Wash Post: Obama Knocks McCain on Social Security

From the Post's On the Trail blog:

GRESHAM, Ore. Sen. Barack Obama came to a senior citizens center here to discuss the squeeze faced by middle-class retirees and reiterate his longstanding proposal to eliminate income taxes for any senior making less than $50,000 per year.

The proposal came as the Illinois senator continued to focus his intentions not on Sen. Hillary Rodham Clinton, his rival in a Democratic primary contest in Oregon Tuesday, but instead on Republican Sen. John McCain.

Obama has spent the past week seeking to tie McCain to President Bush and foregrounding the differences between Obama's views and McCain's on a range of issues, including foreign policy, rural and farm issues, manufacturing jobs, energy reform and health care.

In an hour-long forum with about 50 seniors, Obama turned his attention to the financial pressures facing those in retirement, which he said is something people are "most worried about."

"That American dream feels like it's slipping away," he said.

The senator laid out a plan to "adjust the cap on the payroll tax so that people like me pay a little bit more and people in need are protected. That way we can extend the promise of Social Security without shifting the burden onto seniors." He said the plan would include "a donut hole" to make sure that the change did not "ensnare" middle class Americans.

He also suggested eliminating income taxes for any retiree making less than $50,000 per year.

Obama said his approach differed sharply from that of McCain, who "has already said that he supports private accounts for Social Security -- in his words, 'along the lines that President Bush proposed.'"

"Let me be clear: privatizing Social Security was a bad idea when George W. Bush proposed it. It's a bad idea today. It would cost a trillion dollars to implement at the front end, and would put the retirement plans of millions of Americans at risk on a volatile Wall Street," Obama said. "That's why I stood up against this plan in the Senate, and that's why I won't stand for it as president."

Tucker Bounds, a McCain spokesman, responded to Obama's Oregon remarks this afternoon, saying "Barack Obama's response to our slowing economy is to raise taxes on job creating investment. His response to high gas prices is to raise taxes on oil."

"With his lack of experience, it should be no surprise that Barack Obama's response to the problems facing Social Security is to raise Social Security taxes, while making mis-informed partisan attacks," Bounds said. "His proposal for billions upon billions in tax increases on Social Security is just another example of his weak economic judgment. John McCain has been clear about his belief that we must fix Social Security for future generations and keep our promise to today's retirees, but raising taxes should not be the answer to every problem."

Not much of substance to add here, except a couple quick points:

• First, Obama's plan -- even excepting the reduction in income taxes on retirement benefits -- wouldn't come close to saving Social Security. He's still further along than McCain, who hasn't endorsed anything specific yet, though he has stated he'd focus on holding back on benefit growth;
• Second, the question of whether to have personal accounts isn't related to solvency. Rather, it's about how to spread the costs of solvency over time -- accounts, if properly structured, can set aside money today to ease burdens on future generations -- and the costs and benefits of allowing low-income workers to diversify their retirement portfolio to include stocks and bonds.

Read more!

John McCain on Social Security

Courtesy of The Wonk Room, which takes a decidedly negative view of McCain's staement, is a short passage on Social Security reform from, of all places, the Regis and Kelly show:

MCCAIN: What should be partisan about the fact that Social Security is going to go broke? I mean, should we be divided up among Republican and Democrat…

REGIS: Do you have a plan?

MCCAIN: Yes, sir. It’s gonna require, though, cooperation and participation by the other side. And I’ll reach my hand out…

REGIS: Is it privatization of the Social Security program?

MCCAIN: No, no it isn’t. But I would say that I support…I’d put everything on the table to start with…but second of all…young workers ought to be able to put part of their salary, part of their taxes into Social Security, into an account with their name on it. But that would not in any way effect older workers. But you’ve got to have a negotiation.

The running question underlying this and previous statements from McCain and his campaign is whether he supports so-called "carve out" accounts funded from the payroll tax or "add-on" accounts funded with additional contributions.

Here is the McCain campaign's "official" position on Social Security reform:

Reform Social Security: John McCain will fight to save the future of Social Security and believes that we may meet our obligations to the retirees of today and the future without raising taxes. John McCain supports supplementing the current Social Security system with personal accounts -- but not as a substitute for addressing benefit promises that cannot be kept. John McCain will reach across the aisle, but if the Democrats do not act, he will. No problem is in more need of honesty than the looming financial challenges of entitlement programs. Americans have the right to know the truth and John McCain will not leave office without fixing the problems that threatens our future prosperity and power.

