Monday, January 12, 2009

Treasury releases Social Security issue brief on work incentives

The Treasury Department released the sixth in its series of issue briefs on Social Security reform, with this final brief focusing on work incentives presented by the Social Security program. It's a fairly long piece that explores the issue in detail and is worth checking out. Here are some of the basics:

  • Social Security imposes a "net tax" on most workers, meaning that they will pay more into the system than they'll receive out of it. This negative "income effect" will tend to encourage people to work more, since their lifetime wealth will be reduced and they'll try to make up for it.
  • However, Social Security also imposes a marginal tax on additional work. This "substitution effect" will discourage people from working, particularly under certain circumstances that are specific to the Social Security benefit formula. For instance,
    • Since the system is progressive, higher earners receive lower marginal returns for additional work;
    • Since benefits are based only on the highest 35 years of earnings, marginal tax rates on work years above 35 years can be very high. This would encourage early retirement.
    • Since the lower-earning member of a married couple can receive spousal benefits equal to 50% of the benefit earned by the higher-earning spouse, the taxes paid by the lower-earning spouse often go to waste. This implies a very high marginal tax rate for lower-earning spouses.

The Treasury brief then goes on to discuss potential reforms to improve incentives to work and delay retirement.

No comments: