Should Social Security and Medicare Be Means Tested?
They already are. For example, Social Security’s replacement rate (the benefit as a percent of pre-retirement income) falls as income rises. Also, above very modest income thresholds, 50% and then 85% of Social Security benefits are subject to ordinary income taxes. But the term “Social Security benefits tax” is misleading. Since the first threshold for a single person is $25,000, no tax is likely to be owed if the senior has only Social Security income. It is other income (wages and investment income) that most likely triggers the tax. So in a sense, the Social Security benefits tax is actually a tax on that other income.
As NCPA analysts have shown, the way the tax is applied is diabolically designed to really sock it to seniors who saved for their retirement. Over the phase out range the tax raises the senior’s marginal tax rate by 50% and then 85%. So a senior who otherwise faces a 25% marginal tax rate will face tax rates of 37.5% and 46.25% on non-Social Security income — the latter being a higher rate than Bill Gates is required to pay.
Medicare Part B premiums are also means tested and the implicit marginal tax rate over the relevant range can also be quite steep. If a senior earns $85,000 or less, the annual premium is $1,198.80. But if a senior at the top end earns $1,000 more, his premium will jump by $480 — an implicit marginal tax rate of 48%! At $214,000 a senior who earns $1,000 more will face a premium hike of $840 — an implicit marginal tax rate of 84%!
Furthermore, these explicit and implicit taxes are mainly taxes on saving and investment. That is they are taxes on pension income, annuities, withdrawals from IRA and 401(k) accounts, etc. As a result, this type of means testing penalizes the very activity we want to encourage — since it is precisely the activity that would make Social Security and Medicare unnecessary in the first place.
Recently, there have been calls for even more stringent means testing. In addition to all the usual suspects, Bryan Caplan has produced his own proposal. See that, plus responses from Scott Sumner and David Henderson below the fold.
The days dwindle down
To a precious few.
Here is Caplan’s proposal at EconLog:
For everyone above median income: For every percentage-point by which your income exceeds the 50th percentile, your benefit goes down by 2 percentage-points. So if you’re at the 53rd percentile, you only get 94% (=100-2*[53-50])% of the full benefit. If you’re at the 90th percentile, you only get 20% (=100-2*[90-50])* of the full benefit.
Notice that a simple back-of-the-envelope calculation says this will cut the cost of Social Security and Medicare by 25%.
Here is Scott Sumner’s response in the comments section:
I think this would be a bad idea. The numbers make no sense unless you are referring to income levels of the retired. Suppose a couple saved a million dollars during their life and turned it into a $50,000 annuity on retirement. Also suppose they earned $50,000 combined from Social Security. If the million dollar nest egg puts them in the top 10% of retirees, they lose almost all their Social Security. That’s a huge disincentive to save. And recall that the tax system already has other saving disincentives built in, so it would make the bias against saving much stronger.
Means testing is just another high implicit marginal tax on people who work hard and save.
Actually, in Scott’s example the implicit marginal tax rate on investment income would be 80%. Adding in ordinary income taxes, the marginal tax rate would exceed 100%!!!
David Henderson advances a number of arguments against means testing. But then he “cries uncle” with this comment:
I don’t want to see means-testing removed for those programs because I think my arguments I gave earlier are outweighed by the huge cost of expanding those programs greatly. I don’t have a good argument and I think you have correctly identified something that I didn’t even know was there: status quo bias.
I think there is a better way. Remember, Caplan is only trying to reduce entitlement spending by 25%. Now suppose the government offered you this deal: You can have a check today for 75% of the present value of your future Social Security benefits. This money becomes completely yours and is part of your estate. In return, you waive all claims against any additional promised benefits. Also, you will be exempted from any future Social Security “reforms,” including any new Social Security benefit taxes.
You would have to show that you won’t become destitute. You could do that by showing you have a private pension, some other government pension or substantial assets. Barring that, you may have to purchase an annuity or keep the funds in a trust that has limits on the rate of withdrawal. On the health care side, you would have to show you are covered by an employer’s post-retirement plan, by the VA system, by a public or private disability plan or that you have substantial assets. Barring that, you would have to purchase at least catastrophic coverage.
I think most people would jump at this offer. Especially the folks with above-average incomes, who know they will be the likely target of any future “reform.”
I will write more about this idea in the future.
This is an interesting question. If elderly entitlements are to be means tested, should it be based on past contributions? Most seniors believe they paid into the program and deserve every penny they get back. In reality, early entrants paid very little compared to what they are getting (or can expect to get back). Seniors currently in the program are getting a great return; whereas workers in their 20s can expect a negative return (assuming the programs don’t implode before younger workers reach the age of eligibility). You can make an argument that wealthy seniors made small contributions because they were early entrants into the program. It’s a little harder to make that argument for younger people who are paying 15.3% of their income into the system. Of course, both programs should have been converted to private accounts long ago.
Great analysis.
Interesting proposal, John. I’ll think about it. If I end up agreeing with you, should I cry “aunt?” 🙂
Very interesting. Very good.
John, this approach has been broached by you and others in the past and I have heard no logical objections to it all. Of course we can round up the usual suspects that complain about the “cash out” idea based on the same old mantra that essentially assumes that people are just too dumb to handle their finances.
Personally I think this type solution is the only possible answer that could gain popular support for just about all parties.
Excellent ideas.
studebaker: “Most seniors believe they paid into the program and deserve every penny they get back”
That’s not the only issue for seniors, though. Had there been no Medicare, workers earlier in life would have bargained for or made provisions for alternative prepaid retiree health care. At 60 or 70, there are no alternatives to Medicare. Even at 50, there is no way for someone with long term disease such as cancer or diabetes to make provisions for retirement health care.