This statement talks about accounts "supplementing" traditional Social Security benefits, which some have take as implying an add-on account, while today's statement seems to point toward a carve-out.

I suspect the true answer is that the "add-on vs carve-out" question hasn't really been decided, and at this point there probably isn't too much need to. Social Security reform will ultimately be a negotiated settlement between the parties, so what matters most will be the reform package, not the individual provisions. Read more!

New paper: Have People Delayed Claiming Retirement Benefits?

CBO released a working paper (available here) by two of my very talented former SSA colleagues, Jae Song of Social Security's Office of Retirement and Disability Policy and Joyce Manchester, now of the Congressional Budget Office.

Here's the abstract:

Two changes have been made recently to rules governing the Social Security program: the retirement earnings test was eliminated in 2000 for people aged 65–69, and the full retirement age (FRA) for people born in 1938 or later was scheduled to gradually increase in two-month increments until reaching age 67. This paper examines changes in the age at which people claim Social Security retirement benefits in response to those changes. Data come from a 1 percent sample of administrative data from the Social Security Administration for 1997 to 2007.

Descriptive and regression analyses show that the largest effect of eliminating the earnings test in 2000 occurs at age 65. At that age, the proportion of people who claim retirement benefits increases by 4.6 percentage points among men and 2.4 percentage points among women. In addition, eliminating the earnings test significantly increases—by more than 20 percent—the benefit entitlement hazard for those turning the FRA (that is, the percentage of people who are newly entitled in a given year among those who are fully insured but were not previously entitled). Moreover, the response to the gradual increase in the FRA occurs not only among those who are close to the FRA but also among those who are close to the early retirement age.

Read more!

Obama's Faulty Tax Argument

I have an article in today's Wall Street Journal:

As the presidential campaign heats up, a key issue is whether to extend the 2001 and 2003 income tax cuts, which expire in 2011. John McCain wants to make the tax cuts permanent. Barack Obama and Hillary Clinton want to let the rates rise.

Opponents of the tax cuts point to spending programs that could be financed by the extra revenues. Chief among these is Social Security. Sen. Obama's Web site, for example, argues that "extending the Bush tax cuts will cost three times as much as what is needed to fix Social Security's solvency over the next 75 years."

Such statements imply that if we return to the seemingly modest tax rates of the 1990s, we could fund the $4.3 trillion Social Security deficit, and so much more. As Mr. Obama recently told Fox News, "I would roll back the Bush tax cuts on the wealthiest Americans back to the level they were under Bill Clinton, when I don't remember rich people feeling oppressed."

This argument seems compelling, but it is misguided. In reality, repealing the tax cuts would raise taxes far above Clinton-era levels. Due to quirks in the tax code, average taxes would be almost 25% higher than during the 1990s.

Mr. Obama's claim that the lost revenue from the income-tax cuts exceeds the Social Security shortfall derives from an analysis by the Center on Budget and Policy Priorities. The Center's conclusions have been widely cited, but rely on dubious assumptions.

The basic methodology is simple: Compare the income-tax revenues if the tax cuts expire to revenues if the tax cuts are extended. The Center measures the difference in revenue 10 years from now – to match the government's 10-year budget measurement period – then extends the difference over 75 years to make it comparable to the 75-year Social Security shortfall.

To account for the effects of inflation and economic growth, analysts compare tax revenues to the size of the economy. The Congressional Budget Office projects that if the tax cuts expire, income-tax receipts in 2018 will be 1.5% higher relative to gross domestic product than if the cuts are made permanent. By comparison, Social Security's 75-year shortfall is just 0.6% of GDP.

So Social Security is a costly problem, but the tax cuts cost much more. Open and shut case, right?

Not exactly. Tax revenues would skyrocket if the tax cuts expire, due to "bracket creep." Average incomes are higher today than in the 1990s, but income-tax brackets aren't adjusted for the growth of earnings. As a result, Americans will shift into higher tax brackets and pay a greater share of their incomes in taxes.

Going back to the tax rates of the 1990s doesn't mean that households will pay 1990s taxes. Because the tax brackets haven't risen along with incomes, average taxes would be significantly higher, and grow each year.

If the tax cuts expire, income-tax revenues by 2018 will rise to 10.8% of the total economy from 8.7% today – an increase of 24%. Compared to the average over the last 50 years, allowing the rates to rise would increase tax revenues by 32%.

Believe it or not, income taxes will rise even if the tax cuts remain in place, because the revenue-increasing effects of bracket creep more than offset the lower rates. With the lower rates, total income-tax revenues will increase to 9.3% of GDP by 2018. This level is 7% higher than today, and 13% above the 1957-2007 average. Thus even with the tax cuts, revenues will increase by more than enough to fix Social Security.

