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Are Social Security benefits “earned”? If not, what next?

Are Social Security benefits “earned”? If not, what next?

Last updated on: August 16, 2016 at 9:53 am by Jane the Actuary

Are Social Security benefits “earned”? If not, what next? 2016-08-16T09:53:29-06:00 Jane the Actuary

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That’s the reason, or has, at any rate, always been offered as the reason, why we have an earning cap on Social Security pay — so that Americans can know that these are earned benefits, not a welfare check out of the pockets of the wealthy, and can feel a sense of dignity when they collect their check, and will confidently defend the program as “earned benefits” from those who would wish to dismantle it.

It’s been that way from the very beginning of the program. President Franklin Roosevelt is even quoted as having said,

We put those payroll contributions there so as to give the contributors a legal, moral and political right to collect their pensions. . . . No damn politician can ever scrap my Social Security program,

as quoted, for instance, in an article in the Washington Post from 2012 (which I found via a google search looking for this quote).

It’s the same reason why, at the very beginning of the program, it was a true funded benefit, with participants collecting only those benefits which they had accrued — though, to be sure, it didn’t take long before they increased the generosity for the earliest recipients to levels beyond what they had accrued by their own contributions. (The Post article above contains some of this history.)

And note that the ceiling in the U.S. is actually much higher than in most other countries. One great resource here is Social Security Programs Throughout the World. In Germany, it’s EUR 71,400. In Sweden, it’s 459,183 kroner, or about $56,000. In France, EUR 37,548.

Of course, even with the ceiling, the benefits formula ensures that there is already a subsidy from higher to lower earners, since pay above the higher “bendpoint” accrues benefits at only a 15% rate, compared to the 90% below the lower bendpoint, and 32% in the middle. (It’s this characteristic of Social Security that means that it’s impossible to give any more than an approximate pay-replacement rate, since it varies by income, and can be anywhere from 82% to 27% of pay at normal retirement age.)

But it strikes me this acceptance of the cap is dying, and that, pretty consistently, the answer from the Left on Social Security’s funding deficit is simply to remove the cap.

Here’s Bernie Sanders’ proposal:

Right now a billionaire pays the same amount of money into Social Security as someone who makes $118,500 a year. That’s because there is a cap on taxable income that goes into the Social Security system.

Sen. Sanders has introduced legislation to end this absurdity, by lifting this cap so that everyone who makes over $250,000 a year pays the same percentage of their income into Social Security as the middle class and working families.

This would not only extend the solvency of Social Security for the next 50 years, but also bring in enough revenue to expand benefits by an average of $65 a month; increase cost-of-living-adjustments; and lift more seniors out of poverty by increasing the minimum benefits paid to low-income seniors.

Not only is this the right thing to do from a moral perspective, it is also what the vast majority of the American people want us to do. 61 percent of the American people support expanding Social Security benefits by lifting the cap on taxable income, according to an NBC News/Wall Street Journal poll earlier this year.

At a time when millions of Americans are working longer hours for lower wages, even as virtually all of the new income in this country is going to the top one percent, Sen. Sanders’ legislation will begin to reduce the obscene level of income inequality in America.

And Hillary Clinton’s:

Social Security must continue to guarantee dignity in retirement for future generations. Hillary understands that there is no way to accomplish that goal without asking the highest-income Americans to pay more, including options to tax some of their income above the current Social Security cap, and taxing some of their income not currently taken into account by the Social Security system.

She also proposes providing earnings credits for years spent out of the workforce as unpaid caregivers, and enhancing widow’s benefits, both of which are noble concerns but involve further subsidies rather than earned benefits.

And here’s Ghilarducci, in How to Retire with Enough Money:

There are many ways to increase Social Security benefits and many easy ways to pay for an expansion. In early 2014, after a seminar in New Orleans, a financial planner (a Republican) told me that assuring Social Security’s future is easy: We just have to eliminate the earnings cap like Medicare has done and the system will be funded indefinitely. (p. 102)

And a recent Vox article proposing a wholly new system, a flat, and very generous 80% of pay replacement, up to $61,884 (the current Social Security upper bendpoint), funds the benefit through such a no-cap flat payroll tax.