If we could start over – with the knowledge we have today about the effectiveness of markets – alternatives to Medicare would work. But I just don’t see it happening.
John and All…
This illustrates how inextricably tied are Social Security and Medicare. It would be lovely and logical if fundamental could be re-done first,s then secondary improvements.
1) The public needs to have a clearer idea about where Social Security comes from so they are prepared to make better decisions for themselves and more rational support for policy changes. As long as they believe in the mythical trust fund, that won’t happen. A continual flow of public service ads that thank current workers for the continuing flow of work-earned tax revenue for retired people. I’m not kidding about this. Rational public policy cannot happen when all the people affected by it are off in Brigadoon. (Music swell.)
2) Then, the social security and tax law should be modernized to remove these sudden tax increases that do incent people not to save. The obvious solution is a smooth progression of taxes only on annual cash flow, from whatever source, not considering origin, whether from work or savings. After all, the main aim of this is not to burden current workers with supporting people who make more than they do. Or do we not care about our adult children.
3) Then, means test Medicare in parallel with Social Security. It is also fair that people who pay more in get more benefits, such as travel to tertiary care centers for higher end care. Note that we need to keep higher income people in the same program as lower income people because they demand more and better healthcare and that makes it more economical to offer it for the majority of people. Think if only rich people could get a Cardiac stent or two, or a brain tumor resection with a gamma knife. Instead of just being costly they would be treasures from the deep.
4. Medicare and Medicaid have been paying in a weird way for four and a half decades, leading to “cost-shifts” from public health plans to private plans. Everyone knows this but for various reasons will not make a big fuss about it.
But it does mean that the true costs of paying for M & M patients is not known by any principle party in health policy; it is passed on as an add-on to private patient pricing, so that private health plans are damned for raising their prices. The solution for this is not rate-setting or “review,” as that kind of control leads to a gradual grinding down of capacity and quality, so you wake up some day with British, Canadian or Spanish healthcare. The solution for this is
to have sliding scale vouchers for all public patients to purchase private care at the level the voucher will buy or more if they can afford it. That way, sll prices will apply to all patients signed up with that plan.
And, plans should come automatically coupled with a healthcare system, as is Kaiser, so the subscriber can find out if the benefits for which he is paying are actually available in his area, such as mental health care, or even longitudinal care for children with congenital disabilities. In other words, there should be a correspondence between premiums, benefits and the ability to obtain those benefits. (What if there were a different kind of quality report that showed comparative primary care to population ratios, plus length of wait for appointments.
Note the vigorous growth in healthcare systems in the West, along with even more growth in integrated group practices.
In other words, there is not a whole lot of point in going on and on about redoing Medicare eligibility when there is this whole historical briar patch.
Having said all that, I bring myself back to reality to note the wholly missing ability of Congress to do this.
Love to all who struggle to get it right in the midst of the skirmishes between the Visigoths and Huns.
Wanda J. Jones
President
New Century Healthcare Institute
San Francisco
As a citizen who feels that the debt/deficit problem is the greatest one facing our country, I do not think that we have the luxury of erudite criticism of the marginal tax rates of the first $1000 of income over Medicare Part B indexing cutoffs. The bottom line is that Medicare Part B is not self supporting and adds to the annual deficit. Until someone leads Congress to devise a better system which is self supporting, those of us who can afford to pay full premiums should do so. There is no reason that I and others in my income group should have our Part B care subsidized by our children and those less fortunate. Therefore, I am in favor of indexing and believe that the rates need to be higher. This is a very simple and fair way to raise revenue for Medicare B. It is time to do something about the deficit and quit talking about it. We seem to prefer the old saying, “Don’t tax you, don’t tax me, tax the man behind the tree.” It will not work that way.
Thomas W. Newsome
This is a great question, but does it matter? In a few years social security wont even be around the way the government spends the money.
http://www.socialsecurityofficelocation.net/
Hi John,
Once again a cogent post. But do the “means” justify the ends?
Should I put money into Social Security–or even my pension plan–today, when I know with a high degree of certainty that the tax rate will be higher when I retire? It seems I lose on that deal, and in the meantime, the government is deprived of the taxes I would pay today, thereby boosting the deficit.
The question of savings is critical to health care policy. Since we have no cost-based pricing in the health care system, and since health plans are covering less and less, Americans are facing ever-increasing out-of-pocket expenses.
But their pockets just got a lot shallower. The average American family lost 40% of its net worth in the last four years. So now, as the risk of uncovered health costs rise, so does the likelihood of medical bankruptcy for the average American.
So a national policy that simultaneously discourages savings and leaves Americans vulnerable to huge health bills is not means-testing, it is just mean. As average Americans become more and more aware of their vulnerability they will become more and more motivated to reform health care from the grass roots up, not the top down.
With the revelations of the details of the back-door deals done to get the ACA passed (not a surprise to anyone, I trust), leaving our health care in the hands of politicians seems like a less and less attractive idea. Only by mobilizing patients and the public in alliance with their doctors (as you recently wrote) can there be real change that is both patient-centric and sensibly structured on free market principles. It is to that end that the Patient-Physician Alliance has been formed and welcomes the support of any and all thinking Americans.
Cheers,
Charlie Bond
Dear John:
Excellent piece.
I agree with you — means testing is nothing more than a tax on those who save and invest and accumulate wealth. It’s also no solution to keeping Social Security and Medicare solvent because it raises relatively little revenue.
Means testing is, however, a divisive and distractive issue. It is simply no substitute for fundamentally redesigning both programs so that beneficiaries have the financial and health security they need and deserve.
Regards,
Mike Korbey
Fairfax, VA
Thanks. What a deal! You are a bloody genius.