Friday, February 24, 2017
Thinking About The Social Security Cutoff
Having a Social Security cutoff just seems to be unfair. Everyone this year who earns less than $118,500 pays 6.2% of their income for Social Security taxes. Those who make more than that stop paying after they reach the limit. Long before they reach $1 million, they are paying at a rate of less than one percent but remain eligible for benefits.
But wait. There is also a cutoff for benefits. Social Security was set up to function like an annuity, make regular payments over time and then collect monthly benefits. And the benefits are skewed in favor of the less fortunate. Below is a graph showing benefits at full retirement age for a person earning between $15,000 per year, about minimum wage, up to a person making $125,000, just above the cutoff. (I used the AARP benefit calculator to find the various benefit levels leaving all variables other than income the same.)
It is clear how the size of the increases in benefits flatten out as income increases. Social Security replaces 68% of the lowest worker’s income and only 28% on the high side, even though each pays in 6.2%.
A few thoughts come from this. First, Social Security has been characterized as an annuity, but it has been administered as a pay-as-you-go program. Today’s workers pay today’s retirees. If the rich were forced to pay the tax on all income, it no longer looks like an annuity or insurance or an investment. It looks more like what it really is, a tax collected from everyone to finance a pension program for everyone.
Presumably if they eliminated the earnings cap, they would leave the maximum benefit alone, so people making $1 million would pay $62,000 per year in taxes to later collect benefits equal to $31,700 per year. Not a good deal for them.
This might be an excellent approach, because it would get rid of all the misunderstandings about non-existent lock boxes and a bogus trust fund and people wrongly believing they are collecting their own money that they paid in over the years. They simply paid a tax to the government to cover current and future benefits paid out. That is really the way it works. So, it would be more honest and would collect more money to finance a program in danger of running out of funds. This one change would fix the majority of the shortfall.
The biggest problem with Social Security is that it’s running out of money. A close second is that Americans either don’t take the time to understand how it really works or when they are told, they go into denial because it’s not what they wanted to hear.
On a side note, in my research I found several articles critical of Social Security saying it treated the poor unfairly. This was spurred by a book-length report on life expectancy from the National Academy of Sciences saying that low-income Americans tended to have shorter lifespans, almost 13 years shorter comparing those who have reached age 50. Because they didn’t collect for as many years, the poor were getting shortchanged. The difference in life expectancy was attributed to several factors, some of which were behavioral choices, like smoking, drinking, and poor diet.
Out of curiosity, I used the data I had to compare the highest wage benefits to the lowest wage benefits to find what percent of annual earnings each would receive over a lifetime by applying the age differences in the study. The poorest still received a larger percentage, 6.8 times their annual earnings compared to 5.8 times for the higher earners.
Now, mine was a crude comparison, but any difference couldn’t be as unfair as some of these articles would have us believe. Besides, how can you cheat people out of money they can only collect when they are alive if they're dead? Remember, it’s not really anything like getting back the money you paid in. It’s really a tax to pay current retirees. I guess the purpose of the articles is to make us feel guilty. People who are not critical thinkers seem to spend a lot more time feeling guilty about made up numbers and controllable problems than they should.