Why Do We Subsidize Retirement?
A version of this originally appeared at Forbes.
Have you ever wondered why we have a Social Security system?
Our long-term federal deficit problem requires reforming the entitlement programs, the biggest of which are entitlements for the elderly. The necessity of reform will force us to ask why we have these programs in the first place. What are we trying to achieve?
Until the modern era, there really was no such thing as retirement. People worked until they could no longer work. At that point they needed a source of non-work income to support them. The income could come from savings, the earnings of other family members or from a pension.
At the time the Social Security system was created, life expectancy was 64 years. The average person wasn’t expected to reach the retirement age of 65. Those that did were generally thought to be too old to work. Yet with the passage of time, life expectancy grew, the health of 60 year olds improved and the system evolved into one that literally subsidized retirement.
The days dwindle down
To a precious few . . .
September, November.
People who were physically and mentally able to continue working were rewarded if they chose instead to spend time on the golf course, take cruises and pursue hobbies. Above a minimum amount of wage income seniors lost 50 cents of benefits for every dollar of earnings. This so-called “earnings penalty” was a 50 percent tax on wage income, in addition to the payroll (FICA) tax and state and local income taxes.
Thus seniors with very modest incomes were facing total marginal tax rates that took away two-thirds or more of every dollar they earned. (These same penalties, by the way, still apply to those who choose early retirement.)
In retrospect, it’s hard to imagine why anybody ever defended those policies. No one questions why we provide help to people who are sick or disabled. Or why we provide benefits to people who are temporarily out of work and looking for a job. But why subsidize people who want to play golf? How does that advance any national interest?
In the early 1990s, my colleagues and I at the National Center for Policy Analysis proposed to end this antiwork bias in the Social Security system. Once people reach the “retirement age,” we reasoned, they should be able to claim benefits whether or not they continue working. There should be no additional penalty for contributing to the nation’s output of goods and services.
Our proposal was one of five “pro-growth” reforms we made with the U.S. Chamber of Commerce and these ideas almost immediately became incorporated in a series of bills introduced in Congress. In 1994, they became the core tax proposals in the House Republican Contract with America and a few years later our Social Security reform became the law of the land.
The reform has liberated millions of senior citizens and encouraged their continued participation in the labor market. Recent evidence suggests that our reform is working better than anyone expected. More needs to be done, however.
As the full retirement age is being gradually increased to age 67, more people are choosing to take a reduced benefit and retire somewhere between age 62 and age 67. As mentioned, the earnings penalty for these early retirees is still a draconian 50 percent. But why? Why not let everybody retire — or for that matter re-enter the labor market — whenever they want to, independent of their receipt of Social Security benefits?
Under the current system, the earlier you claim Social Security benefits, the smaller your monthly check. But you can also delay retirement — up to age 70 — and receive a larger than normal benefit. The choice is supposed to be actuarially fair — so that the present value of your expected lifetime benefits is the same, regardless of which age you choose to “retire” at. However, this is true when the calculation is made using the government’s borrowing rate, which is much lower than the rate faced by ordinary mortals. This biases the choice toward early retirement.
As we have argued elsewhere, the government could instead use a higher rate of interest. This would require a lowering of the benefit at age 62 relative to age 70 and would encourage seniors to remain in the labor market for more years.
Then there is Medicare. Once people reach the age of 65 they no longer have to work to get health insurance. The government provides it. People who continue working and who receive health benefits from an employer are actually penalized: the employer plan becomes the payer of first resort. Medicare only pays the bills the employer plan doesn’t pay. So Medicare too is an entitlement program that discourages work and subsidizes retirement.
Is there a better way? Under the Affordable Care Act (ObamaCare), people who obtain health insurance in newly created health insurance exchanges will get federal subsidies. So a 64 year old with a moderate income will pay only a portion of the cost of his private insurance, just as he will pay only a portion of his Medicare insurance cost when he turns age 65.
There ought to be a way to integrate the two subsidy systems so that people are not encouraged to leave the private system as they age. Also, the same subsidies that are offered in the exchange ought to be available to those who get insurance at work — so as not to penalize those who remain employed and who obtain insurance through an employer.
Bottom line: any reform of the system should give people better incentives to work and pay taxes rather than encouraging them not to work.
Good Willie nelson piece.
“At the time the Social Security system was created, life expectancy was 64 years. The average person wasn’t expected to reach the retirement age of 65.”
Perhaps the average *person* wasn’t expected to reach the retirement age, but the average voter certainly was. Life expectancy in 1935 at 30 was 67.3, at 60, 74.8 : [http://1.usa.gov/WTpBJG]. Your other points are well-taken, but quoting birth life expectancy in the context of an old-age social insurance program has little value, I think.
Similar to a Cost of Living Adjustment, can we build an Expected Age Adjustment into Medicare and Social Security benefits?
It would work like this: starting 1 January 2015, only individuals born on or before 1 January of 1941 (74 years old, which is the projected 2015 life expectancy less five years) are eligible for normal enrollment. This would not kick out those already enrolled, and the date would be adjusted for race and sex.
Excellent analysis.
Life expectancy is a conditional figure on attained age. Life expectancy at age 65 is the relevant life expectancy for purposes of Social Security and Medicare computations.
Entitlements have become nearly irreversible. With our changing demographics… these programs will only tighten the finical strangle. I’m worried folks. I’m 29.
