Reforming Social Security to Better Promote Retirement Security

Testimony before the House Committee on Ways and Means
Jason J. Fichtner | May 23, 2013

Good morning, Chairman Johnson, Ranking Member Becerra, and Members of the Committee. Thank you for inviting me to testify today.

My name is Jason Fichtner, and I’m a senior research fellow at the Mercatus Center at George Mason University where I research fiscal and budgetary issues, including Social Security. I am also an adjunct professor at Georgetown University, Johns Hopkins University, and Virginia Tech, where I teach courses in economics and public policy. All opinions I express today are my own and do not necessarily reflect the views of my employers.

I’d like to begin by thanking Chairman Johnson and Congressman Becerra for the leadership you provide this committee in ensuring that important public policy issues involving Social Security and retirement security get the attention and debate they deserve, and also for ensuring that ideas and viewpoints from all sides are aired in a collegial and respectful manner. It is truly a privilege for me to be here testifying before you today.

My testimony focuses on the Social Security program’s incentives—specifically, how the current structure provides disincentives to work and save. I will also discuss how Social Security reform, if done correctly, can increase US savings, labor force participation, economic growth, and federal revenues.

The Economy's Effects on When People Claim Social Security Benefits 

The financial crisis that began in 2008 resulted in a great and unanticipated loss of wealth for millions of Americans. The US stock market, as measured by the broad S&P 500 index, fell nearly 57 percent from a peak on October 10, 2007, to a bottom on March 9, 2009.[1] Housing prices plummeted and unemployment rose quickly to double digits. Survey research suggests financial wealth declined by 15 percent for the median household as a result of the 2008 financial crisis.[2] General confidence in the financial system was greatly weakened.

The widespread economic crisis affected a range of ages and income levels. According to data from the Health and Retirement Study (HRS),[3] about 28 percent of surveyed households reported that they had been affected “a lot” by the financial crisis, 46 percent responded they had been affected “a little,” and only 26 percent reported not having been affected.[4]

Though the broad stock market has recovered much of its losses and reached new highs, and housing prices have started to recover, unemployment is still too high. Unemployment rates for workers ages 55–64 averaged 7 percent for the years 2009–10 compared to 3 percent for the period 2005–8.[5] As of April 2013, the unemployment rate for workers ages 55–64 was 5.1 percent—still far above the 3 percent average between 2005 and 2008.[6]

A sudden and unplanned drop in wealth and income can have significant effects on retirement behavior. Research I’ve done with coauthors John Phillips and Barbara Smith finds that more people will elect to begin taking Social Security retirement benefits as soon as eligible, due to financial shocks, increases in unemployment because of the global financial crisis,[7] and an arrested economic recovery.[8]

A study by Michael Hurd and Susann Rohwedder after the 2008 crisis finds that 3.5 percent more individuals expected to work past the age of 62 than previously, while an additional 4.3 percent planned to work past the age of 65.[9] A financial shock, such as steep drops in the value of stock prices, investment portfolios, and housing assets might cause a delay in people’s retirement plans,[10] with workers remaining in the workforce longer than originally planned to rebuild retirement savings.[11] Those near or post-retirement are more limited in their ability to attain or maintain a secure retirement. For current retirees, sudden declines in wealth from housing assets and financial portfolios might force immediate changes in consumption.

The loss of a job has particularly pronounced effects on workers above the age of 55 and on the decision to retire. According to a special study in 2010 from the US Bureau of Labor Statistics,[12] older workers who lose their jobs are likely to have longer durations of unemployment than younger workers. A Congressional Research Service study finds that older workers who are unemployed have a higher incidence of withdrawing from the labor market than younger workers.[13] When they do retire, they replace earnings with available sources of income, such as pensions and Social Security benefits. Workers who retire early may experience lower lifetime benefits from Social Security, and their removal from the workforce slows economic growth.