So even if the tax cuts are made permanent, future Americans will pay a greater share of their incomes to the government than in the past. But for some in Washington, that's not enough.

Not surprisingly, neither party highlights these rising tax receipts. They undercut liberal arguments that the government is starved of revenue. And they render conservative claims for the tax cuts unimpressive. ("Vote GOP: A smaller tax increase than the other guys!")

The next president will face difficult choices regarding how much to collect in taxes, and how much to spend on entitlements like Social Security. Future citizens may decide that paying higher taxes is worthwhile. But in any event, the misleading tax cuts vs. Social Security argument should not guide policy makers on this issue.

Mr. Biggs, a resident scholar at the American Enterprise Institute in Washington, D.C., is the former principal deputy commissioner at the Social Security Administration.

The basic story is that the actual tax you pay is a function both of the tax rates (10%, 15%, etc.) and the tax brackets, that is, the dollar values determining to what income each rate applies. Since the brackets are indexed only to inflation while incomes tend to rise faster than inflation, taxes will tend to rise as a percentage of income. There are two ways this can happen: first, you may shift into a higher tax bracket. And second, even if you don't shift brackets, a greater portion of your income will be in the highest bracket to which you are subject, and so your average tax rate will rise even if your marginal rate does not. The tax cuts vs Social Security argument focuses only on the rates, not the brackets, and in this way is misleading.

Read more!

(Bad) Idea of the Day: Eliminate the Employer Social Security Payroll Tax Cap

The Center for American Progress puts forward a new idea for Social Security financing:

We propose eliminating the payroll tax cap on the employer side to make businesses pay Social Security taxes on all of the income of the highest paid employers, just like they do for those earning less than $97,500. This is the fairest way to help shore up the finances of Social Security. This change would impact the taxes that businesses pay for only the top 6.5 percent of earners (couples and individuals), yet would yield significant additional revenue to reduce the deficit and bring the Social Security system closer to solvency.

According to the Social Security and Medicare Board of Trustees, the long range, 75-year actuarial deficit is equal to 1.95 percent of taxable payroll. Eliminating the cap on both the employer and employee side would be more than enough to bring the system into long-range balance. Removing the cap on the employer side would thus go a long ways toward restoring solvency as well as help ensure greater progressivity and fairness in the payroll tax.

This idea seemingly has political merit, since it would ostensibly hit businesses (who don’t vote) rather than individuals (who do). But it’s worth thinking how this would play out in practice. To understand that, consider two things:

First, in a competitive economy an employee is compensated according to his contributions to the business (technically, the marginal product of his labor). If he is paid more than he contributes, the firm goes out of business; if he is paid less, he will be lured away by a competing firm. Second, the firm cares about the employee’s total compensation, not about how compensation is divided into salary, health benefits, pension contributions or payroll tax contributions on the employee’s behalf. The employee may care, but the employer focuses on the total amount.

Given these facts, what happens if the employer share of the payroll tax is increased? The employer simply reduces other parts of the employee’s compensation to make up for it. Let’s say a given employee receives $200,000 in salary, $20,000 in health and pension contributions, and $6,200 in Social Security payroll tax contributions, for a total of $226,200. If the $100,000 cap on payroll taxes is eliminated, the employer’s contribution will rise from $6,200 to $12,400. Our best guess is that the worker’s salary and benefits will be reduced by the amount of the tax increase, in order to maintain total compensation at $226,200. Why? Because that’s how much the employee is worth to the firm. Is this always true? Of course not, but it’s the best approximation of what would take place in practice.

For this reason, it’s the standard practice of government agencies such as CBO and SSA to attribute the employer share of the payroll tax to employees. So increasing the employer share has no merit different from increasing the employee share, and potentially less because of the lack of transparency involved.

However, raising the tax cap on employers would have one effect distinct from increasing the employee tax cap: it would tend to reduce non-Social Security tax revenues. Employees pay both state and federal income taxes on the wages that are taxed for Social Security purposes. However, if their wages are reduced by their employers to cover the employers’ increase payroll tax obligations, those wages would no longer be subject to state/federal income taxes. If the marginal tax rate for high earners is in the range of 35-40%, the total revenue raised by this plan could be substantially lower than the static projection based on Social Security taxes alone.

Overall, if the folks at the CAP want to increase the tax cap, they should probably focus on employees or both employees and employers; focusing on employers only isn't particularly good policy.

