Most Social Security–reform plans tweak tax and benefit formulas so that, over time, revenue aligns with costs. But it would be better to start reform efforts by asking, “What kind of retirement system will someone retiring 50 years from now need?” A Social Security program for the future must do three things: save more money, give people incentives to retire later in life, and target resources where they are needed most.
First, everyone who can save for retirement on his own should do so. President Obama and many Republicans support automatic enrollment in 401(k) and IRA pension plans. If all Americans saved just 10 percent of their wages, the need for Social Security payments would be greatly reduced. And, upon retirement, individuals should convert part of their savings to annuities; perhaps annuitized funds could be withdrawn tax-free while other withdrawals are taxed. For the typical person, these steps alone would accomplish most of what Social Security now achieves.
Second, able-bodied individuals should remain in the workforce longer. In the 1950s, the typical worker claimed Social Security around age 68. Today, despite a longer lifespan and work that is less physically demanding, the median American claims Social Security at age 62. It is an economic, budgetary, and moral mistake for Americans to spend one-third of their adult lives in retirement at the expense of those who work. The early and normal retirement ages for Social Security should be raised.
But we should use carrots as well as sticks. My research has shown that the typical worker nearing retirement age receives only around three cents in extra benefits for each additional dollar he pays into Social Security. To give this worker a good reason to keep working, the Social Security payroll tax should be reduced or eliminated for individuals older than 62.
Third, Social Security benefits for high earners should be reduced. While liberals object that “a program for the poor is a poor program” — a view based on the uncharitable assumption that if Americans know a program is redistributive, they won’t support it — the current system gives about $27,000 per year in benefits to every retiree who earned more than $100,000 per year when working. This is a luxury a program facing insolvency cannot afford.
Social Security’s benefit formula also needs repair. As my research has shown, most of the redistribution in Social Security is based on factors other than income. In fact, a worker’s earnings level is a poor predictor of how generously Social Security will treat him. Single-earner couples do better than dual-earner couples; short working careers produce higher benefits than do longer ones; divorced women whose marriages lasted ten years or longer do better than those who divorced earlier. This means that some low-earning households receive relatively low benefits, while some high-earning households receive relatively generous ones. A flatter, simpler benefit structure would make Social Security more understandable and would more effectively prevent poverty.
The experiences of other countries might teach us something. The United Kingdom is moving to increase its benefits, coupled with automatic enrollment in pension accounts. These accounts will invest an amount equal to 8 percent of workers’ earnings, with contributions split between workers, employers, and the government. Australia requires all workers to save 9 percent of their wages in individual accounts; for low earners, it provides a minimum benefit.
Meanwhile, New Zealand offers a flat universal benefit to all retirees, with voluntary “Kiwi Saver” retirement accounts providing additional income. Such a setup would be a significant change from our current system, but would allow us to give the household of every retired and disabled worker a poverty-level benefit with a payroll tax of under 6 percent. A reform that effectively eliminated poverty for retirees and generated income above the poverty level by means of individual savings would be good policy, and might even be good politics.
Reforming Social Security is important not only for its own sake, but to conserve resources for Medicare, where it will be harder to supplant dwindling government benefits with personal savings.
Medicare’s fiscal challenge is like Social Security’s on steroids. Medicare faces all of Social Security’s demographic challenges, and also bears the burden that health expenditures have long been growing faster than the economy.