Indeed, Social Security needs shoring up to help solve the looming retirement crises. If we do nothing, the number of poor or near-poor people over the age of 62 will increase by 25% between 2018 and 2045, from 17.5 million to 21.8 million. And, in the next 12 years, 40% of middle-class older workers will be poor and near poor elders.
Why not just expand Social Security to solve the retirement crises? If we expanded Social Security to provide adequate retirement for the vast majority of American workers payroll taxes would rise to nearly over 25% percent of pay– up from 12.4%.
What Other Nations Do
Rarely do nations secure pensions for all workers with a just a PAYGO system. Nations that achieve widespread retirement security do so with both advanced–funded and Social Security-type pensions. France and Spain are rare cases that started out with just a PAYGO system. Their high replacement rates for the average worker -- 55% for France without taxes and transfers (70% with taxes and transfers) and 82% for Spain -- are paid for with corresponding high payroll taxes -- 37% and 28%.
To keep those tax rates from getting any larger and to scale them down, France and Spain are each developing an advanced-funded system composed of mandated hybrids between defined benefit and 401(k) type plans.
In contrast, the U.S. Social Security system taxes workers and employers 12.4% (6.2% each) which in turn pays for low benefits -- a 35% replacement rate for the average worker. If the U.S. wanted to reach a target replacement rate of 70% -- and that is what most of us need -- the payroll tax would double. (The table at the end of the article, which matches selected nations' payroll tax with their pension benefits, indicates the U.S. rate is 15% because that includes the OECD estimation of Supplementary Security Income. which is funded by general revenues).
The U.S. Needs Social Security and Pensions for All
All workers need a restoration of Social Security promised benefits – Rep. John Larson (Connecticut, D.) and others are sponsoring (Social Security 2100 Act). The bill solves the math problem that without more revenue -- an immediate increase in the Social Security payroll tax from 12.4% to 15.4%, or an elimination of the taxable earnings limit -- Social Security benefits for the median retired household will be cut by a quarter and replacement rates will fall by one-fifth in 2034. All workers and their spouses and children need Social Security’s insurance against disability, early death, and inflation -- this social insurance is the base of any retirement plan. But, though Social Security replaces about 80% of pre-retirement income for the low-wage lifelong earners and their families, it only replaces 38% of pre-retirement income for middle-class workers and less than 20% of pre-retirement income for the top 10%.
It should be obvious by now that despite our aspirations to balance our retirement income by getting funds from a number of sources, the U.S. system is no three-legged stool – only the highest income retirees get a third of their retirement income from Social Security, a third from pensions, and a third from assets. The bottom 40% of Americans over age 65 receive over 90% of their retirement income from the PAYGO Social Security system. Those in the top-half of the income distribution get a smaller share of retirement income from Social Security – an average monthly benefit of about $1,500 – and need more to maintain their standard of living. But nearly half of Americans are not covered by a workplace plan.
Everyone needs an option to the crumbling 401(k) and IRA system and more than anything now proposed in Congress. Workers need Social Security and pensions, so that investment earnings, and not just tax revenue from younger workers, pay their pensions when the times comes to retire.
Because a blend of PAYGO and advanced-funded plans is more efficient, meaning administrative costs and risks are smaller, a large government plan can manage economic and demographic shocks better than a pure PAYGO system or a totally capitalized system. Nobel prize winner Peter Diamond and Nicholas Barr make this point. Households can fund their retirement more cheaply with a combination of regulated add-on pension accounts and Social Security. An improved U.S. retirement system would mandate contributions, professionally-manage investments, and pay out annuities. Even those with access to retirement plans have little saved and face contribution and investment risk and concerns about how the money will last a lifetime. Tony James and I have a plan to supplement Social Security called the Guaranteed Retirement Accounts (GRA). GRAs work in concert with Social Security.
Bottom line: Why not just expand Social Security as our retirement system fails? If we expanded Social Security to provide replacement rates of 75-80% for most workers payroll taxes would rise to over 25% of pay and we would lose the potential efficiencies of advanced-funded retirement plans.
The tax rate for Social Security (old age survivors and disability insurance OASDI) is 6.4 percent for both the employer and employee and is paid on earnings up to a cap, which will be $132,900 in 2019. Based on Social Security’s handy wage data in “Wage Statistics” -- it is a fascinating table -- did you know out of the 165 million wage earners only 205 earn over $50 million a year and report an average earnings of exactly $97,338,760.37? I estimate if we expanded Social Security to provide replacement rates of 75-80% for the 75% of American workers who earn between $10,000 per year and $140,000 per year, payroll taxes would rise to to 25% of pay– up from 12.4% and more if the retiree cohort is much bigger than the working cohort. I only examine the tax rate needed to raise the replacement rate from an average of 34% to 70% for the middle 75% of earners because I assume the bottom 21% of earners who earn an average $5000 a year need public assistance and the top 5 percent who earn over $135,000 will use personal assets for retirement.
Table: Internationally, High Payroll Tax Rates Yield High Replacement Rates (source: OECD Pensions at a Glance and Taxing Wages)