Though the decision to start receiving Social Security benefits can be concurrent with retirement, electing to receive benefits is not necessarily a predictor of leaving the workforce.[14] In fact, the decision whether to stop working can be completely independent from the decision whether to begin collecting Social Security benefits. For example, a worker might choose to stop working but delay receipt of Social Security benefits to take advantage of higher monthly benefit amounts that accrue the later one waits to claim (up to age 70). Or a worker might decide to elect retirement benefits as early as age 62, receiving a permanently reduced monthly benefit,[15] yet continue to work full- or part-time for continued income support.[16] In some cases, a worker might opt to select Social Security benefits and then return to work.[17]

Researchers have long recognized the role Social Security benefits play in a secure retirement.[18] Social Security retirement benefits provide income security for millions of Americans, with 65 percent of all aged recipients[19] relying on Social Security for 50 percent or more of their income, and 36 percent relying on Social Security for 90 percent or more of their income.[20] Because low-income households use Social Security benefits for a larger portion of annual income, the financial crisis has affected these retirees less.[21] As a result, the structure of Social Security has its most significant economic and behavioral effects on the middle class.

Negative Effects of Labor Force Participation

Most analyses of Social Security have concluded that its current design offers substantially negative incentives for work, especially for younger seniors and for secondary household earners. Research by Gayle Reznik, David Weaver, and Andrew Biggs has found that Social Security’s return on payroll tax contributions by those aged 62–65 is −49.5 percent,[22] meaning that the program literally pays back just pennies in additional benefits for each additional dollar contributed. Barbara Butrica and her coauthors have found that the broader array of federal laws strongly inhibits continued work by seniors, with disincentives growing stronger as they age: “The implicit tax rate on work increases rapidly with age, rising for our representative worker from 14 percent at age 55 to 50 percent at age 70.”[23]

Notably, labor force participation did not immediately decline for those younger than 65 (and thus originally ineligible for Social Security benefits) until Social Security’s early eligibility age (EEA) of 62 was established.[24] After the creation of the EEA, labor-force participation by males aged 55–64 also began to trend downward, from 87.3 percent in 1960 to 67.7 percent by 1990. As the Bureau of Labor Statistics notes, “Labor force par- ticipation decreases started in the 1960s for those 55 to 64. Since this time, some of the 20-percentage points decrease for men in this age group has to be attributed to the availability of Social Security benefits to men 62 years of age.”[25] The Bureau of Labor Statistics report also notes the new availability of Social Security’s disability benefits and suggests that they further dampened middle-aged labor-force participation.

How Does Social Security Penalize Work?

The basic Social Security benefit formula is itself designed to impose net incremental income losses on those who extend their working careers.[26] Previous studies by Charles Blahous;[27] Gopi Shah Goda, John B. Shoven, and Sita Nataraj Slavov;[28] and others have explained how returns on contributions generally diminish the longer one works and why they become even more sharply negative once a worker has contributed for 35 years.

The primary reasons for the work disincentives are the facts that the Social Security benefit formula is progressive, while also based on a worker’s top 35 years of earnings on average. Thus, the longer one works, the more “zero earnings years” in one’s wage history are replaced with positive earnings years and the more one’s “average earnings” rise (so that one is gradually considered a relatively higher-wage earner), and thus the worse one’s returns under the program’s progressive benefit formula.[29]

This worsening becomes particularly pronounced after 35 years of earnings,30 when the best a worker can hope for is to replace a previous year in the highest 35 years of one’s wage history with a higher earnings year. That is to say, after 35 years of work, one’s benefit can only rise in proportion to the differential between two previous earnings years, despite paying a full additional year of payroll taxes. Indeed, someone who takes a part-time “transition job” on the way to full retirement may well pay a full year’s worth of additional taxes while receiving no additional benefit credits whatsoever. This embodies a substantial work disincentive at precisely the time when a worker is likely to make a retirement decision.

