Social Security Myths

Previously, I took a closer look at the conservative “myth” that reducing tax rates raises tax revenue. This week I’ll look at a fiction frequently trotted out by those on the left: the rich get off easy on their contributions to Social Security.

A recent example is a Senate hearing (32 minutes into the tape) in which Tom Harkin, the Democratic Senator from Iowa, states that, because of the $106K cap on earnings subject to the Social Security tax, people making $400K paying Social Security tax on 25c out of every dollar while most people in this country pay Social Security tax on every dollar they make. This is true. But what Senator Harkin neglects to mention is that Social Security benefits are also capped.

Let’s look at 3 examples: Joe, making the median annual earnings of $40K; Sally, earning $100K and in the top 5% of earners; and Marilyn, making $150K. Each of them was born in 1950 and will retire at their full retirement age in 2016.

Using the Social Security Administration’s (SSA) benefits calculator , Joe will get a full retirement monthly benefit of $1184 when he retires. Using the default growth rates of income, the SSA estimates Joe’s lifetime income at $848K. Sally will get a monthly benefit of $2100 on estimated lifetime earnings of $2,119K. Sally has contributed 250% more than Joe but will receive less than double the benefit. Marilyn will receive a monthly benefit of $2434 based on a lifetime earnings estimate of $2,623K, triple Joe’s earnings.  Because of the social security contributions cap (currently about $106K), Marilyn has not contributed three times what Joe has contributed, but she has still contributed more than 2.5 times what Joe has contributed.  However, Marilyn gets only double the benefit that Joe receives.

In short, Social Security is both a safety net and an income redistribution scheme. An American Institute of CPAs (AICPA) report notes that Social Security was originally designed as a prepaid pension plan so that benefits received were dependent on contributions made by each person. That original design was amended a few years later to turn Social Security into a “pay-as-you-go” system where retiree benefits were paid for by the taxes of current workers. Although benefits were indexed to contributions, those who earned less received far more benefits in proportion to their contributions. Social Security thus became a hybrid income redistribution scheme for retirees. You can read a colorful history of pensions at the SSA web site.

Few conservative or liberal politicians readily acknowledge the income redistribution aspect of Social Security. The program has been “sold” to taxpayers as though it was an insurance product, similar to an annuity policy that anyone can buy from an insurance company. The only difference is that the federal government is the insurance company. Regardless of what one feels about the income redistribution part of Social Security, it has reduced “the poverty rate among the elderly from 35% in 1959 to 10% in 2003, the lowest of any adult group.” (Source) A recent report by the Census Bureau shows that poverty rates for seniors are 2/3 to 3/4 that of adults in general. Have we gone a bit too far in helping seniors? Poverty rates for children are at a shocking 20% plus, but few politicans dare to propose reducing benefits for the elderly to help children. Seniors vote. Children don’t. Because seniors have been convinced that Social Security is like an annuity insurance program, many seniors balk at any reduction in benefits. They are convinced that they paid in full measure for the benefits they receive.

As the examples above show, both Marilyn and Sally pay a portion of Joe’s benefits. Yet Joe probably thinks that he has earned every penny of his benefits because he “paid into the system.” This misconception is likely to make changes to Social Security benefits extremely difficult. Those who are well off know that they contribute far more into the system than they receive. Those who are less well off will prefer to “soak the rich” even more rather than give up benefit increases.

For those of you who like wrestling, you may be able to see in coming years the (cue up the loud music) “Social Security Smackdown” on a cable channel.

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