Opinion Editorial

Monday, May 24, 1999  

Social Security Is A Bad Deal For Low-Income Workers

One of the main barriers to fixing Social Security is its progressivity. Those with low incomes get relatively higher benefits than those with high incomes. This is a problem because all proposed fixes would diminish redistribution to some degree. However, a new study shows that Social Security is not nearly as progressive as it seems, which may improve the prospects for reform.

Economists Julia Lynn Coronado, Don Fullerton and Thomas Glass look at redistribution through the Social Security system.

  • They calculate that over a lifetime, someone in the lowest 20 percent of households in terms of income will get back about twice as much in benefits as they pay in taxes: $64,700 in taxes versus $125,700 in benefits.

  • By contrast, someone in the top quintile will only get about a third more in benefits than they pay in taxes: $141,400 versus $187,000.

These figures, however, are not adjusted for the time value of money. One dollar of taxes paid early in life is treated the same as a dollar of benefits received 50 years or more later. To make a more accurate calculation, one must use a discount rate that adjusts for the fact that a dollar in the future, even without inflation, is not worth as much as a dollar today.

  • Using a two percent discount rate dramatically lowers lifetime net benefits (benefits received less taxes paid) for all income groups (see figure).

  • In fact, every group has a negative return in present value terms (adjusted for the discount rate), with those at the bottom losing the least.

The economists also make an adjustment for differing mortality rates. Because those with high lifetime incomes tend to live longer than those with low incomes, such an adjustment improves net benefits for the top quintile while reducing benefits for the bottom quintile. All groups are still losing out in present value terms, but the loss for the wealthy is reduced, while it is increased for the poor.

Using this framework, Coronado, Fullerton and Glass looked at some proposals to fix the Social Security system and put it on a sound financial footing. They find that raising the retirement age, raising taxes or reducing benefits all disproportionately hurt the poor.

Privatization, therefore, turns out to be better for the poor than is commonly believed. Although Social Security's redistributive element would be lost, all groups would at least get a positive rate of return. True, the poor would not benefit as much as the rich, but they would still be better off than under the status quo.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, May 24, 1999.

For NBER text http://www.nber.org/papers/w6989

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