Penalities Against Seniors and 55-65-Year-Olds 

Though this sustained trend toward early retirement has bottomed out and begun to reverse somewhat in recent years, Social Security on balance clearly remains a substantial barrier to labor participation by Americans in their late middle age. For example, seniors who continue to work after claiming Social Security benefits at 62 (but before normal retirement age [NRA] of 66) are subject to an earnings limitation under which they are required to temporarily give up as much as $1 in benefits for every $2 earned above a $15,120 threshold.[31] This rule is but one of the program’s facets that nudge individuals into early retirement.

Social Security’s EEA of 62 is, in fact, the most common age of benefit-claiming.[32] Over 70 percent of beneficiaries take advantage of the opportunity to claim Social Security retirement benefits before NRA, despite receiving lower monthly benefits by doing so.[33] Not long ago, Social Security Administration (SSA) field offices often encouraged early retirement under the mistaken belief that it leaves beneficiaries better off. Early retirement is only certain to make beneficiaries better off in the short run, however. The reduction in monthly benefits that accompanies early claims also results in net lifetime benefit reductions for those who live to especially advanced ages—often a time in life when beneficiaries are most likely to rely on Social Security benefits to pay their expenses. Fortunately, the SSA has more recently adopted policies recognizing that individual circum- stances must be carefully considered when determining one’s optimal age for claiming benefits.[34]

Penalties for Two-Earner Couples

Social Security specifically provides a disincentive to taxpaying work by more than one earner per household. Incremental returns on taxes paid by women have been estimated at −32.0 percent relative to what they would receive by staying out of the paid workforce altogether and instead often collecting the nonworking spouse benefit.[35] As a general rule, Social Security aggressively redistributes income from two-earner married couples to one-earner married couples, thus penalizing a household decision to have both spouses work and contribute payroll taxes. For example, a medium-wage two-earner couple, both born in 1955, can expect to receive back only 80 cents from Social Security on each dollar contributed (in present value), whereas a one-earner couple can expect to receive $1.39.[36] Today 61 percent of married women participate in the labor force, compared to only 32 percent in 1960—and there are more women than men in the modern-day workplace.[37] Much of the original welfare system was designed to support single-earner families.[38] As a result of changing demography, Social Security needs to reflect the evolving workplace and not penalize two-earner couples.

One reason for this income redistribution and these negative labor participation incentives is the structure of Social Security’s nonworking spouse benefit. Individuals without any history of paid employment can be entitled to receive a benefit equal to 50 percent of their spouse’s earned benefit. Consequently, an individual who is married to a high-wage earner may receive a benefit well exceeding what another individual might earn based on an entire working career of payroll tax contributions.

Despite the complexities involved in determining one’s net effective tax rate on Social Security–covered work, there is evidence that individuals and two-earner couples do respond rationally to these disincentives. As Jeffrey B. Liebman, Erzo F. P. Luttner, and David G. Seif point out in a 2008 study, “Our estimates conclusively reject the notion that labor supply is completely unresponsive to the incentives generated by the Social Security benefit rules. We find reasonably robust and statistically significant evidence that individuals are more likely to retire when the effective marginal Social Security tax is high.”[39] For most seniors, these effective marginal tax rates are indeed enormously high.

These various features of Social Security—from the technical details of its benefit formula, to the earnings limitation, to the benefit eligibility at age 62, to the nonworking spouse benefit, to others—all act as a drag on labor-force participation and thus interfere with the goal of maximizing future economic growth.

The Fiscal Importance of Labor-Force Participation 

The financial unsustainability of current federal entitlement programs is substantially attributable to insufficient projected growth in the US labor force. This conclusion can be substantiated by some simple math. Social Security’s initial benefit formula, for example, increases along with growth in the national Average Wage Index.[40] Because program payroll tax revenues also automatically grow with national wages, this benefit formula would be financially sustainable within a stable tax rate if the worker-to-beneficiary ratio never declined—or in other words, if gains in longevity and health were always matched by proportional increases in the duration of workers’ taxpaying careers.[41] This proportionality, however, is not being maintained. Worker– beneficiary ratios are projected to become much more unfavorable going forward.