As an aside, there is one instance in which the cap on employer taxes has already been lifted: for individuals with multiple jobs. Individual wages subject to Social Security taxes are capped at $102,000; if an individual has multiple jobs, each earning under the cap, he may end up paying Social Security taxes on more than $102,000 in earnings. At the end of the year, however, he can claim these excess taxes back on his tax return. His employers, however, cannot do so. Read more!

Entitlement reform event with Sens. Conrad and Gregg

On May 12 from 3-5 p.m. the Woodrow Wilson International Center for Scholars in Washington DC will hold an event entitled "The Seniors’ Entitlement Crunch: The Politics of Social Security and Medicare Reform," featuring Sen. Kent Conrad (D-N.D.), Chairman, Senate Budget Committee; Sen. Judd Gregg (R-N.H.), Ranking Republican, Senate Budget Committee; Asst. Prof. Kimberly J. Morgan Dept. of Political Science, George Washington University; Julie Rovner, Health Correspondent, NPR & Congress Daily.

Here's the event description:

When the next President and new Congress take office next January, they will face a critical issue that has not been addressed in either the current presidential campaign or the congressional budget resolutions, and that is how to deal with the impending insolvencies of the Medicare and Social Security Trust Funds in the next decade. The top two senators on the Senate Budget Committee have cosponsored legislation to deal with the problem early in the next Congress by acting on the recommendations of a bipartisan commission of House Members, senators, and administration officials that would be created and mandated to report findings next January. Similar bipartisan process approaches have been introduced in both houses of Congress and proposed by prominent economists of various political stripes. Will the political will exist to address this long festering fiscal fissure? This forum will explore these vital economic security and political issues.

You can RSVP here; a webcast will be available here. Read more!

Met Life Social Security Claiming Age Calculator

Met Life has released an online calculator to help people determine the best age at which to claim Social Security benefits. This is obviously a step in the right direction, given how many people choose to claim at 62, the earliest age at which retirement benefits available. As best I can tell, the underlying approach is taken from SSA's own retirement calculators, though Met Life tweaks it with gender specific life expectancies and a generally snazzier interface (including Snoopy).

In short, the user inputs their age, earnings and gender, and the calculator estimates their benefits and life expectancies at different ages. Users compare claiming benefits at age 62 with claiming at some higher wage (say, the normal retirement age or age 70). The calculator then calculates the break-even age -- the age at which total benefits received are equal between the two claiming ages -- and the probability of the user surviving to the break-even age.

That said, and as much as I'm reluctant to criticize something which attempts to move in the right direction, there are a couple problems with the Met Life calculator.

First, if you're going to do a break-even analysis, total benefits should be calculated as a present value, meaning that the interest value of benefits is included, rather than simply summing benefits received in multiple years. Granted, SSA also simply adds up benefits, but this is wrong; no economist or actuary would do it this way.

Second, the break-even age approach isn't really the best way to choose a retirement age. Choosing your retirement age isn't a game in which you try to maximize lifetime benefits. Rather, you should retire at an age that provides you with an adequate income. Imagine, for instance, that you could maximize your lifetime Social Security benefits by claiming at age 62, but that your benefit at 62 would be below the poverty line. Would it make sense to claim then, or delay a few years to receive a higher benefit? Common sense says to delay, if you are able, but the considerations of benefit adequacy aren't accounted for in break-even exercises.

Third, the calculator doesn't take into account the annuity value of Social Security benefits. Retirement benefits are paid as an annuity, meaning that they last as long as you live. Annuities are very valuable compared to lump sums since they insure against the chance of outliving your assets. (So much so that even groups with below-average life expectancies, like black males, benefit from the Social Security annuity. See here.) By delaying claiming benefits, you're essentially "buying" more of the Social Security annuity. The insurance value of an annuity is hard to represent in an online tool, but it's worth bearing in mind research showing that a retiree would need a lump sum of around $150,000 to provide the same lifetime income security as an actuarially fair annuity with a premium of $100,000.

Fourth, the calculator doesn't tell the full story on the Social Security earnings test. It does note that early retirees with earnings above $13,560 will have their benefits reduced on a $1-for-$2 basis. What it doesn't tell is that at the full retirement age, Social Security not only stops reducing your benefits, but actually increases them to make up for benefits lost to the earnings test in earlier years. Over the course of a full retirement, total benefits are around the same. So the earnings test shouldn't discourage people from working while collecting benefits.

Overall, the Met Life calculator is a welcome addition to financial planning tools, particularly since it's designed to be easy to use. However, with improvements it could be significantly better.

Read more!