How Much Do Americans Depend on Social Security?

Studies | Social Security

No. 301
Tuesday, August 07, 2007
by Laurence J. Kotlikoff, Ben Marx and Pietro Rizza


Effects of Moderate Reductions in Social Security Benefits

"A 30 percent cut in Social Security benefits would substantially reduce the retirement income of 65 year olds."

A reduction in benefits — particularly the benefits of higher-income households — is possible to balance Social Security's large projected deficits. As expected, even small cuts would reduce the living standards of low earners. But the highest earners will also be affected.

Effects of a 30 Percent Benefit Cut on Older Households. A 30 percent cut in benefits would significantly affect all 65-year-old households approaching retirement because they would have little time to compensate through additional saving. Indeed, the reductions in consumption of these older households would range from 11 percent for the highest-income households to 32.2 percent for low-income households. For example [see Figure VI]:

  • The couple with a preretirement income of $100,000 a year who would have had $40,456 in discretionary consumption at retirement with full Social Security benefits would have only $29,541, or 27 percent less discretionary consumption.
  • The couple with a preretirement income of $200,000 who would have had $55,247 in discretionary consumption at retirement would have only $42,989, or 22 percent less.
  • Finally, the couple with a preretirement income of $500,000 who would have had $108,454 in discretionary consumption at retirement would have only $97,087, 11 percent less.
Figure VII: Discretionary Consumption at Retirement of 65-Year-Old Singles after a  30 Percent Social Security Benefit Cut

Like the couples, 65-year-old singles would have less discretionary retirement consumption [see Figure VII] with the 30 percent benefit cut:

  • The single with a preretirement income of $50,000 a year who would have had $21,312 in discretionary consumption at retirement with full benefits would only have $15,261, about 28 percent less.
  • The single with a preretirement income of $100,000 a year who would have had discretionary consumption of $29,279, will have only $22,990, almost 22 percent less.
  • The single earning $250,000 a year who would have had discretionary consumption of $49,691 will have only $43,923, about 12 percent less.

"Younger households would reduce their current consumption spending very little to increase their savings."

Effects of a 30 Percent Benefit Cut on Younger Households. The effect of the announced benefit cuts on current living standards depends a lot on the age of the household. The 35-year-old households have decades to compensate for a reduction in Social Security benefits by increasing their savings. But they reduce their current consumption by very little. The reason for this is that couples with annual incomes of less than $100,000 are borrowing constrained [see the sidebar on Smoothing Consumption]. They cannot reduce their current consumption by much in order to increase their savings rate. 8 As a result, they will experience a larger reduction in their retirement standard of living than if they had been able to reduce their current consumption when younger. In fact, with the exception of those earning $500,000 a year, at age 65 all income levels will have at least 15 percent less discretionary consumption than they would otherwise. Only the top income earners will face minimal reductions in their retirement standard of living.

Figure VIII: Discretionary Consumption at Retirement of 35-Year-Old Couples after a  30 Percent Social Security Benefit Cut

Among 35-year-old couples [see Table I and Figure VIII]:

  • Couples with annual incomes of $100,000 would reduce their current consumption only three-tenths of one percent, from $43,860 to $43,710!
  • At retirement, these couples would have $36,481 annually for discretionary consumption, almost 16 percent less than the $43,276 they would have had with full benefits.
  • Couples earning $200,000 a year would reduce their current consumption only one-tenth of one percent, from $74,508 to $74,402.
  • But at retirement, these couples would have $55,099 in discretionary income, about 15 percent less than the $64,938 they expected.

"Younger couples at most income levels would face a reduction in their living standards at retirement."

However, 35-year-old couples with annual incomes of half a million dollars would reduce their current consumption by about 5 percent — more than any other income level — from $169,301 to $160,313. At retirement, they would have $111,868 in discretionary income, only 5 percent less than the $118,140 they would have had for discretionary consumption with full benefits. Thus, they are able to spread the loss of their Social Security benefits over their remaining lives.

For 35-year-old single earners [see Table II and Figure IX]:

  • Those with annual incomes of $50,000 would reduce their current consumption only one-tenth of one percent, from $24,918 to $24,904.
  • At retirement, these singles would have $19,008 in discretionary income, about 18 percent less than the $23,081 they would have had available to consume with full benefits.
  • Singles with annual incomes of $100,000 would not reduce their current consumption at all, but maintain it at $42,456 a year.
  • At retirement, they would have $28,400 in consumption income, 15 percent less than the $33,561 they would have had with full benefits.

Figure IX: Discretionary Consumption at Retirement of 35-Year-Old Singles after a 30 Percent Social Security Benefit Cut

 

"Only the wealthiest young individuals would fully adjust to 30 percent benefit cuts."

Finally, the highest-earning singles, with annual incomes of $250,000, would reduce their current consumption 5 percent, from $100,414 to $95,179. At retirement, they would have $52,569 to consume, only about 5 percent less than the $55,460 they would have consumed with full benefits.


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