Retirement is a sensitive matter. There are many cases of people who reach a certain age and shouldn’t be working full-time any longer — even becomes hard to drive to work. However, people at 65 nowadays in general are more likely able to physically function better, so it’d make sense to increase retirement age accordingly. On entitlement, I am not sure pensions (costly) and 401k’s (too dependent on market volatility) are not the best solution, nor is social security, so it’ll be imperative to continue finding ways to ensure people of retirement age are assured a more peaceful segment of the latter part of their lives.
“to ensure people of retirement age are assured a more peaceful segment of the latter part of their lives”
I came into this world kicking and screaming – why not leave the same way.
After all, Hobbes considered life to be “nasty, brutish, and short”. I am not entirely certain I believe that I am entitled to a peaceful life just because the government tries to give me one.
Surely, penalizing senior citizens when they are holding a job seems like an inefficient economic policy. If a senior individual is intellectually sharp and physically healthy, he/she should be allowed to work and become a productive member of society. Subsidizing retirement costs society, and it has very little return for our community at large. Given that every modern society/ economy needs as many skilled individuals to produce, senior citizens, with their breath of life experience, will be a valuable addition to society.
Then there is this:
This trend may depress you, but consider the upside. The economist Josef Zweimuller, at the University of Zurich, recently co-authored a study which found that early retirement, as much as we may crave it, seems to be bad for our health:
“[A]mong blue-collar workers, we see that workers who retire earlier have a higher mortality rates and these effects are pretty large.”
Right or wrong, one of the justifications for SS at the time was that because of the Great Depression, many had lost their savings and/or pensions and needed the “social i.e. government security”. As you know, it was not meant to be a full retirement system but rather “supplemental”.
“However, this is true when the calculation is made using the government’s borrowing rate, which is much lower than the rate faced by ordinary mortals. ***This biases the choice toward early retirement.***”
John, I don’t subscribe to the NBER, but according to the digest of NBER Working Paper No. 17866 Issued in February 2012 “The Decision to Delay Social Security Benefits: Theory and Evidence” There is a distinct advantage to waiting until age 70 especially if interest rates are low.
“A “delay” strategy is particularly beneficial for married couples. The primary earner can delay claiming benefits, while the secondary earner takes benefits early. If the secondary earner outlives the primary earner, he or she gets to step up to the primary earner’s benefits. That strategy helps married two-earner couples most, but married one-earner couples also benefit. “Delaying the primary earner’s benefit is equivalent to purchasing a second-to-die or joint life annuity,” the authors write. “In contrast, a single person who delays claiming only receives a single life annuity based on his or her own earnings record.”
Interest rates also play a role in determining the financial rewards to claiming benefits at different ages. The lower the real rates, the better it is to delay benefits. Secondary earners in two-earner households benefit less from delaying than primary earners, but even they can increase the present value of their benefits by delaying if real interest rates are 1.6 percent or less. Singles also gain from delaying benefits until age 64 if interest rates are below 3.5 percent (for men) or 4.1 percent (for women).” There are additional schemes for generating higher income not mentioned in the report.
I realize that you are trying to promote a broad direction with regard to work and entitlements that I support which is not essentially affected by this report. I don’t know if this has been addressed in other areas of the NCPA, but if so and they are known to you I would like to know where. Thanks.
Arnold Kling weighs in here:
http://www.arnoldkling.com/blog/the-three-axis-model-and-social-security/
John, Always appreciate your well thoughtout comments and hope you keep them comming them for a long time to come.
Just thought I would expand a couple points regarding your reference to medicare. Currently for small employers,(fewer than 20 employees basically) medicare is primary to the employer’s benefit plan. For large employers, medicare is secondary. Also, coverage is not “provided” by government for retirees over 65 (not employer subsidized) if you consider they pay significant costs to enjoy decent overall coverage. In addition to Part B they would pay for Part D (RX)plus a medicare supplement to plug most of the gaps. Could cost $4000 to $6000 yearly per person.
I’ve worked since I was 16, I had t have a social security card to do so, I didn’t ask for one, it was mandatory. None of social security money is the Governments, it is the workers money, no one elses. The Government were supposed ot hold hte mnoney in trust , not spend it, it wasn’t theirs to spend but they took it over and over again and it became part of the deficit. This ocuntry prospered after th ewar, Mom was taken care of when sh eretired and if pop died sh got the remainder of his social security, Kids could og liv eat home wihtout hurting anyone. I am gad yuou ar eso healthy, not eveeryuone is, when people reach 70- or 75 they start getting things, arthritis and a bum knee and all the rest of it, not everyone works at a desk either,wishin gpeople would die is nto the way ot og, thats kind of cold , there are billiosn of dollars going ot foreign countries that hate us every day, we have spent millions , billions on these wars and you ar worried about a few old timers who will finally be able ot take it easy or take that rip they couldn’t afford beffore, shame on you. If you htik owkring until yuou die they do it, you probably don’t have anything else to do anyway, osme people rather work than play golf or og boating, that their choice but I could n’t work anothe rday if my life depended on it, working instead of retiring has ot be something you really want to do other wise its pure hell. no new life ot look forward to. We deserve it just as much as all the new Africans and Hindus and Mexicans that are comning in and we are paying for, all new SUV’s to drive, and I am still driving an old pickup, what about them? none of them seem to be working either, there are no jobs, maybe thats because the old duffers don’t want to retire and let the younger people work for a change, they have kids ot support. they don’t get social security, you will.