Thursday, April 16, 2009

New paper: “Does It Pay to Work? The Case for Cutting the Social Security Tax for Workers near Retirement”

I have a new Retirement Policy Outlook released by AEI today. The paper, "Does It Pay to Work? The Case for Cutting the Social Security Tax for Workers near Retirement," focuses on the marginal returns paid by Social Security to workers near retirement. The marginal return is the additional benefits earned for an additional dollar of taxes paid, and is a key incentive affecting decisions to continue working or leave the workforce and retire. Here the opening:

Social Security's 12.4 percent tax is the largest paid by most workers and Social Security benefits are the largest income source for most retirees. An individual considering whether to work or retire might ask, "What's in it for me? If I continue to pay into Social Security, how much additional benefit will I receive?" The answer: not much. The typical individual who works for an additional year before retiring will receive only 2.5 cents in additional benefits for each dollar of extra taxes paid to Social Security. This translates to a marginal rate of return of -49.5 percent. One reform to extend working years and enhance income security in retirement would be to reduce or eliminate the payroll tax for individuals above a given age.

Marginal returns are low for men because the Social Security benefit formula counts only their highest 35 years of earnings in calculating benefits; if an additional year of work isn't in the highest 35 – part time work comes to mind – then no additional benefits are received. Marginal returns tend to be low for women due to the presence of spousal benefits, under which a lower-earning spouse receives the higher of her own benefit or half her spouse's benefit. Women who receive auxiliary benefits, as most do, will in general face a -100 percent marginal return for additional taxes paid.

The argument here is that if we want older Americans to remain in the workforce, we need to give them an incentive to do so. The current Social Security benefit formula pays very little extra benefits to people who choose to work longer, which weakens incentives to delay retirement. While a number of different policies could improve marginal returns, I focused here on reducing the payroll tax for older workers. It's an easily understandable way to improve incentives to work and I think is worth considering as part of larger reforms.

This Retirement Policy Outlook is drawn from a longer paper co-authored with David Weaver and Gayle Reznick of the Social Security Administration, which was released by SSA earlier this week. That paper includes all the RPO's information on marginal returns, as well as analysis of lifetime rates of returns and a third measure we call incremental returns. The incremental return looks at the benefits a married person could receive by working, over and above the spousal benefits they would receive based on their spouse's earnings record. For example, a woman who works might receive only a little bit more benefits based on her own earnings record than she would receive if she had not worked and simply collected a spousal benefit. This structure means that most of the taxes she pays over her lifetime don't generate new benefits for her, and thus serve as a disincentive to work. Married women are generally held to be more responsive to tax rates than unmarried women or men, so it can be counterproductive if married women face the highest net tax rates at the margin.


WilliamLarsen said...

In 1935 SS-OASI was used as an inducement for older workers to retire freeing up jobs for younger workers. Looks like we have gone the full circle. Here is a novel idea. If you want to keep older workers working and at the same time allow younger workers the ability to save for retirement, pay for healthcare, college, buy homes and be part of a strong economy, then cut the payroll tax for everyone. The more you cut the payroll tax the larger the real growth will be. No more artificial stimulus.

But back to the premise of cutting the payroll tax for older workers. Again this is artificial stimulus on the economy. Who will pay for this? Do you reduce the benefits these people will get? Keep in mind that the payroll taxes these older workers paid were not set aside to pay their benefits, but were used to pay overly generous benefits to those who were first.

What we have here is a Bernie Madoff scheme, but on a much larger scale.

When will America kick the addiction to Social Security? Just say not to Social Security!

Andrew G. Biggs said...

I'm not sure what an 'artificial stimulus on the economy' is. If people work longer, they produce more. That seems sensible if we can do it.

As I thought of this, you would reduce the tax rate but not reduce their benefits, the reason being that in general people are earning next to no benefits for their additional taxes anyway. So the purpose is to get closer to actuarial neutrality, not to subsidize people of a given age.

Arne said...

You are trying to calculate the return on investment of an insurance premium. The question is absurd, so the answer is absurd. The reasons for continuing to pay the premium are largely independent of the actual premium, so trying to change behaviour with incentives is largely futile.

On top of that, corporate America is providing larger incentives to induce workers to leave the workforce than anything SS can do, so it would be a waste of effort anyway.

Andrew G. Biggs said...

The 'it's insurance' argument is basically a non-argument. Social Security is partly insurance, but partly a mandatory savings plan. The insurance element doesn't imply that you can simply ignore the savings element.

Incentives to leave the workforce exist, but aren't universal. And while buyouts push people out of the labor force, DB pensions have become less bad in doing so. I won't claim that these issues have no effect, but Social Security is a) the largest tax on most workers, and b) the largest income source for most retirees. So to ignore it doesn't make much sense.

Anonymous said...

Social Security is not fair. It is terribly designed. But this article worries about those who will actually see some social security benefit- namely those close to retirement.

What would be the point of granting those with 35 years the opportunity to pay no more tax- so they can still work and spend?

How about instead eliminating payroll tax for all under 35. As full retirement age for them is 70- this will give them 35 years to pay into the system. And it will give them freedom from payroll tax when they most need it- entering the workforce, paying off student loans, trying to save for a house, starting a family, etc.

I have much less sympathy for those that have reached 60 and need to work longer because they have lived a debt-ridden lifestyle than those that are starting out and have to pay for the sins of the prior generation.