Time to Dump the Unfair Social Security Earnings Penalty

Commentary by Pete du Pont

We may be about to rid ourselves of the Social Security earnings penalty - and about time. Congress is supposed to consider eliminating it this year, and President Clinton has said he favors eliminating it. Opposition to the proposal has yet to surface. And the budgetary arguments against it, always based on suspicious economics, have been weakened by a surging economy.

The earnings penalty applies only to wage income. In other words, if you're over 65 years old and not yet 70, you can earn thousands or millions of dollars from your investments and still draw full Social Security benefits. But if you actually work at a real job, the government takes away one dollar of your Social Security benefits for every three dollars you earn above $17,000 per year.

Or if you begin drawing Social Security benefits at age 62, the government takes away a dollar of benefits for every two dollars you earn above $10,080 - until you get to be 65, when you become subject to the lesser earnings penalty.

Once you reach 70, there isn't any earnings penalty.

If this sounds unfair, that's because it is. As my National Center for Policy Analysis colleague Bruce Bartlett recently said in testimony before the House Ways and Means Subcommittee on Social Security, "This disparate treatment makes a mockery of the notion that Social Security is an earned benefit that people are entitled to by virtue of long years of work. It makes Social Security equivalent to a welfare program where benefits are rightly withdrawn from people who no longer need them."

The Social Security Administration says 743,000 workers from 65 to 70 years old had their benefits reduced in 1995 (the latest year for which a count is available). Of this group, 214,000 lost all their benefits. Another 152,000 workers didn't even apply for benefits because they earned more than the limit.

When retirees are penalized by the earnings limit, their nonworking spouses and minor children are also penalized because the family benefit is also affected. In 1995, that meant 62,000 females and 2,000 males lost these secondary benefits.

The earnings penalty actually is an additional tax on elderly workers' earnings - imposing a 33% marginal tax rate on those ages 65 through 69 and a 50% marginal tax rate on those ages 62 through 64. Add to that the 15.3% in Social Security and Medicare payroll tax that the worker and the employer pay together (most economists agree that the employer share ultimately is borne by the employee), and a 65-year-old worker in the 15% income tax bracket faces a marginal tax rate of 63%. A 62-year-old who's drawing benefits and working faces a marginal tax rate of 80%. And that's before considering any state taxes.

Given these amazing statistics, it is little wonder that fewer and fewer retirees choose to work. In 1949, 47% of men over age 65 were in the labor force. By last year, the figure was 16.9%.

The earnings test is a relic from the days of the Great Depression when Social Security originally was enacted. The idea was to get older workers out of the labor force to make room for more younger workers. Whether this made good economic sense back then or not, it doesn't any longer. Now we have a shortage of workers, especially well-educated and experienced workers.

For a long time, some members of Congress from both parties have argued that the earnings penalty should be eliminated, but their proposals have run up against budgetary considerations: dropping the earnings test would mean the government would have to pay additional billions of dollars in Social Security benefits.

These were, and are, short-sighted arguments. If Social Security beneficiaries were allowed to earn more, they would pay more taxes - including Social Security taxes. However, what is perhaps of even more importance is what is called the "delayed retirement credit." People who don't start drawing benefits when they're 65 years old get a higher monthly benefit whenever they do start. The National Bureau of Economic Research has said that most workers would get more total benefits over the rest of their lives if they didn't start drawing Social Security at age 65.

When the Social Security Act was passed, we were in the Great Depression and the male life expectancy at birth was less than 65 years. Obviously, much has changed since 1935. Congress has an opportunity to do something long overdue: repeal the Social Security earnings penalty.

 

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The National Center for Policy Analysis is a public policy research institute founded in 1983 and internationally known for its studies on public policy issues. The NCPA is headquartered in Dallas, Texas, with an office in Washington, D.C.