Is there a way to save Social Security without raising taxes — and make it better? There is, and it has nothing to do with privatization or personal accounts. We discuss that solution in my latest Ricochet Money & Politics Podcast with guest Andrew Biggs of the American Enterprise Institute. Before joining AEI, Biggs was the principal deputy commissioner of the Social Security Administration, where he oversaw SSA’s policy research efforts. In 2005, as an associate director of the Bush White House National Economic Council, he worked on Social Security reform. In addition to discussing his pro-growth Social Security reform plan, Biggs explains why changing inflation measures, popular with Republicans, is a poor way to fix entitlements.
Among Biggs’s writings:
The Chained CPI: A Bad Deal All Around - National Review
Here are edited highlights of our chat:
You have a lot of ideas about how to reform Social Security. But partially privatizing Social Security through personal accounts isn’t one of them. There was lots of talk about this in the 1990s and early 2000s, but not any more. What happened to that idea?
You’ve had two strands of thinking about Social Security reform that haven’t always been productive. One thinks only about the financing of the program. That says, this program is going broke, but otherwise, there’s nothing to worry about. All we have to do is find some combination of tax increases and benefit cuts to keep it going.
The problem there is you’re not saying, Why do we have a Social Security program? How well is it fulfilling its goals? You’re taking for granted that the system is doing what it should. The reality is the system doesn’t accomplish its goals effectively. As a social insurance program for the poor, it’s a haphazard level of protection. Some low earners do well from the system; others do badly. It’s like an insurance policy that may or may not pay off when you need it. At the same time, it discourages saving and labor force participation. It encourages early retirement.
For a lot of folks, personal accounts are philosophical goals. You want people to have greater control over their income and to help their wealth.
President Bush called this “the ownership society.” The problem was back in 2005 when he put a lot of political capital into Social Security reform, that ownership goal appealed to about a third of the population. The rest asked, what will these accounts do? They’ll keep the government from spending the Social Security surplus. They’ll build savings on an individual and economic level. But Social Security’s financing is already running big deficits, where do you find the money to fund these carve-out accounts?
When the personal accounts were proposed in the mid-1990s through to when President Bush pushed them around 2005, Social Security was running surpluses equal to around 2 percent of payroll, collecting a 12 percent tax, but the cost to the system is only 10 percent of your wages, leaving extra money. The government takes that money, spends it, and credits it to the Social Security Trust Fund. There’s no saving going on. People proposed personal accounts funded at around 2 percent of the payroll. You could take that money, put it into the account, and save it to pay benefits in the future.
The surpluses that funded the accounts have mostly turned into deficits partly due to an aging population, but partly due to the weakness of the economy, fewer people are working and paying taxes. Letting people take some money out for a personal account, at least in the short-term, makes that deficit worse. Transition costs come about where you have to come up with the extra money to fund these accounts.
OK, let’s get to your plan, which you outlined in National Affairs. Here is something you wrote in that piece
What Republicans need is a compelling vision for Social Security reform, one that is consistent with principles of limited government and individual responsibility. By articulating the case for a strong Social Security program, highlighting the ways in which the current system falls short, and outlining broad policy changes to make Social Security effective and financially sustainable, reformers can begin to develop a constructive, conservative approach to preserving and improving Social Security.
So what is that approach?
The folks who think we just have a financing problem say, Social Security is the greatest anti-poverty program ever invented and we just need more money for it. Today we spend over $700 billion each year on Social Security benefits, yet 9-10 percent of seniors in America are living in poverty. You could give every retiree in America a poverty level benefit for half the cost of the current Social Security program.
Social Security for middle-class people is a forced saving program with no saving. From the individual level, you’re paying money in today and getting money back later, but at the macro level, it’s simply a transfer from the young to the old. It weakens the economy.
My solution is if you want middle and upper class people to save for retirement, tell them to save for retirement. Say everybody has to sign up for a 401(k) with their employer. Their employer has to match their contributions. That’s going to go a long way towards solving this problem because if everybody’s saving, then Social Security’s job is easier.
Among low-income people, some do well, some don’t. What I propose is give every person a flat poverty level benefit coming from the government.
Not just low-income Americans, but everybody would get this benefit?
The benefit would be paid irrespective of your earnings and labor force participation. It’s a universal retirement benefit. New Zealand and a few other countries have the universal pension. The idea is, We’re going to pay you these benefits, so you’re not going to starve. This is going to take the place of sort of the redistributive end of Social Security, also take the place of a number of welfare programs like Supplemental Security Income.
Nobody will get a benefit below the poverty line. The poverty rate among seniors should go from 9 percent to 0 percent. But nobody will get a benefit above the poverty line. If you want more than that, you have to save for it. That’s where these individual-based accounts come in.
If you put the two benefits together, this poverty-level benefit, plus the individual accounts, the result is near what Social Security promised to pay, but can’t afford. It’s a more reliable system for low-income folks and it’s more affordable on the tax end.
