How Much Do Americans Depend on Social Security?
Tuesday, August 07, 2007
by Laurence J. Kotlikoff, Ben Marx and Pietro Rizza
Table of Contents
Social Security benefits over the next 75 years will exceed payroll tax revenues by $4.6 trillion. To close this enormous fiscal gap, one proposal is to cut the benefits of high-income workers. Many low-income workers depend almost entirely on Social Security for their retirement income, but it is often assumed that high-wage workers can maintain their standard of living without Social Security benefits due to their private pensions and savings. Surprisingly, however, even high-wage workers depend on Social Security for a substantial portion of their retirement income and would significantly change their consumption and saving behavior in the absence of Social Security. Specifically:
- Social Security accounts for virtually all of the discretionary consumption of households with modest preretirement incomes (less than $50,000 a year for couples or $25,000 for singles).
- It is equal to about one-third of the consumption of the highest-earning households (couples with preretirement incomes of $500,000 and singles with $250,000).
This study is based on modeling of representative households. Living standards are measured by the dollars available for discretionary consumption after subtracting such “off the top” expenditures as taxes, contributions to tax-favored savings, mortgage payments, college tuition and life insurance premiums. The model assumes that, other things equal, people will try to maintain their standard of living by evening out their consumption over their remaining lifetimes.
There are two ways people can smooth their lifetime consumption: 1) They can borrow in order to increase their current consumption, or 2) They can save in order to increase their future spendable income. Borrowing requires them to lower their future standard of living (as they pay back the debt), while saving requires them to lower their current standard of living (by cutting spending). However, this is difficult for lower income people. Due to their current obligations, they often cannot increase their retirement savings. Also, they are limited in their ability to borrow in order to increase their current consumption. If Social Security were abolished tomorrow, younger households would have many years to adjust, but only the wealthiest would be able to spread the loss of Social Security benefits evenly over the whole of their remaining lives. The high-earners would reduce their consumption by about 18 percent for every remaining year of life.
People with less income could not adjust fully to the loss of Social Security benefits by reduced consumption and increased savings. As a result, they would face substantial reductions in their living standards at retirement:
- If Social Security were abolished tomorrow, 35-year-old couples with annual incomes of $200,000 would reduce their current consumption almost 24 percent; but at retirement, they would have 39 percent less discretionary consumption than under the current system.
- Singles earning $100,000 a year would reduce their current consumption about 16 percent; but at retirement they would have about 42 percent less.
What about a less drastic cut in benefits? In the face of a 30 percent cut in benefits, even the highest-income retirees would reduce their consumption by 11 percent. Low-income retirees would reduce their consumption almost dollar for dollar with the benefit cut.
Although they would have much more time to adjust, younger households at most income levels would make only minor changes prior to retirement. For example:
- Thirty-five-year-old couples earning $20,000 to $200,000 would reduce their current consumption spending by less than one-half a percent if faced with a 30 percent benefit cut; however, they would have 15 percent to 29 percent less discretionary consumption at retirement.
- The highest income couples, earning $500,000 a year, would smooth out their consumption by reducing it by more than 5 percent per year for every remaining year of life.
These results imply that workers at every income level depend substantially on Social Security. If retirement benefits were eliminated for middle-aged workers, only the highest-earning couples would be able to maintain their standard of living pre- and post-retirement. However, many workers with modest incomes would find the necessary adjustments difficult or impossible to make.