Though press attention rightly focuses on how the Baby Boomers’ Social Security and Medicare benefit claims will increase federal spending, the other side of the coin is the corresponding reduction in labor force growth rates as the Boomers cease working. Whereas from 1963 through 1990 inclusive annual labor-force growth rates never once dropped below 1.2 percent despite periodic recessions, from 2019 onward labor force growth rates are projected never to exceed even half that rate (0.6 percent).[42] Thus, to the extent that Baby Boomers and subsequent generations perceive greater rewards for extending their working lives, the picture of our national economic future will brighten enormously.

It bears emphasis that workforce participation trends among those in their 60s are not driven primarily by issues of physical incapacity. Labor-force participation among males over 65 was much higher in the mid-20th century than it is now despite substantial gains in national health and longevity since then. Incentives have played a much greater role. Beyond the fact that it is generally more attractive to enjoy additional years of leisure rather than to continue work, our federal entitlement policies have made the decision to retire virtually irresistible financially as well. Given these incentives, it is unsurprising that our future economic growth outlook is depressed by current projections for labor-force participation, relative to what would be the case if more of our national gains in longevity and health were converted into longer periods of taxpaying work.

The economic benefits of longer working careers well exceed, however, what is shown in federal scorekeepers’ analyses of program finances. Repeal of the Social Security earnings limitation, for example, is scored under current SSA methodology as actuarially neutral, although it would almost certainly incentivize longer working careers, both generating additional government tax revenue and benefiting the economy as a whole. Similarly, proposals to raise Social Security’s EEA of 62 are not scored by the Social Security actuaries as producing direct financial gains for the program, though the change would better incentivize taxpaying work by those in their early 60s.

A recent Congressional Budget Office (CBO) analysis of raising the EEA acknowledges this effect conceptually but does not attempt to quantify it: “This option also would probably lead workers to remain employed longer, which would increase the size of the workforce and boost federal revenues from income and payroll taxes. Moreover, the additional work would result in higher future Social Security benefits, although the increase in benefits would be smaller than the increase in revenues.” But “the 10-year estimates for this option do not include those two effects.”[43] Other CBO analyses, including those of the Diamond-Orszag and the Bush Com- mission’s proposals, quantify some potential advantages of reforming Social Security benefits for promoting economic growth. CBO found that the Bush Commission plan to constrain the growth of benefits beyond price inflation would increase national GNP relative to the budget baseline, whereas the Diamond-Orszag proposal to raise Social Security taxes would reduce it. These findings in turn reflected analyses that the Bush Com- mission proposal “could cause some people to work longer or harder,”[44] whereas under the Diamond-Orszag proposal, “households would choose more leisure.”[45]

Extended workforce participation would pay dividends for individual seniors as well as for the economy as a whole. As Butrica and her coauthors noted in 2004, “Working longer increases the net output and productiv- ity of the economy, generates additional payroll and income tax revenue, and reduces the number of years that individuals receive retirement benefits. . . . [P]eople could increase their annual consumption at older ages by more than 25 percent simply by retiring at age 67 instead of age 62. The increased tax revenues generated by this work could be used to support a wide range of government services, including public support for the aged.”[46]

For these and many other reasons, Social Security reform as well as broader entitlement reform should be undertaken with an eye toward rewarding those in late middle age who decide to extend their working careers.

Social Security Reforms to Improve Work Incentives

Bowles-Simpson and the Bipartisan Policy center Plans

The impact of Bowles-Simpson and the Social Security reforms of the Bipartisan Policy Center (BPC) on work incentives vary depending on the specific provision examined. While some reforms encourage greater participation in economic activity, others limit the desirability of work and could incentivize even earlier retirement. Some proposals would encourage significant behavioral shifts while others would encourage only marginal changes.

Both plans include the following policy recommendations that would encourage greater labor force participation: adjusting the cost-of-living adjustment (COLA) to be indexed according to a Chained-CPI-U, to account for substitution effects as consumers change what goods they purchase in response to changes in prices; reducing the growth of benefits for the highest-earning beneficiaries; and indexing the benefit formula for longevity. Of these three reforms, indexing the COLA to Chained-CPI-U would most increase the desirability of individual saving. President Obama has also proposed indexing the COLA to the Chained-CPI-U in his FY 2014 budget.

