Brown: “Why Do We Fund Social Security Differently From Other Government Programs?”

University of Illinois economist Jeffrey Brown, writing in Forbes, asks why we fund Social Security through a dedicated payroll tax while most other government programs are supported mostly from income tax revenues. The answer, he says, isn’t economics as much as politics:

The political rationale for using the payroll tax traces back to the program’s origins.  President Franklin Roosevelt famously quipped:

“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.”

In short, FDR designed the payroll tax system to ensure its political sustainability.  Were it viewed as just another social welfare program, it would be forced to compete more directly with other programs for scarce public resources.  Instead, Social Security was structured to have the look and feel of an insurance contract that establishes a “legal, moral and political right” to receive benefits in the future.  It is fair to say that the fierce political resistance to cutting Social Security benefits is evidence that President Roosevelt knew exactly what he was doing.

Click here to read the whole article, which is very interesting.

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Blahous: “Rubio’s Retirement Security Vision.”

Over at e21, Chuck Blahous – a scholar at the Mercatus Center and one of Social Security’s public trustees – summarizes and discusses Sen. Marco Rubio’s recent proposals to increase retirement security and improve Social Security’s finances. Blahous writes:

Under current law, federal entitlement programs affecting seniors promise far more than they can deliver.  This unsustainable imbalance presents elected officials with a choice; they can either curry political favor with seniors’ groups by promising to defend benefit promises that they know cannot be honored, or they can accept the political risks associated with designing the changes required for these programs to benefit younger generations as well. Which choice an elected official makes can often be inferred by whether they speak primarily in terms of what they would not change about these programs, or in terms of the reforms they support.

Too few elected officials on both left and right make Senator Rubio’s choice to propose needed reforms, even though it is widely understood that continuing the status quo would lead to financial disaster. Perhaps the most significant aspect of the Rubio speech is his decision to lead with specific proposals in this critical policy area. 

Check out the whole article here.

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Dem Sens Introduce “Retirement and Income Security Enhancements Act.”

Democratic Sens. Patty Murray (WA) and Mark Begich (AK) have introduced the “Retirement and Income Security Enhancements Act,” the acronym for which comes out to – you guessed it – RAISE.

SSA’s Office of the Chief Actuary has posted their analysis of the bill. The following bullet points taken from the OACT memo give the policy highlights:

• Allow divorced individuals to receive benefits based on the former spouse’s earnings after 5 years of marriage (at a reduced rate), rather than 10 years under current law.
• Make survivors’ benefits equal 75 percent of the former couple’s total benefit, rather than 50-66 percent as under current law.
• Allow children of deceased or disabled worker to collect benefits through age 23, rather the current age of 18.
• Apply a 4-percent surtax on earnings above $400,000, coupled with a nominal benefit increase in exchange for these higher taxes.

My thoughts: The first two provision are pretty decent, targeted ways to increase benefits. I’ve experimented with lowering the marriage threshold for receiving divorced spouse benefits and it hits low earners pretty effectively, though the rationale for paying a lifetime of benefits based on a marriage of five years is obviously pretty thin. Increasing spousal benefits also makes sense and is a staple of many reform proposals. I don’t have strong feelings one way or the other about extending child benefits, with the (again fairly obvious) point that, at age 23, you’re not exactly a child anymore.

With regard to the surtaxes on high earners, I would make this (I think) pretty important point: the same tax increase can only pay for one thing. Then-Sen. Barack Obama proposed a similar “donut hole” tax increase back in 2008. I wasn’t a fan, but at least Sen. Obama would have used the proceeds to extend Social Security’s solvency.

Now, in fairly typical manner, that same tax increase has been harnessed to increase benefits rather than fill the $10 financing hole Social Security is looking at. More specifically, the Murray-Begich plan would come close to tapping out high earners for tax increases while reducing Social Security’s long-term financing gap by a whopping 3.6 percent.

Sure, it would help some people but what do Sens. Murray and Begich propose we do to make Social Security solvent for everyone?

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New research papers from Sylvester Schieber and Gaobo Pang

Both articles are well worth the read:

Pang, Gaobo and Schieber, Sylvester J., American Workers’ Retirement Income Security Prospects: A Critique of Recent Assessments (April 10, 2014). Available at SSRN: http://ssrn.com/abstract=2433193

Pang, Gaobo and Schieber, Sylvester J., Understanding Social Security's Income Replacement Measurements (April 30, 2014). Available at SSRN: http://ssrn.com/abstract=2433181

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New papers from the Social Science Research Network

SOCIAL SECURITY, PENSIONS & RETIREMENT INCOME eJOURNAL

"The Macroeconomics of PAYG Pension Schemes in an Aging Society"

LIONEL ARTIGE, University of Liege - HEC Management School
Email: lionel.artige@ulg.ac.be
LAURENT CAVENAILE, New York University (NYU) - Department of Economics
Email: laurent.cavenaile@gmail.com
PIERRE PESTIEAU, University of Liege - Research Center on Public and Population Economics, Centre for Economic Policy Research (CEPR), CESifo (Center for Economic Studies and Ifo Institute), Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE)
Email: p.pestieau@ulg.ac.be

This paper analyzes and compares the macroeconomic performance of defined-benefit and defined-contribution pay-as-you-go pension systems when population ages. When the fertility rate decreases or longevity rises, it is shown that a shift from defined benefit (defined total benefit or defined annuities) to defined contribution always results in higher per-capita income and life-cycle welfare at the steady state. All results are derived with general production and utility functions.

