Social Security’s financial health has deteriorated significantly over the past eight years, with multi-trillion-dollar funding shortfalls posing a threat to retirees and taxpayers alike. But if Social Security is to thrive in the 21st century, the next president needs to do more than simply adjust its tax and benefit rules. Instead, Social Security needs a new paradigm for how individuals and government programs contribute to retirement security.
Social Security receives scant attention compared to many other policy issues, large and small. But Social Security is an important program, both in its impact on Americans’ lives and in what it says about the political parties’ philosophies. The scale of Social Security’s reach is enormous: It is the biggest federal-government program, the largest tax most American workers pay, and the largest source of retirement income for most households. Americans interact with Social Security from the day they enter the workforce as teenagers to the day they die, and Social Security affects how much they work, whether they become disabled, when they choose to retire and, some research shows, even how many children they choose to have. How the political parties deal with the program — with its day-to-day functioning, with its $10 trillion–plus long-term deficit, and with how Americans save for retirement on their own — says a lot about their governing philosophies.
Americans have not yet been so co-opted by the welfare state that they embrace progressive activists’ model of an expanded Social Security program supplemented by government-run savings accounts, a model in which most Americans could eventually receive the vast majority of their retirement income from government programs. But Americans have gone far enough down that road that a conservative agenda on Social Security reform has to be about more than simply cutting benefits. Whatever the conservative policy approach may be, on a program as large and important as Social Security, there has to be a philosophy of governance behind it.
The philosophy under which Social Security was founded in 1935 states, “A program for the poor is a poor program.”
The philosophy under which Social Security was founded in 1935 states, “A program for the poor is a poor program.” President Franklin D. Roosevelt explicitly wished to distinguish Social Security from what then was called “relief” and what we today would call “welfare.” Participants must work ten years just to qualify for benefits, and benefits increase with the worker’s earnings. Benefits are progressive, but a worker earning the maximum taxable wage of $118,500 still receives a benefit 3.5 times that of a worker in the bottom fifth of the earnings distribution.
“Earned benefits” unquestionably strengthen Social Security’s political support, and were affordable in a time of favorable demographics. By demographics I mean not simply the ratio of workers to beneficiaries, which was much higher in Social Security’s early decades than it is today, but also the fact that most households were composed of a married couple in which an adult male regularly worked.
When the population ages and the ratio of workers to beneficiaries falls — as it has, from about 16-to-1 in 1950 to less than 3-to-1 today — paying generous benefits to middle and high earners is expensive. Over one-third of all Social Security benefits are paid to households in the top lifetime-earnings quintile, and nearly two-thirds flow to the top two quintiles. Much of the increase in Social Security’s costs comes from paying higher benefits to higher-earning households.
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Just as important, old-age poverty in the 21st century has different causes than it had in the past. An individual who works at a low-wage job every year of his life — a person who in reality is quite rare — will retire with a Social Security benefit that, while certainly not opulent, will keep him out of poverty and enable him to maintain his pre-retirement standard of living. In reality, though, most people retiring poor today had only sporadic attachment to the labor force during their working years. The highest earning quintile of workers retires with roughly twice as many average years of work as those in the bottom quintile. As a result of their short work histories, nearly one-fifth of the poorest quintile of retirees fail to even qualify for Social Security, and nearly one-third of those who do qualify receive a benefit below the poverty line. The poorest retirees can fall back on the Supplemental Security Income program, but this means-tested welfare plan also pays a sub-poverty-level benefit and effectively prohibits recipients from working their way out of poverty.
The result is a poverty rate among the elderly of 10 percent, despite Social Security spending sufficient to pay every American over age 65 a benefit roughly 12 percent above the poverty threshold. This is a very expensive way to not protect against poverty.
So far, most presidential candidates in both parties are sticking with the old script. On the Democratic side, Senator Bernie Sanders wishes to expand Social Security, raising taxes substantially to do so. But his plan would still leave someone who had worked and paid Social Security taxes for just under ten years with no entitlement to benefits. In fact, under Sanders’ plan, households in the top lifetime-earnings quintile receive percentage benefit increases almost as large as those in the poorest quintile.