The proposed CPI-U price index accounts for living expenses for around 87 percent of the US population. It is a measure of inflation facing all urban consumers. The current CPI-W index, however, measures the higher rate of inflation experienced by all urban workers, roughly 32 percent of the population.[47] Because the W index represents a subset of the U population, many Social Security recipients experience inflation-adjusted wages that exceed their actual cost-of-living increases. Adjusted wages in excess of inflation incentivizes less individual saving and lower labor-force participation in exchange for greater reliance on Social Security.

The two other benefit reductions considered by the Bowles-Simpson and BPC plans are designed to make the benefit structure more progressive and to slow the growth of benefits for higher-income workers. The first would marginally reduce the growth of benefits for approximately the top 25 percent of beneficiaries. The proposal by BPC would slowly reduce the top bend point in the primary insurance amount (PIA) formula applied to a person’s average indexed monthly earnings from 15 percent to 10 percent over a 30-year period.48 For someone eligible for benefits in 2013, this percentage would apply to additional monthly covered earnings in excess of $4,768. The Bowles-Simpson plan would also adopt a more progressive benefit formula that slows the growth of benefits for higher-income earners by expanding the amount of earnings at the bottom end that are covered by the 90 percent replacement rate and would subject higher-income earners to a new and lower top-end replacement rate of 5 percent. While this reform should encourage the top 25 percent of beneficiaries to work longer and save more, a more progressive benefit formula that gives a higher benefit amount to lower-income workers could have the opposite effect and would not encourage additional saving or longer labor-force participation.

The second benefit change considered by both Bowles-Simpson and BPC is to adjust benefits for expected increases in longevity. As Americans live longer, the financial commitment of Social Security increases as well. Lifetime benefits for Social Security recipients are greater than ever and will continue to increase. BPC would reduce benefits beginning in 2023 (after the full retirement age increases to 67 under current law) by 0.3 percent each year in order to offset part of the additional costs of estimated longevity increases. Bowles-Simpson would gradually increase both the early eligibility age and normal retirement age to account for increases in longevity. Adjusting Social Security to reflect increases in longevity would encourage greater labor-force participation and saving.

The following policy recommendations would penalize the decision to work and encourage earlier retirement: raising the amount of income subject to payroll taxes and increasing the special minimum benefit. Raising the amount of income subject to payroll taxes could have negative implications for investment and saving levels. I won’t elaborate in detail in my testimony on the negative economic effects of raising payroll taxes, as previous witnesses have testified before this committee extensively on the topic.[49] But, in brief, raising Social Security payroll taxes would generally mean that people would work less, because the financial return from work has been decreased; save less, because they now have less after-tax income with which to save; and retire early, because the replacement rate of Social Security benefits will rise.[50]

The final policy recommendation from the BPC and Bowles-Simpson is to increase the special minimum benefit and to provide a “bump up” in benefits for beneficiaries in their 80s. The special minimum benefit was enacted in 1972 to provide minimum financial protection for low-income workers.[51] However, the current minimum benefit is adjusted for changes in prices, not wages. As wages have grown faster than prices, the PIA for most low-wage workers is higher than the special minimum PIA. The BPC plan would propose a special minimum benefit set at 133 percent of the poverty level for retirees with at least 30 years of covered work. The Bowles- Simpson plan would set the special minimum benefit at no less than 125 percent of the poverty level in 2017 and index it to wage growth thereafter. The proposed “bump up” is a small boost in income that retirees would receive between the ages of 81 and 85 (BPC plan), and for those on benefits 20 years after the earliest eligibility age (Bowles-Simpson), as saving levels tend to be significantly reduced once beneficiaries reach this age range.

