New Paper: “Are There Opportunities to Increase Social Security Progressivity despite Underfunding?”

The Tax Policy Center has released a new paper by the Urban Institute's Melissa Favreault and Gordon Mermin titled "Are There Opportunities to Increase Social Security Progressivity despite Underfunding?" Here's the abstract:

This paper reviews why Social Security fails to lift more aged low-wage workers and people of color out of poverty. It examines the payroll tax and benefit formula and reviews literature about OASDI outcomes by race, gender, and earnings level. It describes how mortality, earnings, disability, childbearing, immigration and emigration, and marriage patterns all differ across U.S. racial/ethnic groups, and highlights the importance of these differences for program outcomes. The paper then uses the DYNASIM model to examine lifetime OASDI redistribution under current law and a trust fund-neutral reform package that would enhance system progressivity and improve outcomes for some vulnerable to retirement poverty.

In addition to being a good summary of existing research on who does well and who does poorly under Social Security – and why – Favreault and Mermin present a number of potential reforms to Social Security to reduce poverty among seniors. Definitely worth a read.

Here's my quick take, based on forthcoming work for AEI: while Favreault and Mermin's paper is very good, the emphasis on whether Social Security should be more or less progressive actually misses the point a bit. The problem Social Security faces is that it isn't consistently progressive, meaning that there is too much disparity in treatment among people with the same lifetime earnings. Poor people get higher average replacement rates than higher income people, but that average hides a lot of disparity: many poor folks do really well, but a lot also do pretty poorly. The reason, as Favreault and Mermin point out, is that Social Security redistributes based on a lot of factors other than the person's lifetime earnings. (E.g., length of marriage, relative earnings between spouses, length of working career, etc.)

The chart below illustrates. As can be seen, average replacement rates decline as lifetime earnings increase – this shows that Social Security is generally progressive. However, the distribution of replacement rates at any given level of lifetime earnings can be pretty wide, especially for low earners. Some do really well, others do pretty poorly.

If Social Security is to be successful as social insurance, it needs to pay off consistently. There are a number of ways, including those discussed by Favreault and Mermin, to improve the targeting of Social Security benefits by earnings level. If Social Security's progressivity were better targeted, the same amount of average progressivity could produce better protections for low earners in old age.

Update: An anonymous commenter asks, "The problem you note may be related to the disparate way benefit formulas apply to couples in general. The chart would probably look more equitable for wage earners only. Is the way we treat couples still as relevant as it was in the 1930's?"

It's a logical point but turns out not to be the case. Social Security benefits are better targeted at a household level than an individual level. The chart below differs a bit from the one above (it shows data points rather than interquartile ranges), but the dispersion in replacement rates by lifetime earnings is significantly higher at the individual than the household level.

One way to look at is to measure the R-squared values of a regression of replacement rates on lifetime earnings. At the household level the R-squared value is around 0.55, which indicates that around 55% of differences in replacement rates can be accounted for by differences in lifetime earnings. (Given that Social Security is designed to redistribute by lifetime eranings, this strikes me as a lower value than you'd want.) At the individual level, however, the R-squared is only around 0.3; this indicates that 70 percent of differences in replacement rates between indivduals are due to things other than differences in their lifetime eranings. This again strikes me as very haphazard given that we're trying to target low earners.