Economy & Business

Would Social Security Expansion Gut the Economy?

(Dreamstime) Alexey Yuryevich Rotanov)
Boosting pension payments would be a bad idea in Canada — and even worse in the U.S.

Democratic presidential nominee Hillary Clinton won support from progressive activists by adopting one of their signature issues: expanding Social Security. While once viewed as a fiscal centrist, Clinton today pledges to oppose any and all benefit reductions and even to enact targeted benefit increases. While Social Security expansion may have served Clinton politically, it undermines the economic growth that will be essential to addressing population aging.

Social Security faces insolvency by the early 2030s, as 10,000 retiring Baby Boomers per day shift from paying taxes to collecting benefits. But population aging poses a more basic economic problem: how smaller numbers of workers can provide the goods and services required by rising numbers of retirees. The answer is that by working more and saving more, we can grow the economy to provide for retirees without beggaring working-age households.

But expanding Social Security benefits could do quite the opposite. A newly released government analysis from Canada provides a warning. This summer, Prime Minister Justin Trudeau’s Liberal party brokered a plan to gradually boost retirement benefits paid by the Canada Pension Plan (CPP). This CPP expansion will be funded by raising the payroll tax rate from 9.9 percent to 11.9 percent and increasing the maximum salary on which taxes are levied from US$41,000 to about $62,000. Even then, Canadians would enjoy lower taxes than the 12.4 percent rate that Americans pay on their first $127,200 in earnings.

But in a heavily redacted memo obtained by the Canadian Broadcasting Corporation through a freedom-of-information request, Canada’s Department of Finance projects that CPP expansion could slow the Canadian economy for up to two decades. “In the short run, raising CPP contribution rates for both employers and employees will reduce workers’ take-home pay and increase employers’ wage bills.” Higher employer costs would reduce demand for labor while “lower take-home pay could also reduce the number of hours workers are willing to work.” The Finance Department also warns that Canadians will “reduce other forms of retirement savings to reflect higher future CPP benefit payments.”

And though the Finance Department projects long-run economic benefits from CPP expansion — principally through higher national saving — these don’t apply to the U.S. While the Canada Pension Plan is a prefunded system that holds and manages real assets, our Social Security is a pay-as-you-go program. Social Security expansion simply means more taxes flowing in and more benefits flowing out.

But wouldn’t expanding government pension benefits prevent a crisis of inadequate retirement incomes? Not according to Canadian actuaries Bonnie-Jeanne MacDonald and Fred Vetesse, who found that CPP expansion would increase the number of Canadians with appropriate retirement incomes by only four percentage points, from 52 percent to 56 percent. Higher CPP benefits would reduce the share of Canadians with inadequate retirement incomes but also cause more households to oversave for retirement.

For those tempted to dismiss these results as north-of-the-border concerns, we have similar evidence right here at home. In 2004 the Congressional Budget Office analyzed a Social Security–reform proposal by MIT professor Peter Diamond and banker Peter Orszag, who went on to become President Obama’s budget director. The Diamond-Orszag plan would increase Social Security taxes while providing a mix of benefit reductions and targeted benefit increases.

Mrs. Clinton’s targeted benefit increases would boost Social Security costs by about 5 percent. More taxes and higher benefits imply less work and less saving.

The CBO found that under the Diamond-Orszag proposal “real (inflation-adjusted) GNP could be between 0.7 percent and 0.8 percent lower in 2025 — and between 1.5 percent and 1.7 percent lower in 2080” compared with making Social Security solvent by reducing benefits to match current-law tax revenues. The plan’s higher payroll taxes “would reduce the participation of workers in the labor market and cause them to reduce their hours of work,” while with higher benefits on offer, “people would not need to work and save as much for retirement.” Long-run employment would fall by almost 2 percent while the U.S. capital stock would decline by about 1 percent.

Mrs. Clinton’s Social Security plans would almost certainly have even larger negative economic effects than the Diamond-Orszag proposal. While the Diamond-Orszag plan reduced long-term Social Security costs by roughly 10 percent, Mrs. Clinton’s targeted benefit increases would boost Social Security costs by about 5 percent. More taxes and higher benefits imply less work and less saving.

Better solutions aren’t hard to come by. A stronger Social Security safety net could dramatically reduce the 10 percent of retirees who currently live in poverty. Likewise, reducing the growth of future benefits for middle- and high-income households would increase retirement saving, as research from both the U.S. and abroad finds that these households calibrate their own savings to what they expect to receive from the government. Increasing retirement-saving opportunities by expanding access to 401(k)s and automatically enrolling all workers would ease the path to a sustainable Social Security program.

Social Security expansion means higher taxes that penalize work and higher benefits that discourage personal saving for retirement. A slower-growing economy is the opposite of what an aging population needs.

— Andrew G. Biggs is a resident scholar at the American Enterprise Institute and a former principal deputy commissioner of the Social Security Administration.

Andrew G. Biggs is a resident scholar at the American Enterprise Institute and a former principal deputy commissioner at the Social Security Administration.

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