The goal of the special minimum benefit and “bump up” for those in their 80s should be to reach beneficiaries who would otherwise be unable to provide for themselves rather than to provide a general welfare expansion for all retirees. Social Security’s benefit structure already discourages labor-force participation. So, while we should definitely ensure that our society’s most vulnerable members are protected against poverty, an expansion of the special minimum benefit should reach only those most in need in order to avoid having further negative impacts on the labor-force participation rate.

Raising the Early Eligibility 

With age 62 now the most popular age to claim benefits, raising the EEA would necessarily delay many claims and would likely correlate with continued employment.[52] Research has estimated that raising the EEA to 65 would increase long-run GDP by 3–4 percent.[53]

Several key points should be kept in mind with regard to raising the earliest eligibility age. First, an EEA increase of three years, for example, would merely bring the age of earliest eligibility to what it was at the program’s inception; it would not begin to adjust for the substantial health and longevity gains since. Period life expectancy at birth has grown by more than 14 years since 1940, while life expectancy at 65 has grown by more than six years.[54]

Second, raising the EEA to bring it closer to the NRA would likely reduce poverty among seniors, as they would be subject to a smaller early retirement penalty. As previously noted, annual benefits under Social Security law are adjusted downward from full benefit levels in proportion to how early one claims before reaching the NRA. This keeps expected lifetime benefits constant, regardless of the age of claim; some of the risk of old-age poverty resides with seniors who retire early, have “too low” an annual benefit, and then outlive their other savings.

Increase the Delayed Retirement Credit

Another positive work incentive could be created by increasing the program’s actuarial penalty for early retirement as well as its delayed retirement credit (DRC). The current actuarial penalty for early retirement is a 25 percent reduction in annual benefits for those who retire at 62, four years before the current NRA of 66, or about a 6 percent reduction for each year.

On the other hand, the delayed retirement credit is an 8 percent increase in annual benefits for each year (up to age 70) claims are delayed beyond the NRA. For someone delaying claiming benefits until age 70, this credit amounts to a 32 percent increase in the monthly benefit.[55] These current-law adjustments hold expected life- time benefits constant for a typical retiree, and thus do not account for the value of additional payroll taxes likely contributed if an individual delays claiming benefits and continues working. Increasing these adjustments may better reflect the value of additional payroll taxes contributed by working seniors.

Offering the DRC as a lump-sum option could potentially provide an additional incentive to continue work- ing, without adding a financial cost to the system. The current DRC offers an increase in one’s monthly Social Security benefit proportional to the time over which the benefit claim is delayed. However, only a minority (between 5 and 6 percent in 2011) take advantage of this option.[56] It is also worth noting that more than 70 percent of those claiming retirement benefits in 2011 did so before their normal retirement age, thus receiving reduced monthly benefits.[57] An option potentially more attractive to workers would be to allow an individual to receive the entire DRC as a lump sum when claimed, while also receiving the basic monthly benefit as it would have been calculated at NRA. This option could potentially allow claimants to receive a lump sum of tens of thousands dollars on the date of their delayed claim. Recent research by Jingjing Chai and his coauthors confirmed that offering a lump-sum option could boost the average retirement age by 1.5–2 years.[58]

The precise amount of a lump-sum DRC could be calculated to be the actuarial equivalent of the standard monthly DRC, thus creating no additional system costs but potentially spurring longer taxpaying work. But even if the lump sum were designed to be slightly smaller in present value than the DRC would have provided as a monthly benefit stream—thus producing a net improvement in system finances—many individuals might still find the lump-sum option more attractive because they would have immediate access to and control over the funds.

The various reforms mentioned above would likely be useful if enacted separately, but would work best in tandem. Steepening the actuarial penalty for early benefit claims could, despite its other policy benefits, potentially worsen some early claimants’ subsequent risk of poverty if enacted as a standalone measure, but would not do so if accompanied by an increase in the EEA. If the NRA is increased while the EEA is held at the current age of 62, a higher minimum benefit could be offered to those in physically challenging jobs unable to work past age 62. However, it is worth noting that SSA only has wage data available and determining which individuals would be allowed a higher minimum benefit at EEA, instead of a regular actuarial reduction, would be administratively challenging and burdensome to say the least, and may be impossible to administer.