It’s more conducive to saving because people do real saving or real investment, it’s more conducive to work because people see their money going to their own account. It’s a way of aligning the incentives to build the economy.
And how would it alter the financial trajectory of the system?
In the short-term, costs for Social Security will rise because we have retirees and baby boomers shifting into the system at the rate of 10,000 per day.
The new system would be phased in so that somebody entering the workforce today would retire under that new system. In 40 years, the system won’t cost 16 or 18 percent of wages as is currently projected, but around 10 percent of pay. You would also have your individual account.
Why not just raise taxes? Many folks on the left reject any real means testing, and really don’t trust folks on the right to reform Social Security?
There’s natural skepticism there. Because Republicans have often treated Social Security as a budget problem to be solved by cutting spending rather than treating it as a program that they want to fix.
We have to get more credibility with people. There’s the fixation with some people of sticking it to the rich. The problem is that the idea of raising taxes and eliminating the cap on the Social Security payroll tax isn’t going to sell.
Now, the Social Security tax is 12 percent of your wages of the first $110,000 that you earn. If you’re above that, you no longer pay the payroll tax. Bill Clinton’s justification is that high-income people pay higher income tax rates, making up for the fact that this payroll tax is capped.
The problem with eliminating the payroll tax ceiling is the 12 percent increase in the marginal tax rate that affected people are going to pay.
Due to changes passed by President Obama, probably the top current tax rate on earned income is around 40 percent. You add 12 percentage points there and your top marginal tax rate at the federal level is 52 percent. This would be before we’ve done anything to fix Medicare and Medicaid, which everybody on the left say is a bigger problem than Social Security.
They would also like to fix those plans by raising taxes.
I’d have more sympathy for fixing Social Security by raising taxes if they didn’t want to fix Medicare and Medicaid by raising taxes too. Social Security is the logical place where we can substitute individual saving for government benefits. It’s harder to do on the Medicare and Medicaid end because they’re big integrated insurance programs and it’s illegal to supplement your doctor. But if you cut my Social Security benefits, I’m going to save more on my own, on a 401(k) or an IRA.
And I would guess that one other criticism is that what you’re describing will sort of cut into popular support among middle class and upper income Americans for the plan that it seems. By just having this kind of low universal benefit, you’re turning it into more of a welfare program.
I had a conversation with a top economic adviser to President Obama. He made this argument. If you take this approach, it’s going to weaken support for Social Security among high-income people because they won’t feel they get much out of it. His solution is massive tax increases on high-income people. For that view to make sense, you either have to think that high-income people care a lot about their benefits and don’t care about their taxes. Or the high-income people are just really bad at math.
Medicaid –the idea because it’s a program for the poor, it’s easier to cut. Medicaid is growing just as fast as Medicare is and Medicare is a program for the rich. The general liberal view is a program for the poor is a poor program, since the 1930s. We need to wrap all Americans into these programs because otherwise higher and middle-income people won’t support it.
It’s a really cynical view of people.
It’s doubly cynical in the sense that middle and high-income Americans wouldn’t support these programs if they understood what was going on. We live in a democracy, you should let them make those choices.
Back when you had 15 workers for each retiree, we can give good benefits to every retiree, rich and poor alike, with low tax rates. When you have two workers supporting each beneficiary, you can’t. Let’s focus the government resources on the people who need it the most, the truly poor, and give them a good benefit, better than today’s benefit. Middle and high-income folks would just set them up to save more on their own because they can. They could be saving more on their own. One reason they don’t, though, is because these benefits come from Social Security.
Let me float an idea, which may or may not be compatible with your plan. It’s the idea of Universal 401(k) plans. Let me describe a version outlined by Tyler Cowen:
The core idea is simple. The federal government will create tax-free retirement accounts for lower income Americans, supplementing private accounts where they already exist, and matching personal contribution to those accounts. The amount of the match depends on the income of the family and how much they save. Just as the earned income tax credit pays poor people to work, the universal 401(k) plan would pay poor people to save. And there’s an obvious way to pay for these plans, where every dollar spent on the universal 401(k) plan, the federal government could spend $1 less on Medicare and Social Security benefits.
What do you think of that idea?
I’m generally in favor. Adding on individual accounts is broadly consistent with that. What you want to do is get low-income people to participate because middle and high-income folks are going to save regardless. The use of matches in trying to induce them, I’m skeptical. It’s not that effective. A lot of folks won’t participate even with a generous match rate. The idea of automatic enrollment in the accounts will be effective in getting people. If you want to have the employer match or even the government match, you can do it. A match itself isn’t going to be sufficient.
For middle and upper-income Americans, if the Social Security benefit went down, wouldn’t they save more. Isn’t it just sort of an offset, one for the other?
There was a paper done by a well-known economist that looked at the decline in national saving in the U.S. since World War II. Everybody has complained we don’t save as much anymore, they look at the data and they attribute a lot of that decline to the rise of entitlement programs, the rise of Social Security, Medicare, and Medicaid.
