NEW EVIDENCE ON THE PHONY "RETIREMENT CRISIS" / THE WALL STREET JOURNAL OP EDITORIAL

New Evidence on the Phony ‘Retirement Crisis’

A CBO study shows that Social Security benefits are far from meager, despite progressive claims.

By Andrew G. Biggs

   

Photo: Getty Images/Tetra images RF    

 

 

Every Democrat running for president has pledged to increase Social Security benefits, on grounds that Americans’ retirement savings are inadequate and the costs are affordable. Republicans in the race instead focus on restoring Social Security to solvency—by reducing benefits for high earners or raising the retirement age—and expanding opportunities for Americans to save. New data released Dec. 15 by the Congressional Budget Office suggest that the Republican approach is better grounded.
 
It’s almost dogma among today’s progressives that Americans face a “retirement crisis” due in part to stingy Social Security benefits. But how do we know if this crisis is real? One common measure compares a household’s Social Security benefits or total retirement income with its pre-retirement earnings. Most financial advisers believe that a “replacement rate” of 70%-80% is sufficient, since the cost of living falls once a person stops working.

The question then turns on how best to measure replacement rates. Financial advisers compare retirement income to a household’s earnings in a single year—the year before retirement. The problem is that a single year’s earnings may not reflect a household’s true standard of living.

The Social Security Administration instead calculates replacement rates using career-average earnings, but indexed for the growth of wages economy-wide. The problem here is that the SSA’s wage-indexing overstates the true purchasing power of lifetime earnings by about 20%, and makes Social Security replacement rates—which the SSA says average only around 40%—seem low.

The bipartisan Social Security Advisory Board appointed an expert panel, headed by Boston College economist Alicia Munnell, to look into the issue. After almost a year of deliberations, the panel recommended in September that replacement rates be calculated relative to an average of several years of late-in-life earnings. Years of very low earnings should not be counted, it said, since many people shift to part-time work before retirement. The panel also said the focus should be on individuals with reasonably full working careers, since replacement rates aren’t very meaningful for individuals with short careers.

Following the panel’s recommendations, economists at the Congressional Budget Office compared retirees’ Social Security benefits to the inflation-indexed average of their last five years of substantial earnings, defined as annual earnings equal to at least half the individual’s career-long average. The calculations were restricted to retirees who had earned at least 10% of the national average wage over at least 20 years of work.

The results are striking: The CBO projects that a typical middle-income individual born in the 1960s and retiring in the 2020s will be eligible for a Social Security benefit equal to 56% of his late-in-life earnings. For individuals in the bottom fifth of lifetime earnings, Social Security replaces about 95% of their substantial late-in-life earnings.

Even so, the CBO excluded the spousal or widow’s benefits that more than one-third of female retirees receive on top of the benefit based on their own earnings. Among retired women who receive these auxiliary benefits, the average total monthly benefit was $1,128, versus $634 based only on their own earnings. In short, the true replacement rates for many retired women are significantly higher than CBO figures show.

Add in 401(k) and other plans, and it should not be difficult for a typical worker to achieve a total replacement rate of 70% or even 80% through individual savings and Social Security benefits. Total retirement savings measured by the Federal Reserve are at record levels relative to personal incomes, additional evidence that this goal can be reached.

Overall, the CBO’s Social Security figures, taken together with rising individual retirement savings, undercut the often-voiced claim that Americans face a “retirement crisis” that only an expanded Social Security program can fix.

Nevertheless, the CBO report also brings sobering news. The agency projects that the Social Security program is underfunded by 24% over the next 75 years. Raising the payroll tax rate to restore its solvency would require an immediate and permanent 4.37 percentage-point increase to the existing 12.4% tax.

To restore the program’s solvency, some want to remove the ceiling on earnings subject to the Social Security payroll tax—currently $118,500. That was the progressives’ favorite proposal, until they decided to instead to use much of the additional revenues to increase benefits.

However, taxing all earnings would fill only 41% of Social Security’s long-term deficit. Fixing the rest would require either cutting benefits or raising taxes on lower-earning households, which Democratic front-runner Hillary Clinton has pledged not to do.

The CBO’s new replacement-rate figures show that Social Security’s promised benefit levels are far more adequate than is often portrayed. But the program is far short of being able to pay what it has promised. Both sets of figures show the folly of expanding benefits before Social Security’s underlying finances are fixed.


Mr. Biggs is a resident scholar at the American Enterprise Institute. From 2007-08 he served as principal deputy commissioner of the Social Security Administration.