What’s more, the new approach by Social Security boosters to talking about the program is to emphasize the idea that it is insurance. That’s not really true: these types of programs are called “social insurance” but they only similar in broad terms to “insurance” as we think of it, as insurance policies that we voluntarily purchase in the private market to cover our homes, our cars, or to provide for our dependents in case of untimely death. But it’s the cornerstone of the new defense of the program: rather than saying, “retirees have earned their benefits,” it’s “everyone contributes because these are essential insurance protections.”

Now, it might seem reasonable to label disability and suvivors’ benefits as “insurance” but not retirement benefits — after all, everyone knows that they’ll retire when they hit 65 or 67, so that it’s not an unforeseen event, but the rationale for calling retirement benefits “insurance” is that it’s protection against the unforeseen event of outliving your assets. Is that disingenuous? The label “social insurance” is widely accepted as a label, but it strikes me as inappropriate to try to push the notion of Social Security as “insurance” equivalent to all other kinds of insurance, too hard.

But here’s what the National Academy of Social Insurance, in A Young Person’s Guide to Social Security, has to say:

Social Security is insurance. Workers pay premiums (the payroll tax) to secure coverage for themselves and their families. And like any insurance, their coverage protects them on the occurrence of a specific event. With Social Security, that event is being no longer able to work. This happens in three instances — old age, disability, and death. As early as age 62, you can claim reduced old-age benefits for yourself, your spouse, and your young children. If you become disabled, you can claim benefits for yourself, your spouse, and young children. And if you die, your spouse and children can claim benefits based on your earnings record.

Insurance exists to protect individuals from risk. What are the risks associated with not being able to work? Poverty. It is the risk that you can end up with nothing, nothing because you made low wages and could never save, nothing because you never had pension or 401(k) benefits through your job, nothing because you were laid off during a recession and had to burn through your savings to make it to the next job, nothing because you became ill and had to stop working, nothing because your child became ill and you had to stop working, or nothing because the company you work for went belly up or the stock market crashed and wiped out half of your 401(k).

That’s a long list of nothings. And some of those “nothings” make it clear that Social Security’s benefits are meant to be there for you even if you weren’t able to “earn” them, that one of the “risks” against which Social Security “insures” is the “risk” of earning low wages over your lifetime.

Megan McArdle, in a recent blog post, repeated the conventional wisdom on the Social Security earnings ceiling:

This [the payroll tax/ceiling] is thought in many quarters to enhance the program’s political support, by making it seem more like an insurance program than like welfare. And judging by the number of people who respond to any attempt to alter the benefit formulas with an indignant claim that they earned those benefits, that strategy is working.

But it strikes me as new that the benefits are being presented as being “deserved” by the mere fact of being employed in America. And the call for benefit enhancements further unrelated to earnings is growing as well.

Perhaps in an era when presidential candidates promise free college for the middle-class, and free parental leave (funded by taxes on the wealthy, instead of, as other countries do it, an earnings-capped Social Security-type program), and daycare subsidies for the middle class, it’s no surprise that there’s growing comfort with treating Social Security as just another program that exists to channel benefits to a defined group of people. Politicians are tapping into the same issues of “fairness” and “making the wealthy pay their fair share” when it comes to Social Security as with any other issue of federal spending and taxation.

So what next? If we get rid of the cap, why not just fund the benefits through general revenues, with the requiste income tax hike, so that all income, not just wage income, is taken into account? If you recall, the Jane Plan does this for the basic-level benefit, while the second-tier benefit is fully-funded with benefits in proportion to contributions, under the rationale that anti-poverty benefits should be funded by all of society, in the same way as other social welfare benefits, but the “middle-class” level benefit is something that should be individually funded. (Recall, too, that the Jane Plan splits out disability and survivors’ benefits into a separate program.)

One could even place a certain rationale for a removed cap by saying that, essentially, Social Security is already this two-tier benefit, thinking of the 32% level as “earned” by the individual workers, and the 90% benefit as “subsidized” by the higher earners.

But that still requires a debate about appropriate tax levels. You can’t boost tax levels on the wealthy to pay for Social Security funding deficits and enhancements, and free college, and parental leave, and daycare subsidies for the middle-class, and a host of other benefits, and, up to now, the Social Security ceiling has served to have a moderating effect on marginal income tax hikes for the wealthy. And, truth be told, I’d rather we improve our provision for the poor, and pay for middle-class entitlements through broad-base tax hikes, as indeed the rest of the world does.

Image: https://commons.wikimedia.org/wiki/File:Social_security_card.gif; originally produced by the Social Security Administration and in the public domain

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