As mentioned earlier in my testimony, both the Bowles-Simpson and BPC plans would offer an increased minimum benefit to protect low-wage workers, as well as a bump-up in the benefit amount for those in their 80s and the long-term disabled. While the Bowles-Simpson plan recommends increasing the early eligibility and normal retirement ages, the plan also recommends that the Social Security Administration be tasked with designing a policy that would allow a hardship exemption for those that cannot physically work past age 62.

Adjusting the Benefit Formula

Another potentially important work incentive reform would be to redesign the basic benefit formula so that it operates on each separate year of work rather than on one’s career average earnings. As discussed previously, the current formula causes one’s returns from Social Security to drop with extended work, as one’s career average earnings rise and the system’s progressive benefit formula thus delivers lower returns.

An alternative suggested by Charles Blahous, a public trustee for Social Security, would be to calculate benefits by considering every year of one’s earnings, rather than only the highest average 35 years of earnings.[59] In addition to greatly improving work incentives for seniors, this reform would have other advantages. For example, the current formula often mistakes intermittent high-wage earners for low-wage earners because their career “average earnings” look the same. This confusion causes problems in the treatment of those who move in and out of Social Security coverage—for example, higher-wage state and local employees and immigrants, whom the formula mistakes for needy low-wage workers—necessitating complex fixes such as the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO). Such controversial complexities would become unnecessary if Social Security simply accrued proportional benefits with each additional year of taxpaying work, since all intermittent workers would be treated the same, more in the fashion of a traditional private-sector pension.

Constraining Nonworking Spouse Benefits for High Earners 

Another work-incentive reform would be to gradually restrain the growth of nonworking spouse benefits associated with higher earners. The nonworking spouse benefit does play a useful role within Social Security by recognizing the value of stay-at-home work and of raising the next generation of wage earners. It is, however, inefficiently designed in that it is both regressive and a significant disincentive to paid employment. A two- earner couple both with low wages, for example, receives lower returns from Social Security than a high-wage one-earner couple,[60] despite the intended progressivity of the basic benefit formula.[61] Additionally, someone married to a high-earning spouse might well receive a higher nonworking spouse benefit than another individual might earn based on a full career of paying payroll taxes on modest annual earnings.

It is not necessary to eliminate the nonworking spouse benefit to address the inequities described above. One option is simply to constrain its growth so that no future nonworking spouse can receive a benefit exceeding the inflation-adjusted value of the benefits that today’s low-wage workers receive based on a full career of payroll tax contributions.

Payroll Tax Relief 

Others have suggested that payroll tax relief be offered to seniors who extend their working lives.[62] There are policy downsides to this approach. For example, it would reduce much-needed Social Security tax revenues, though it would increase regular income tax revenues. Also, if enacted in the wrong way, eliminating or reducing the payroll tax contributions for seniors could embody age discrimination. That said, the positive effects such a policy could have on labor participation by seniors should not be dismissed. Versions that avoid the age- discrimination pitfall have been put forward by Mark Warshawsky and John Shoven.[63] The basic idea would be to establish a status of being “paid up” under Social Security after a given number of years of contributions (45 in the Warshawsky formulation), after which no further payroll taxes would be collected. Notably, this change would offer a work incentive to individuals on the way to paid-up status, and not only upon reaching a given age.

One policy challenge associated with improving Social Security’s work incentives is that doing so will likely shift the distribution of Social Security income somewhat from women (who are more likely to have work interruptions to bear and raise children) to men (who are more likely to have longer working careers). This income shift is indeed a likely effect of enacting work-incentive repairs in isolation, and it is a concern if one wishes to preserve the full amount of income redistribution from men to women that occurs under current-law Social Security. The concern can be addressed, however, by making the basic benefit formula incrementally more progressive at the same time that work incentive improvements are enacted.[64]

There is no way to know for certain how much Americans in late middle age would respond to reforms to render Social Security friendlier to those who extend their working careers. Evidence from Liebman, Luttner, and Seif suggests that there would be a positive labor supply effect and thus a positive effect on federal revenues, retirement income security, and broader economic growth.[65] At a time when America desperately needs the labor productivity of our skilled, healthiest younger seniors to foster economic growth, we would do well to advance a Social Security system that sides with those who provide us with the benefits of their continued work.

