Don’t Gut Private Savings to Save Social Security

By Veronique de Rugy.

"Social Security needs fixing. That’s an understatement. Unless it’s fixed, benefits will be cut across the board by over 20 percent in the next ten years. But the way to go about fixing Social Security isn’t to put it on life support with revenue taken from gutting private savings.

Yet, such a bailout is the somewhat surprising proposal made recently by the American Enterprise Institute’s Andrew Biggs and Boston College’s Alicia Munnell in a new report titled “The Case for Using Subsidies for Retirement Plans to Fix Social Security.” They suggest ending the tax treatment of employer-sponsored retirement plans and IRAs, which they claim isn’t working well at incentivizing savings and is, as of 2020, a $185 billion tax break for the rich. That revenue would then be used to bail out Social Security.

A few scholars have already registered their opposition to this proposal: Adam Michel of the Cato Institute, AEI’s Stan Verger and Hoover Institution’s Josh Rauh, Dan Mitchell of the Center for Freedom and Prosperity, the Mercatus Center’s Charles Blahous, Bipartisan Policy Center’s Jason Fichtner, and me. There is some pushback on X, too.

We all point to Biggs’s and Munnell’s mischaracterization of the tax treatments of savings. Yes, there is a current tax-deferred treatment of retirement savings accounts, including employer-sponsored retirement plans and IRAs. But the reason for this treatment isn’t a desire to favor the rich, as Munnell and Biggs claim. It’s also not only about encouraging savings (although it does that too). Instead, it is one means of preventing the double taxation of some savings. As Blahous, Fitchner, and I note, “the money that individuals set aside in such accounts is typically income that has already been taxed, in the case of a Roth-style account, or, in the case of a traditional IRA, will be taxed only once upon withdrawal.”

Eliminating or reducing the tax advantages of accounts like 401(k)s and IRAs would amount to double taxing all savings. It would discourage private savings, making more people dependent on Social Security for their retirement. I recommend reading Michel’s piece, as well as Rauh and Veuger’s article, for a much more complete refutation of the claim that tax-deferred saving accounts do not increase savings. A tidbit from Rauh and Veuger:

But even setting those considerations aside, it is not at all clear that TDAs [tax-deferred saving accounts] do not increase national saving. Biggs and Munnell rely heavily on a study that looks at a policy change in Denmark that made one type of TDA less attractive. In response, some but not all savers stop relying on this type of TDA, only to pivot toward a different kind, as one might expect. It is not at all clear how this evidence relates to net savings in the absence of TDAs altogether. In fact, the same study finds significant increases in total savings from employer contributions to TDAs and from mandatory contributions to retirement accounts: households did not offset these elsewhere.

And here’s a summary of Michel’s point on this:

The crux of their argument—that tax‐​advantaged retirement accounts “do little to increase retirement saving”—is an overconfident misinterpretation of the academic literature that does not acknowledge the broader economic benefits of private saving.

The overwhelming evidence is that tax‐​advantaged accounts significantly increase private savings. Over time, even small increases in private savings can contribute to a larger capital stock, additional labor supply, and a bigger economy. The private benefits to additional saving, combined with the broader economic benefits, outweigh any temporary government losses, even if the lower revenue does not induce a one‐​for‐​one increase in private savings.

This leads me to the most problematic aspect of the paper: the idea that we should bail out Social Security with more revenue. There are many reasons to avoid such a move. Blahous, Fichtner, and I note that:

Social Security has its problems and challenges. It also has some cardinal virtues, however, one of them being that it’s not permitted to spend more on benefits than the resources collected for its trust funds, the vast majority of which consist of payroll taxes paid by participating workers. Individually, one’s Social Security benefit is a direct function of one’s earnings subject to the Social Security tax, and collectively, the program may not pay more in benefits than workers are deemed to have funded with their contributions. This is the critical distinction that separates Social Security from welfare both politically and substantively. Largely because of this feature, workers’ Social Security benefits have historically been secure and reliable, without the persistent renegotiation of eligibility rules and benefit levels to which welfare programs are subjected.

To bail out Social Security with general revenues, regardless of the rationale, would effectively put an end to Social Security’s continued functioning as an earned-benefit program. Thereafter, there would be no rhyme or reason to the benefit levels that Social Security offers. Once disconnected from the amounts of workers’ contributions, benefits would simply be whatever politicians say they are. This would be the worst of both worlds from a policy standpoint, in that program spending would effectively be unleashed from the constraints of self-financing, while at the same time workers’ benefits would be less secure, since they could no longer be defended as earned. Social Security would simultaneously become more expensive and less reliable.

Importantly, the changes proposed by Biggs and Munnell also would effectively eliminate any remaining incentives for legislators to engage in the challenging but necessary task of moderating Social Security’s benefit growth. The fundamental problem underlying Social Security’s finances is not primarily a revenue deficiency; rather, it’s that its rate of automatic cost growth is persistently faster than the growth of its tax base in workers’ earnings and indeed faster than the growth of GDP.

Congress has proven its inability to reliably manage retirement income for American retirees. Using the savings of Americans who have diligently saved for their future, to compensate for the deficit created by Congress, is troubling to say the least."