These programs are shifting money from working-age people to older people who save less. Part of the decline in American savings, across all income groups, is that Social Security, Medicare and Medicaid are substituting for those savings, but they’re not real substitutes because the money you put in your 401k gets invested in capital, in building industry, and doing research, making the economy more productive. These transfer programs don’t do that.
You have to think about the effects that these programs are having down the road. If you’re giving a high income person a government benefit, they’re rationally going to save less as a result.
Now, my preferred savings plan is having kids. I have a big family, and all the kids have been told they’re going to have to give me 10 percent pre-tax income when they get older. That is my savings plan.
You have to find a way to enforce it.
Well, guilt, tremendous guilt. That’s the lever here I’m using. Do we have any good feel for what the impact is sort of – you know, my situation aside – the impact on Social Security and other kinds of retirement programs on fertility rates?
People in the past would have kids would be to help support them in retirement. You didn’t have stocks and bonds and mutual funds so you invested in human capital instead, your kids. You had lots of kids and you’d hope they were going to be able to support you later.
The problem is that the financing of programs like Social Security and Medicare is sensitive to the fertility rate. A higher birth rate means these programs become easier to support with more people paying into them. Social Security undermines its own financing. It encourages people to work less so they’re paying less into the system. It encourages them to save less, so the economy is less productive. It encourages people not to have kids, with fewer new people paying into the future.
I’ve proposed the idea of a lower payroll tax for families with kids. The idea is to make the system fairer to acknowledge the contributions that parents make, what their kids are doing for Social Security.
And how would you pay for that? If someone like me is paying less, then that’s a shortfall. So who’s paying more?
I’ve gauged this with fairly conservative assumptions. You have a small increase in the payroll tax rate overall (the rate would go up from 12 percent to 13 percent.) and then a rebate from that for each child you have.
If you have even a modest increase in fertility rates, that would improve Social Security’s financing sufficient that you wouldn’t need to have the payroll tax rate increase at all.
One item that constantly gets mentioned in budget talks is chain weighted CPI. How would that affect entitlements and is it a good idea to change sort of the inflation metric or the inflation measure that we’re using when we figure entitlement benefits.
The chain weighted CPI debate is over how you measure inflation and how you build that measure of inflation into the cost-of-living adjustment (COLA) that’s paid to Social Security.
The consumer price index overstates inflation because it doesn’t account for the way that people change their buying habits in response to changing prices. For instance, if the price of apples goes up and oranges goes down, I’m going to buy more oranges and fewer apples. The current CPI assumes I’m going to keep buying apples no matter how expensive they get. When you account for this upper level substitution bias, you generally get a lower rate of measure inflation.
The chain CPI – which accounts for this change in buying habits – is a better measure of inflation. Switching makes the COLAs smaller and saves us enough to cut 15 or 20 percent of the Social Security deficit. This is the Washington policy wonks’ favorite thing.
You don’t like it though. You don’t like this idea.
MR. BIGGS: Inflation adjustments of benefits in retirement is valuable to people, the policy elements of Social Security that actually work well. You don’t get inflation protection from your 401k, only from Social Security.
I’ve argued for a higher COLA for Social Security, one that goes not just with inflation but goes about a percentage point higher and rises with wages. You’d get an extra increase on top of inflation for your Social Security benefits, making up for not getting inflation adjustments for your 401k or traditional pension benefit. That’s going to be coupled with lower benefits early in life. When you retire, the advantage there is the lower initial benefit encourages people to keep working.
By having a higher COLA, you have lower benefits early in retirement. When you’re 62, you really should be working longer but when you’re 72, when you can’t go back to work, your benefits are going to be higher.
The chain CPI is not about fixing Social Security. It’s about generating money for the budget up front because it cuts benefits quickly.
It has an impact on taxes as well, fairly significant the further out you go, right?
The income tax brackets are also indexed to the consumer price index. If you use a chain CPI, you’re going to increase people’s tax rates because more of their income will fall into these higher tax brackets.
It’s a regressive tax increase because if you’re a high-income person, most of your income is in the top tax bracket anyway. It can’t get worse for you. If you’re a lower middle-income person, it’s going to raise your taxes more.
The chain CPI is a combination of cutting benefits for the vulnerable Social Security beneficiaries, the 90-year-old person, coupled with a regressive tax increase on working people –it doesn’t appeal to me.
So it’s a fairly significant tax increase over the decades.
You get a real bracket creep, where, at least in decent times, people’s incomes grow faster than inflation. Since the tax brackets are indexed only to inflation, more income falls into higher tax brackets so the average tax rate rises.
Even if we had made the Bush tax cuts permanent and indexed the alternative minimum tax for inflation, the Congressional Budget Office projects that tax receipts relative to GDP would rise at record levels within 10 years.
If you add the chain CPI, you’re exacerbating this trend, with record levels of taxes. Again, you want to say, what kind of Social Security program do we want? Similarly, what kind of tax system do we want to have?
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