Wednesday, October 14, 2015

New paper: “Social Security Replacement Rates”

WASHINGTON, DC – The Senate Budget Committee today released its October 6, 2015, issue of the Budget Bulletin focused on Social Security replacement rates. The Budget Bulletin provides regular expert articles by Senate Budget Committee analysts on the issues before Congress relating to the budget, deficits, debt, and the economy.

Read the full Senate Budget Bulletin here.

Excerpts follow:

Social Security Replacement Rates

Social Security provides monthly cash benefits to retired and disabled workers, as well as their eligible spouses, dependents, and survivors. The current benefit formula, enacted by Congress in 1977, was first applied to individuals born in 1917, who turned 62 in 1979. To evaluate the adequacy and equity of this formula, benefits are often compared with wages. The ratio of benefits to wages, known as the replacement rate, reflects the extent to which benefits replace the wages lost due to retirement, disability, or death. The higher the ratio, the easier it is for workers to maintain their standard of living after they become eligible for benefits.

Replacement rates provide a useful way to assess the relative value of benefits, provided they are presented in a clear and consistent manner. These rates as typically presented by the Social Security Administration (SSA), however, have been subject to criticism focused on SSA’s use of career-average, wage-indexed earnings as the denominator in their calculations, resulting in the rates’ removal from the 2014 and 2015 annual Social Security trustees’ reports.

The Social Security disability trust fund will be insolvent by the end of next year. The retirement and survivor trust fund will be insolvent in less than two decades. While that might seem like plenty of time to solve the problem, it all depends on which path the federal government chooses to take. Some solutions are more time-sensitive than others.

The public deserves the opportunity to consider all the options to address Social Security’s pending insolvency while there is still time to make a difference. And careful consideration starts with a better understanding of replacement rates and their public policy implications.

1 comment:

WilliamLarsen said...

I rather enjoyed the article. It was well written and explained the difference in the approach of looking at social security.

“On the one hand, the decision to provide constant replacement rates at constant AWI-relative wages reflects the view that benefits should increase with the nation’s standard of living. This view holds that despite a rising standard of living, future workers should rely more on Social Security and less on their own savings and investments when retired.

On the other hand, the decision to provide constant replacement rates at constant real wages reflects the view that a progressive system should not provide higher real benefits to those with higher real wages. This view holds that due to a rising standard of living, future workers will be able to save and invest more for their own retirement, and thus be less reliant on Social Security.“

More than two decades ago I ran this calculation based on increased wages, increasing the bend points and thus determined very easily that as wages increased, so did benefits. The replacement rate of benefits to the initial Average Wage at age 60 was the same ratio across all age groups. I did not have a catchy name for it “constant replacement rates at constant AWI-relative wages.” I did not get into why the 1977 formula was created that way, but simply based my computer model on the formula enacted into law.

My only thought in 1984 was that the formula seemed to be fair across cohorts as long as the payroll tax remained constant. If payroll tax increased, then the cost of benefits for those cohorts increased (their rate of return or the value of OASI decreased).

“Provide constant replacement rates for workers who earn the same AWI-relative wages, regardless of how high their real wages grow. Consequently, future taxes would be higher than in the past or present.” ,

Of course my computer model clearly showed that the 1977 benefit formula to be divergent. As wages increased, so did future benefits and thus the requirement for higher payroll taxes to fund them. Of course if wages were stagnant the rate of change in the growth of future benefits slowed and the payroll tax might be too high relative to the benefits. Clearly congress when they passed the 1977 benefit formula never bothered to check if both sides of the equation balanced (equaled) costs <= revenue

It clears up why many who choose the “constant replacement rates at constant real wages” view differ so much from mine and why they believe higher payroll taxes can be supported due to higher wages. The problem is that this is nothing but a new tax on the standard of living. In essence we will tax the future to pay for the current benefits today.