Andrew Biggs wrote in to elaborate on one of the points I raised in my last post on Social Security reform:
One note you made prompted me to follow up: you mentioned the idea of exempting people from payroll taxes once they’ve reached some threshold level of work years; I think John Shoven pegs it at 40, while Mark Warshawsky does so at 45. You’re right that there’s some administrative complexity to the years-of-work criterion, but that’s not the main reason I took the route I did. It’s because not many people make it to 40 years of work, much less 45, and the few that do are disproportionately high income, meaning they’re more likely to delay retirement anyway and less likely to need the extra money. I believe the typical person retires with around 32 years of earnings, so even on average they’re really not very close.
Under the age-based approach, you’d have the incentive to work past 62 even if you took a lot of years out of the workforce when you were younger. So it hits a much broader swath of people, which is important if you want to have a macro-level effect, but it also encompasses the low earners, which matters if you want to address micro-level financial security issues.
I personally think about the work-years based approach the way I think about the ‘low earner benefit enhancements’ contained in a lot of reform plans. They sound good – say, a career-long minimum wage worker receives a benefit equal to 150% of poverty, or whatever – but it doesn’t actually do anything because the universe of potential beneficiaries is so limited. That’s one reason I went for the flat universal benefit, because I realized that you couldn’t truly do anything about poverty unless you were willing to look at people with really sporadic labor force attachment.
Social Security benefits are determined through a multi-step process. Part of this process involves summing up a beneficiary’s highest-earning 35 years (limited to taxed Social Security earnings and adjusted for inflation — if you’ve worked fewer than 35 years, $0 will be factored in to the calculation) and dividing this number by 420, or 35 multiplied by 12. This number (your average indexed monthly earnings or AIME) is then used to determine the amount of money you’ll receive, depending on when you retire, which bracket you fall into, etc.
(1) Shoven et al. propose using 40 years rather 35 years of Social Security earnings to set the AIME;
(3) and they propose creating a category of “paid-up” workers — after working for 40 years, you no longer have to pay Social Security payroll taxes.
They summarize the case for these reforms as follows:
There is a theoretical justification for these policies. The intuition of optimal tax theory would be to place heavier taxes on more inelastic supply (and demand) and lighter taxes or no taxes on highly elastic behavior. Our hypothesis is that the 41st and 42nd years of work, for instance, are far more sensitive to incentives than the 21st and 22nd years of work. The practical significance of these three 9 reforms is to make employment of veteran workers more attractive for both the employee and the employer. Taken together, these three proposals result in a benefit cut. In order to compensate for this and keep the reforms benefit-neutral in aggregate, we increase retirement benefits proportionately in order to keep aggregate benefits constant before and after the reforms. Assuming no behavioral changes, the adjustment needed is a 19.4 percent increase in benefits. The proposals also result in redistribution from those with shorter careers to those with longer ones.
This approach has a strong intuitive appeal, yet as Biggs suggests above, the Shoven et al. approach is hard on workers with sporadic labor force attachment. One can characterize this as a virtue — it is certainly a strong inducement to remain attached to the labor force — yet as Biggs explains, workers with 40 years or more of work experience tend to be higher-earners (and, separately, I suspect that they tend to be male).