Monday, July 12, 2010

Social Security benefits are skewed to low earners

There's been much bloggiating lately on means-testing social security, raising the retirement age, or listing the cap on earnings subject to the social security tax (FICA), currently set at $106,800. The FICA tax is 6.2% each for employer and employed -- or 12.4% for the substantial percentage of high earners who are self employed.

While raising the retirement age disproportionately affects lower earners, who have lower life expectancies,  lifting the FICA cap combined with making benefits contingent on need would mean truly socking it to the wealthy and affluent.  Proponents -- including, oddly, traditionally zealous enemies of "confiscatory" taxes on wealth -- seem to suggest that high earners are getting some kind of free ride from social security. Here's John Boehner, for example, in favor of means-testing:
If you have substantial non-Social Security income while you're retired, why are we paying you at a time when we're broke?
What seems lost in this conversation is the fact that at present social security benefits are allocated disproportionately to low earners. It's true that the tax is not progressive -- those earning $100k pay the same percentage as those earning $20k, while and those earning, say, $213,600 (twice the cap) pay half the rate on their total income.   But the benefits reaped constitute strongly diminishing returns as one's income increases.  Benefits are based on a taxpayer's  average indexed monthly earnings (AIME) up to the taxable cap. Of those earnings, averaged over 35 years, those who retire at age 66 currently get the following in SS benefits:
  • 90% of the first $761 of AIME
  • 32% of the AIME between $761 and $4,586
  • 15% for the AIME above $4,586 (up to $8900, beyond which there's no tax or benefits).

At present, if your work life is completed and your AIME is $8900, your monthly takeaway is $2,556, or 28.7% of your AIME.  At an AIME of $4586 (roughly $55k/year), you'd get $1909, or 41.6%.  If you earned just $3k/month over your working life, your monthly SS payment would be $1401, or 46.7% of your AIME.  For an income of $2k per month, the payout would be $1081, or 54% of income.

If the cap were lifted and beneficiaries continued to be paid 15% of everything over $4,586, a person with an AIME of $20k/month would get $4221, or 21.1%.  For really high earners, the percentage would drift down toward the 15% of AIME collected for earnings above $4,586. And who's to say that if the cap is lifted, lawmakers won't create a new "bracket," beyond which beneficiaries get less than 15% of AIME?

As Kevin Drum has pointed out, fixing social security is relatively easy (compared to controlling Medicare costs), and the more variables are put in play, the more moderately each needs to be tweaked. Here's his general prescription: 
You could, for example, partially uncap the payroll tax or change the tax rate slightly (or a combination of the two); gradually increase the retirement age to 68; and adjust the inflation calculation for annual benefits slightly.

Raising the retirement age and adjusting the inflation calculation disproportionately affects lower earners (who also have lower life expectancy); raising the cap and further reducing AIME earn-back in higher levels would hit the wealthy.

I might profess shock that John Boehner proposes to "spread the wealth" collected by the FICA tax by denying high earners their relatively skimpy portion of contributed earnings. But I suspect that his real passion is in starving the SS beast generally, mainly through changing the formula for cost-of-living  increases.  Keying COLA adjustments to increases in wages, rather than to the consumer price index, is what has made  social security such a powerful guarantor of a decent life in retirement.  Changing that formula radically would vastly diminish the government's ability to "spread the wealth."  I suspect that what the wealthy might give up in benefits -- just 15% of most of their working-life income -- they'd probably more than make up for in diminished taxes if benefits generally were tied to the CPI.

1 comment:

  1. Mr. Sprung, your conclusion, that "social security benefits are allocated disproportionately to low earners," is based on an incomplete set of facts. I'm not sure what the right answer is, but it is certainly relevant to the analysis that the top half of earners, on average, live nearly six years longer than the bottom half:

    That's almost six more years of benefits while at the same time only being taxed on a much smaller percentage of their income. Sounds like the low earners are getting the shaft in a number of ways.