Financial Literacy

The Social Security Administration plays a unique role in the financial security of millions of Americans, and in helping people better prepare for retirement. Therefore, both the Bowles-Simpson and BPC plans encourage the SSA to increase financial literacy efforts to inform people about their retirement choices and to increase savings. Specifically, the BPC plan

directs SSA to revise aggressively its communications and messaging around the retirement choice. The material provided to workers during their careers about the retirement decision must more clearly show the implications of collecting benefits at different ages. It must highlight the permanent financial consequences of this choice, not only for workers, but for spouses and survivors as well. In particular, SSA should remind workers of uncertainties in retirement, such as potential health-care costs and the possibility that they may live for many years after retiring.

Although people are living longer, a significant fraction of workers continues to start receiving Social Security benefits early, though this permanently reduces monthly benefits. Research links financial literacy and saving behavior, indicating that the less financially literate are also less likely to plan for retirement.[66] Better informing people about the full costs of claiming benefits early may lead to more people choosing to delay claiming until the full retirement age, or longer, thus improving labor-force participation among seniors. For example, an innovative study by Jeff Brown, Arie Kapteyn, and Olivia Mitchell uses the American Life Panel to experiment with different ways of framing monthly benefit information. The authors hold constant the factual information presented but vary how the information is presented to highlight the financial gains of delaying or claiming. That study finds that framing information strongly shaped respondents’ expected claiming ages.[67]

Promoting financial literacy should be done regardless of any Social Security reform plan, in part because research finds differences between how much people expect to receive in Social Security benefits when they retire and what they actually receive. For example, only 19 percent of workers can correctly identify the age at which they will be eligible for full benefits from Social Security.68 Further, the 2011 Retirement Confidence Survey (RCS) found that current workers are half as likely to expect Social Security to provide a major share of their income in retirement (33 percent) as current retirees are to say Social Security makes up a major share of their income (68 percent).[69] However, research conducted by the Employee Benefit Research Institute (EBRI) found that 60 percent of those aged 65 or older received at least three-quarters of their income from Social Security in 2009.[70] Additionally, although people are living longer, a significant fraction of workers continues to take Social Security benefits at age 62 even though this permanently reduces monthly benefits for the rest of their lives. Research also links financial literacy and saving behavior, indicating that the less financially literate are also less likely to plan for retirement.[71]

A number of Social Security reforms could be implemented that provide incentives to healthy seniors to continue working. Some of these changes would produce net direct savings for the program, whereas others would benefit individual participants at some expense to program finances. The following often-discussed proposals to raise Social Security eligibility ages would likely have a positive effect on worker output and economic growth.

Conclusion

Social Security faces real financial challenges. Dismissing the real and current fiscal challenges facing the Social Security system and kicking the “reform can” further down the road will only increase the severity of the burden associated with reforms when they inevitably must take place.

In order to ensure that Social Security remains solvent and continues to provide retirement security for generations to come, while minimizing the burden on current and future generations, reforms must happen sooner rather than later. The Social Security Trustees recommend that lawmakers address the projected trust fund shortfalls in a timely way in order to phase in necessary changes and give workers and beneficiaries time to adjust to them. Implementing changes soon would allow more generations to share in the needed revenue increases or reductions in scheduled benefits. Social Security will play a critical role the lives of 56 million beneficiaries and 159 million covered workers and their families in 2012. With informed discus- sion, creative thinking, and timely legislative action, Social Security can continue to protect future generations.[72]

These reforms should not only address the program’s fiscal solvency issues, but also remove the disincentives to working later in life.

Thank you again for your time and this opportunity to testify today. I look forward to your questions.

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