Gene Steuerle and Stephanie Rennane
We’ve gotten some interesting comments on our recent post about Social Security reform. In the post, we note that many reform options would slow the growth of benefits from one age cohort to the next, but not cut lifetime benefits relative to what people receive today. We didn’t focus on the specific issue of raising the retirement age, but used that option as an example of how benefits could continue to grow over time, but at a slower rate than what is currently being promised.
Regardless of the reform option in question, we certainly agree with those commenters who urged that we consider how reform might affect different groups in the population. We have long advocated proposals such as a minimum benefit level to maintain and increase progressivity—and offset the impact of other changes such as any increase in retirement age.
As a technical matter, however, it should be noted that adjusting the retirement age for life expectancy does not disproportionately affect lower-income groups, mainly because it does not affect disability insurance, and the disabled come disproportionately from lower-income groups. However, one should be debating the effects of the package as a whole on different groups—not one aspect of reform at a time.
The bottom line, though is that benefit reforms–whether increasing the retirement age, indexing benefit growth differently, or a variety of other schemes– can be designed so that on average lifetime benefits continue to increase over time, though at a slower rate. That still leaves open the issue of how to distribute any particular level of benefits.
Will Social Security reform cut benefits? That’s highly unlikely. It’s more likely that reform will simply cut the rate of growth in benefits.
Social Security reformers have often thought about reform in terms of the annual benefits they want to give people. The complication with this approach is that it ignores the enormous increase in the number of years that benefits have been paid as people retire much earlier and live longer than they did when Social Security was first created.
That’s why it helps to focus on lifetime benefits—how much will be paid over a normal lifespan—rather than just looking at the annual benefit. That way, reformers can get a better sense of how much they want total benefits to rise and, for a given cost, the tradeoff involved as more years of retirement support reduce the level of annual benefits payable.
Fortunately, CBO’s July 2010 report on Social Security Reform Options helps put a focus on lifetime benefits by showing how much they would grow with no reform and under various reforms that adjust benefits.
Consider scheduled benefits, or how much the current benefit formula projects would go to future generations. This assumes that current tax rates will generate enough income to cover those benefits, which they will not.
CBO projects that scheduled lifetime benefits will grow substantially since the current system increases benefits automatically for future cohorts as real wages grow and people live longer. In today’s dollars, CBO calculates that a single person born in 1960 (assumed to retire at age 65 in 2025) who earns close to median wages over their lifetime is scheduled to receive approximately $250,000 in lifetime Social Security benefits, while a similar earner born in 2000, expected to retire in 2065, would receive around $420,000.
On the other hand, if Social Security only pays out what the current tax rate can fund, lifetime benefits still grow, but only to $320,000. That simple calculation tells us that, regardless of the level of tax increase that Social Security reform might entail, it is extremely unlikely that real lifetime benefits will ever fall below their current levels. (There still could be a transition issue in the near-term because of rapid impact of baby boom retirement, but the basic conclusion holds.).
Now consider some of the benefit cut options in the CBO report. For instance, CBO projects that raising the full retirement age to 70 would cover approximately half of the current imbalance in the system. The person retiring in 2025 would receive approximately $242,000 in lifetime benefits, and the person retiring in 2065 would receive $357,000—well above the $320,000 benefit payable to that cohort under the current system.
The basic point is simple: Social Security reform, almost no matter how designed, is likely to provide higher levels of lifetime benefits for future cohorts of retirees compared to today’s retirees—just not as much as is scheduled under today’s unsustainable system.
Following the flap over our Tax Policy Center colleague Bob Williams’s calculation that close to half of all families did not pay income tax in 2009, we thought it would be instructive to take a look at history. It turns out that over the past five decades, there have been other periods when families with close to average incomes have been exempt from the income tax, and that their current exemption levels were due to both Republican and Democratic efforts to reduce taxes for moderate-income households and to find alternatives to welfare.
Consider the tax entry threshold—the maximum amount of income that that a family can have without being subject to income tax—and then compare that to median family income. A value of 100% would mean that the threshold is exactly equal to median family income—families earning at or below that level would pay no income tax.
In 1947, a family of four owed income tax once their earnings hit 89 percent of median family income (see table). Over the following three decades, this tax threshold fell steadily, reaching a low point of 33 percent by 1974, just before Congress enacted the Earned Income Tax Credit (EITC). It rose steadily from 1985 to 2003, when it reached 70 percent, where it remained through 2008. While that’s higher than most of the past thirty years, it is still below the levels of the late 1940s and early 1950s.
This u-shaped pattern is somewhat more pronounced for single parents with children, or heads of household (see graph). They began to pay taxes at over 80 percent of median income in the late 1940s, but the threshold fell to a low of 35 percent in 1978 and then rose to over 110 percent in 2008. For singles, however, the tax entry threshold has actually fallen over time relative to median income: 44 percent in 1947, 38 percent in 1974, and 34 percent in 2008.
Two factors drive these numbers for families with children: (1) the significant decline in the value of the dependent exemption relative to the average family’s income (the 1986 Tax Reform Act was the major exception); and (2) the introduction of and several increases in the EITC and in the Child Tax Credit, which are treated as tax reductions for those otherwise owing tax.
If we exclude the Earned Income Credit and Child Credit and treat them like direct expenditures, the tax threshold as a percent of median income has remained relatively low in recent decades for families with children as well, increasing only slightly even from the relatively low 1975 level. (We did not include temporary effects from the 2008 Economic Stimulus Act. Including them would further increase the threshold at which families would owe tax.)
We need to be careful about interpreting these shifts as a result of liberal or conservative policies. Presidents Gerald Ford, Ronald Reagan, George H.W. Bush, Bill Clinton, and George W. Bush all approved increases in either the EITC or the Child Credit or both—as alternatives to welfare and minimum wage increases, as offsets to Social Security tax increases, and, more generally, as pro-family tax policies. After seeing some of my (Steuerle’s) work on how the decline of the personal exemption over several decades had significantly raised taxes on families with children, Reagan promoted doubling the personal exemption and, later in tax reform, removing poor families from the income tax rolls entirely. Finally, these calculations ignore the rise in the combined Social Security and Medicare tax rate on earnings from 3.0 percent in 1950 to 15.3 percent today. That change, of course, increased federal tax liabilities for low-income working families.