"State Fiscal Constitutions and the Law and Politics of Public Pensions"
University of Illinois Law Review, Forthcoming
Minnesota Legal Studies Research Paper No. 14-24

AMY MONAHAN, University of Minnesota - Twin Cities - School of Law
Email: monahan@umn.edu

Pension plans for state and local employees are, as a whole, significantly underfunded. This underfunding creates intense fiscal pressure on governments and often either crowds out other desired governmental spending or results in employees and retirees losing earned benefits. Political theorists often explain that underfunded public pension plans are all but inevitable given the political realities that affect funding decisions. Politicians who desire to be reelected should rationally prefer to spend money on current constituents, rather than commit scarce funds to a pension plan to pay benefits due to workers decades in the future. These dynamics are exacerbated by existing state fiscal constitutions that require balanced budgets and often restrict the ability to raise taxes. Paying a pension plan less than the amount due provides an easy way to free up money in the state budget by creating a form of debt that is not reflected on the state’s balance sheet. This article presents original analysis of the effect that state fiscal constitutions – even those that contain explicit requirements to fund public pension plans – impact public pension funding dynamics. It finds that even where explicit constitutional funding requirements are in place, plans often continue to be underfunded both because of political and financial pressures, and also because of the distinct lack of an enforcement mechanism. The article concludes by suggesting that these weakness in pension funding requirements can be addressed through the creation of clear and objective funding standards and, most importantly, through the creation of enforcement mechanisms that can, where appropriate, override legislative decisions to underfund public pension plans.

"'Social Insurance,' Risk Spreading, and Redistribution"
Daniel Schwarcz and Peter Siegelman, eds., Research Handbook in the Law and Economics of Insurance (Edward Elgar, Forthcoming)

JAMES KWAK, University of Connecticut - School of Law
Email: jamesykwak@gmail.com

Social Security, Medicare, unemployment insurance, and a poorly defined group of similar programs are often called “social insurance.” Social insurance is most often thought of as (a) insurance schemes in which workers make payroll tax contributions and receive benefits following certain insured events or (b) government responses to failures in private insurance markets. Both of these conceptualizations, however, fail to accurately describe some of the programs that are generally considered as social insurance. In this paper, I show that these programs have the following property: in the short term, they are clearly redistributive because we know the relevant outcomes and therefore who will make contributions and who will receive benefits; but in the long term (over one’s lifetime), they spread risk because we do not know what outcomes will occur and therefore who will benefit from the insurance they provide. I propose a new conceptualization of social insurance as government interventions in insurance markets that are redistributive in the short term but that, seen from a lifetime perspective, most people would choose to participate in because of their insurance value. At the margins, it is difficult to define the limits of social insurance. At one extreme, government regulation of automobile liability insurance and individual health insurance imposes risk spreading and redistribution that would not occur in a private market; at the other, public assistance programs such as Medicaid have insurance value for people who do not know what income category they will fall in. The definition of social insurance will always be politically contested because there is no clearly correct timeframe to use when evaluating these programs; proponents can frame social insurance as long-term insurance that benefits most participants, while opponents can frame it as naked redistribution from “makers” to “takers,” without either being obviously wrong.

"A Value-Based Approach to the Redesign of US State Pension Plans"

ZINA LEKNIUTE, Tilburg University
Email: Z.Lekniute@uvt.nl
ROEL M. W. J. BEETSMA, University of Amsterdam - Research Institute in Economics & Econometrics (RESAM), Centre for Economic Policy Research (CEPR), CESifo (Center for Economic Studies and Ifo Institute), Tinbergen Institute - Tinbergen Institute Amsterdam (TIA), Netspar
Email: r.m.w.j.beetsma@uva.nl
EDUARD H.M. PONDS, Algemene Pensioen Groep (APG), Tilburg University - Department of Economics, Netspar, Tilburg University - Center for Economic Research (CentER)
Email: eduard.ponds@apg.nl

This paper explores the financial sustainability of a typical U.S. state defined benefit pension fund under the continuation of current policies and under alternative policies, such as changes in contribution, indexation and investment allocation policies. We explore the "classic" asset-liability management (ALM) results, which indicate that a policy of conditional indexation may substantially improve the financial position of the fund. We also investigate the value-based ALM results, which provide a market-based evaluation of the net benefit changes to the various stakeholders of changes in the fund's policies. All cohorts of participants derive a substantial net benefit from the current pension contract, implying that tax payers have to make substantial contributions. The aforementioned adjustment measures can be instrumental in alleviating the burden on the tax payer, although this will happen at the cost of a reduction in the value of the contract to the fund participants.

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2014 Retirement Research Consortium Meeting

The 2014 RRC Meeting will be held on August 7-8, 2014 at the National Press Club in Washington, DC.

