the lifetime, both proposals would have the poor do better and the burden of adjustment borne by people with higher incomes. High earners either gets benefits that are now promised-but-not-payable and pay more in taxes than under current law, or pay the same taxes as under current law but receives less in future benefits. The net is the same.

Given the existence of a financing gap, the burden of adjustment must be paid by someone through either higher taxes or lower benefits.  In considering who should bear the burden of adjustment, policy makers will look at both distributional concerns within each generationâ€"the rich vs. poorâ€"and issues of generational fairness (today’s workers and retirees vs. those int he future).  To see this, imagine the Harkin-Warren proposal in which benefits are not lowered and all reform comes through changes in revenues from higher earners.  Waiting for several decades to undertake this reform means that several decades worth of rich people do not share in the burden of the adjustment,, which is borne by the future rich rather than shared with the current rich.

Finally, opponents of reductions in promised benefits sometimes note that such a reform would reduce the link between contributions paid and benefits received and could reduce societal support for Social Security, perhaps by making the program seen as something closer to “welfare” than to social insurance. This concern is a reasonable one, involving a mix of optics (as one commenter put it), politics, and sociology. On the economics, however, looking at reforms from the perspective of the net lifetime approach shows that lowering the promised benefits of high earners and raising their taxes have the same impact and differ mainly on whether money is run into the government from those with relatively high earnings to pay it back out in benefits for retirees who had high lifetime earnings.