As for the Republicans, the general philosophy seems to be “keep doing what we’ve been doing, just less of it.” Governors Chris Christie and Jeb Bush have proposed combinations of retirement-age increases, means-testing on upper earners, and adjustments to various benefit formulas, producing a system that, while more financially sustainable, would be vastly more complex and still lacking a safety net adequate to inspire confidence among Americans. And without the confidence that they will not fall into poverty in retirement, many middle and high earners will not accept the benefits reductions needed to restore Social Security to solvency.
#share#But there is a new paradigm that rejects the “program for the poor is a poor program” credo in favor of a different philosophy: that if government provides a solid, reliable safety net against poverty in retirement, retirement saving on top of that base should largely be entrusted to individuals investing in private-market accounts that they, not the government, would control.
New Zealand, the United Kingdom, and Australia have all evolved in the same direction: The government provides a guaranteed minimum retirement benefit of about $1,000 per month. New Zealand pays this benefit to all residents, the U.K. scales it based upon the number of work years, and Australia means-tests the benefit based upon other income. But in all cases, the government aims at providing a solid base income to keep retirees out of poverty, not generous benefits for middle- and upper-income households.
If government provides a solid, reliable safety net against poverty in retirement, retirement saving on top of that base should largely be entrusted to individuals.
On top of that base, individuals participate in 401(k)-type defined-contribution retirement plans. In Australia, participation is mandatory, though only the employer must make contributions, of 9.5 percent of worker wages. In New Zealand and the U.K., workers are automatically enrolled but may withdraw if they choose. In those countries, both workers and employers contribute, and the government provides a modest match.
I have proposed a similar reform for the U.S. Social Security program. Beginning immediately, Social Security would pay every long-term U.S. resident a minimum benefit pegged at the poverty threshold of $950 a month, regardless of the retiree’s work history or earnings. This minimum benefit would take the place of both the redistributive aspects of Social Security and the Supplemental Security Income program, but do so with greater protections against poverty and no prohibition on work and saving. In fact, the Social Security payroll tax would be eliminated at age 62 to encourage longer work lives.
But over several decades, the maximum Social Security benefit would be scaled down so that eventually every retiree will receive the same flat dollar benefit from the government. For the bottom third of retirees, benefits would increase, but for middle and upper income Americans, benefits would decline relative to currently promised levels. This makes sense. At any given time, higher-income Americans are less dependent upon government than lower-income households. As incomes rise over time, Americans should gradually become less dependent on the government for income in retirement and more able to build their own savings.
To ensure an adequate retirement income, middle- and upper-income Americans would need to save more on top of Social Security. Federal policies should work to help them do so. Currently, around half of employers automatically enroll their employees in 401(k) plans, a policy that dramatically expands participation. Auto-enrollment should be made universal, as a simple best practice for pension administration. To expand pension coverage by small employers, which often find 401(k)s costly to establish, Congress should allow for less-expensive “Starter 401(k)s” and multiple employer-defined contribution plans, as proposed by Utah senator Orrin Hatch. Finally, 401(k) plans should adopt auto-escalation, which gradually increases contributions over time. Again, employees can withdraw, but most don’t even notice the increased contributions, and the vast majority choose not to reduce them.
#related#This plan would not cheat Americans out of Social Security benefits they had already earned. But it would change the terms on which Americans earn future benefits, to a paradigm in which government provides a real safety net against poverty — the ultimate “retirement crisis” — but treats middle- and upper-income households as adults who can and should generate most of their retirement income through their own saving.
Unlike the actuarial minutiae of conventional Social Security–reform plans, this new approach would give a presidential candidate a compelling agenda to talk about in plain English that ordinary Americans can understand.
Make no mistake: This is a conservative plan, at least as far as cost is concerned. Not only would Social Security be made permanently solvent, but over the long term the program would run a substantial surplus. The reason is simple: guaranteeing Americans against poverty in old age isn’t expensive, so long as Social Security doesn’t also pay higher-earning households benefits that are two and three times the poverty level. A true guarantee against poverty in old age is a promise that progressives would like to make, but that only a fiscally conservative plan could deliver.
— Andrew G. Biggs is a resident scholar at the American Enterprise Institute.