By Charles Blahous
October 22, 2021 at 5:00 am ET
It’s well-documented that Social Security faces a massive financing shortfall that threatens its solvency unless lawmakers swiftly enact corrections. However, this isn’t the only reason to reform Social Security. The program doesn’t treat work or workers fairly, and this needs to change.
By the time workers reach late middle age, each dollar of payroll taxes they contribute delivers on average only 2.5 cents in additional benefits. The reasons for this mistreatment are various, but are rooted in the fact that lawmakers have never adequately considered Social Security’s effects on work.
The 1935 Committee on Economic Security that advised President Franklin Roosevelt on Social Security’s design took it for granted, amid the Great Depression, that workers “past middle life” had “uncertain prospects of ever again returning to steady employment.” In the 1970s, lawmakers enacted automatic annual benefit increases that cannot be sustained unless workers’ tax burdens rise dramatically. Workers now beginning their careers are projected to be made poorer by Social Security, on average, by an amount exceeding 3 percent of their lifetime earnings.
The damage wrought by Social Security’s work disincentives is enormous. Healthy, productive workers are induced to drop out of the workforce, right at a moment in life when they are typically deciding whether to retire or continue working. Evidence shows that workers respond to these incentives by quitting work when their marginal Social Security tax rate is high.
Even before the pandemic, we faced an enormous labor participation challenge, with the baby boomer generation retiring in droves to spend more of their lives drawing government benefits than any previous generation. But especially now, when America lacks enough willing workers to fill employers’ needs, the last thing we need is for our largest domestic program to make the problem worse.
One problem is the archaic design of Social Security benefits. The benefit formula, reflecting bygone data limitations, is based on a worker’s average earnings in their highest 35 years (adjusted for national wage growth). The problem with this is obvious: As soon as a worker works for 35 years, he or she no longer accrues benefits at the same rate, because each subsequent year of earnings only counts toward benefits to the extent that it exceeds a previous year’s earnings.
Far better would be for workers to accrue Social Security benefits each year they work, just as workers in private pensions do. This requires changing the formula so that it operates separately on each year of earnings rather than on a career average. A side benefit of this reform is that it would actually save the system money, mostly by constraining benefit growth for sporadic high-income workers (to whom the current formula pays windfalls because it mistakes them for low-income workers).
We should also reform Social Security’s early retirement penalties and delayed retirement credits. The current system rightly adjusts monthly benefits for one’s age of claim — reducing benefits for those who claim early and draw for more years, while increasing benefits for those who delay retirement. The problem is that these adjustments are weak. Wharton economics professor Olivia Mitchell has found that offering the delayed retirement credit in a lump sum option (typically in the tens of thousands of dollars) could be a more powerful inducement to delay retirement than the current method of adjusting monthly benefits by a few percentage points. Current early/delayed retirement adjustments also don’t consider that those who keep working also continue to pay payroll taxes. To properly take workers’ taxes into account, early retirement penalties and delayed retirement credits need to be made larger than they now are.
Of course, there is no avoiding the most politically difficult issues, including Social Security’s outdated eligibility ages. There is only so much that other adjustments can accomplish, so long as eligibility ages remain badly out of sync with demographic realities.
The most common age of benefit claim today is 62. As long as healthy workers continue to claim benefits so early, program costs will be inflated, and workers’ tax burdens will be needlessly compounded. It bears noting that the current earliest eligibility age of 62 could be raised by three years, and still allow 21st-century workers to claim Social Security benefits at a younger age than those of the generation that fought the Spanish-American War of 1898. Then, too, initial benefit levels are currently indexed to grow faster than workers’ after-tax earnings. Until this cost growth is moderated, American workers’ standards of living will continue to fall behind.
While specific reforms should be thoroughly debated, we would all benefit from a general shift in Social Security’s posture toward work. To serve 21st-century needs, Social Security must be converted from a program that penalizes work to a program that rewards it.
Charles Blahous holds the J. Fish and Lillian F. Smith Chair at the Mercatus Center at George Mason University and is a former public trustee for Social Security and Medicare.
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