The Fallacies Underlying the Warren Social Security Plan

By Charles Blahous of Mercatus. Excerpts:

"Problem #1: Misunderstanding Social Security benefits and replacement rates. In arguing for an across-the-board Social Security benefit increase, Sen. Warren writes:

“For someone who worked their entire adult life at an average wage and retired this year at the age of 66, Social Security will replace just 41% of what they used to make. That’s well short of the 70% many financial advisers recommend for a decent retirement—one that allows you to keep living in your home, go to a doctor when you’re sick, and get the prescription drugs you need.”

This presentation is inaccurate. The 41% percentage cited by Sen. Warren comes from a Social Security Administration (SSA) Actuary’s office memo, and is not actually a percentage of what a retiree “used to make” while working. Instead it is a percentage of the worker’s prior earnings “wage-indexed to the year before retirement”—that is, multiplied by subsequent average wage growth in the national economy. In other words, it’s not a comparison of that individual’s retirement benefits to his or her own previous earnings, but instead to the earnings of others who are working at the time the beneficiary retires. While this comparison may be of interest to some, it is not a measure of the degree to which retirees maintain their own pre-retirement standards of living.

This is a very significant error that essentially invalidates the argument advanced above. The nonpartisan Congressional Budget Office (CBO) recently reported that Social Security will provide the average retiree born in the 1960s a benefit equal to 55% of the average inflation-adjusted value of their own career earnings. For workers in the lowest-income quintile, the average replacement rate is a much higher 80%.

When Sen. Warren’s mistaken interpretation of Social Security replacement rates is corrected, her foundational case for an across-the-board benefit increase disappears. Social Security replacement rates for low-income workers are already above the level Sen. Warren cites financial advisers as recommending, so they cannot be further increased without causing these Americans’ standards of living as workers to be much lower than they would later be as beneficiaries. In addition to being problematic for the workers themselves, this perverse outcome would create huge disincentives for labor-force participation and personal saving. Even middle-income Americans are already in a situation where Social Security is crowding out much of the saving they could or would otherwise do on their own for retirement. Unless we want to have Social Security displace nearly all long-term saving done by the lion’s share of Americans, the across-the-board benefit increase specified in Sen. Warren’s proposal runs counter to widely-expressed societal objectives for Social Security—namely, to provide a base of income protection underlying other retirement saving."

"Problem #2: Misunderstanding benefit increases under current law. Sen. Warren’s piece also contains the following statement in support of the case for an across-the-board benefit increase:

“…Congress hasn’t increased Social Security benefits in nearly 50 years.”

What this sentence omits is critical: a core reason no such legislation has been enacted in nearly 50 years is that federal law was changed back then to cause Social Security benefits to increase automatically without Congress having to act. Prior to the 1970s, Social Security operated very differently. Before then, Social Security benefits didn’t increase unless Congress enacted legislation to increase them. But in 1972, Congress passed a law (amended in 1977) that would cause Social Security benefit levels to increase over time, not only in absolute terms, but substantially faster than consumer price inflation. While people can differ over how large and generous the Social Security program should be, it is inaccurate to suggest that its benefits haven’t increased in nearly 50 years. The following graph shows how benefits for medium-wage workers have increased in real (inflation-adjusted $2019) dollars in recent decades.

Social Security Benefits Increase Automatically Under Current Law

Instead of failing to increase Social Security benefits, we have the opposite situation: The current benefit formula causes benefits and costs to grow faster than our economic capacity and faster than workers’ earnings. It has been known since the 1970s that this rate of cost growth cannot be financed via a stable tax rate. Congress’s Social Security Consultant Panel cautioned back in 1976, “this Panel gravely doubts the fairness and wisdom of now promising benefits at such a level that we must commit our sons and daughters to a higher tax rate than we ourselves are willing to pay.” Sen. Warren’s proposal would cause the required tax increases to rise even faster, while her statement above creates a misimpression that is exactly opposite of what is happening. Instead of reflecting the reality that program benefits and costs are growing faster than is sustainable (as shown in the following figure reproduced directly from the Social Security trustees’ report), it fosters confusion to the effect that benefits haven’t been increasing at all."

"Problem #6: Mismeasuring inflation. The Warren plan would use an experimental index called the CPI-E to calculate beneficiaries’ annual cost-of-living adjustments. As I stated in a previous piece about another Social Security bill, “there is a general consensus among economists that CPI-E overstates price inflation relative to CPI-W (the measure Social Security currently uses), which in turn overstates inflation relative to C-CPI-U, a more accurate measure tracked by the Bureau of Labor Statistics. Relative to accurate inflation indexing, the bill’s CPI-E would cause COLA overpayments of roughly 0.5 percentage points annually. . . . These overpayments would disproportionately benefit higher-income seniors who live longer, pushing costs and worker tax burdens higher.”"