Drastic declines in the stock market and increased focus on security issues now overshadow the public discussion about Social Security that was common only a couple of years ago. This is good and bad news.
It’s good that the popping of the stock market bubble erased naive optimism about the payoff of equity markets. But it’s bad because the nation still needs to face hard choices about how we’ll manage an aging population.
One of the disturbing aspects of the Social Security debate is that people often make sweeping generalizations about the program based on their own personal experience. But Social Security has been modified many times since its Depression-era start, as terms that suited one time didn’t work for another.
Consider the following two statements about the level of return people get from FICA taxes they pay into the system:
“Workers do not get back dollar for dollar what they put in. They get back about 30 cents on each dollar they put in.” Nobel Laureate Gary Becker asserted that in a magazine article published six months ago by the Federal Reserve Bank of Minneapolis.
Ten years ago, Peter G. Peterson, a cabinet member in the Nixon administration and co-founder of the anti-deficit Concord Coalition, argued something very different: “Most currently retired Americans receive Social Security benefits that are two to five times greater than the actuarial value of prior contributions by both employer and employee. The payback for the Medicare hospital insurance program is five to 20 times greater.”
The gap in their estimates of return is pretty stark. It would seem they both can’t be right, but they are to an extent. The paradox is that, to the degree Becker is right, it is largely because Peterson is also correct.
Here’s why:
Extremely generous benefits to those who retired 10 to 30 years ago result in huge transfers from those born after 1965 to those born before 1935.
People like me, who were born after 1935 but before 1965, will not do as well as Peterson suggests but considerably better than Becker does. The unwillingness to acknowledge the differences experienced by people of different ages is a prime reason why the debate over Social Security has so much heat and so little light.
Becker does not give any detail about how he arrived at his 30 percent figure. But it is a plausible return for someone who entered the work force after FICA taxes were raised to current levels in the 1980s, spends most of her work life earning a high salary and receives no benefits under the survivors and disability components of the program.
Peterson focuses on the people who worked when FICA tax rates and the limit on covered earning were both low and then retired after the spectacular increases engineered by Richard Nixon and Wilbur Mills in the early 1970s. They are getting an enormous return on their “contributions.”
His example is explained in the 1993 book, “Facing Up: How to Rescue the Economy from Crushing Debt & Restore the American Dream,” published when the large deficits cumulated under the Reagan and Bush administrations had just quadrupled the national debt.
He correctly noted, “A middle-income couple who retired in 1981 has already received back, with interest, not only the total value of their previous Social Security and Medicare taxes but also the total value of their lifetime federal income taxes.”
Such a couple’s return is so high because, if they retired in 1981, they probably were born in 1916. They probably worked a few years before Social Security was even instituted and spent many years working when the combined employer and employee tax was 2 percent to 5 percent of earnings. The combined bite did not hit 7 percent until they were nearly 50.
However their grandchildren have faced a combined rate of more than 14 percent since they got jobs in high school. And if one ignores the survivors and disability portions of Social Security, the eventual retirement benefits of the grandchildren may amount to only 30 percent of the taxes they paid.
A skewed age distribution and a decade of strong economic growth tempted Mills and Nixon into the same error made by virtually every other industrialized nation during the same period — promising retirees a better deal than could be sustained over the long run. The modifications made in the 1970s fundamentally changed Social Security from a limited social insurance program to an inter-generational income transfer program that may be harshly unfair to people born after the baby boom.
It is a mess. We can clean it up, but we have to recognize the mistakes that we made and that includes acknowledging that for many retirees Social Security constitutes a vast, unearned windfall.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.