Click here to register and to view the agenda.

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Kotlikoff: Why Social Security Lowballs Benefit Estimates

PBS has a nice story featuring Boston University economist Larry Kotlikoff on the benefit estimates that are provided to working-age individuals through the Social Security Statement.

The Social Security Administration’s benefit online calculators aren’t to be trusted for use for people under age 60, even for someone who is single and was never married and will never marry. The reason is that unless you change their assumptions, they assume (in contradiction to the Social Security Trustees’ Report’s own assumptions) that the economy will experience zero economy-wide average real wage growth and zero inflation between now and the end of time. That’s an odd assumption for an economy that’s experienced positive average real wage growth rates as well as inflation for each of almost all the postwar years.

There’s another way to understand the issue, which I’ve outlined in a Christian Science Monitor op-ed and a longer research piece for RAND. In this reading, which is mathematically equivalent to what Kotlikoff describes, the SSA estimates benefits using reasonable assumptions regarding wage growth and inflation and generates a decent estimate of the nominal benefits a person will be entitled to.

But the SSA then indexes that future benefit to the present using, not the Consumer Price Index, but the Average Wage Index. So while SSA sometimes claims that benefit estimates are in today’s dollars, or adjusted for the cost of living, they’re actually not.

The scale of the difference is meaningful. For instance, a typical worker retiring 30 years from today will receive a nominal Social Security benefit of about $64,750 per year. Adjusted for inflation, that future benefit will be $27,683 in today’s dollars. But that’s not the figure he’ll see on his Social Security Statement. Rather, because the SSA wage-indexes his future benefits, the figure he would see on his Statement will be just $17,982, which is 35 percent lower than the true purchasing power of his benefits is expected to be.

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How would taxing health coverage affect Social Security revenues and benefits?

Many health analysts believe that exempting employer-provided health coverage from taxation encourages overspending on health care, as well as depriving the federal budget of revenue.

Some have proposed making health coverage subject to social security payroll taxes; that is, health coverage would count as earned income when it is provided, and so workers would pay taxes on it. Health coverage also would count as earnings when benefits are calculated, so benefits would increase as well.

The Tax Policy Center’s Howard Gleckman reviews new research from the Urban Institute’s Eric Toder and Karen Smith. Read the whole piece, but here’s Gleckman’s bottom line:

Eliminating the tax preference for employer-sponsored insurance would improve the government’s overall financial condition as well as the health of the Social Security trust fund. But the increase in Social Security benefits would affect different earnings groups in very complicated ways. And while the Social Security Trust Fund would be strengthened by higher payroll taxes, that improvement would be mitigated by an increase in benefits.

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New papers from the Social Science Research Network

"What Impact Does Social Security Have on the Use of Public Assistance Programs Among the Elderly?"
CRR WP 2014-5

NORMA B. COE, University of Washington - Department of Health Services, Boston College - Center for Retirement Research
Email: nbcoe@uw.edu
APRIL YANYUAN WU, Boston College - Center for Retirement Research
Email: wuuv@bc.edu

Low take-up by elderly Americans in most means-tested federal programs is a persistent and puzzling phenomenon. This paper seeks to measure the causal effect of the benefit levels on elderly enrollment in two public assistance programs – the Supplemental Nutrition Assistance Program (SNAP) and the Supplemental Security Income (SSI) program – by using the variation in SNAP and SSI eligibility and benefit levels introduced by Social Security retirement benefits. Our findings are three-fold. First, the low take-up among the elderly is not driven by changes in the composition of the eligible pool: individuals who become eligible as they age exhibit average take-up patterns that are similar to those who were eligible before reaching Social Security benefit claiming ages. Second, Social Security has a significant impact on the use of public assistance programs among the elderly, because the increase in income decreases the potential benefits available from public programs. Third, we estimate different behavioral responses to SNAP and SSI programs: a $100 increase in SSI benefits leads to a 4-6-percentage-point increase in the probability of taking up SSI, but we are unable to estimate consistent results on how benefits impact the take up for SNAP. Together with the fact that eligible individuals who begin receiving Social Security benefits continue to participate in SSI more often than they maintain SNAP enrollment, we posit that the different estimated behavioral responses could be due to individual preferences for cash over in-kind transfers.

"Differential Mortality and Retirement Benefits in the Health and Retirement Study"

BARRY BOSWORTH, Brookings Institution - Economic Studies Program
Email: bbosworth@brookings.edu
KATHLEEN BURKE, Brookings Institution
Email: Kathleen.BURKE@cec.eu.int

This analysis uses data from the Health and Retirement Study (HRS) to examine the sources of variation in mortality for individuals of varying socioeconomic status. The use of the HRS allows a distinction between education and a measure of career earnings as primary determinants of socioeconomic status for men and women separately. We use those predictions of mortality to estimate the distribution of annual and lifetime Old Age, Survivors, and Disability Insurance benefits for different birth cohorts spanning the birth years from 1900 to 1950. We find differential rates of mortality have had substantial effects in altering the distribution of lifetime benefits in favor of higher income individuals.

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