Proposed Social Security Reform

It’s an opinion, but I feel that for 20 years or so, students have been fairly well-informed that Social Security is not sustainable in its current form. (Unfortunately, like the general public, they do not seem aware that Medicare, because it is both trending upwards and currently has no boundaries is the bigger long-term problem).

Having said that, most seem to lean towards the idea that social security will simply not be around, or won’t be a major contributor, to their retirements around mid-century.

In class, I’ve generally voiced the opinion that I thought it would be around, in much like its current form, and that it would be contributions from younger working people that would change. The big problem here is that older people vote with more frequency, and the politics is you don’t hurt the people who vote more.

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Reform proposals come and go, and the new one on the table is from the Democrats (here are some recent proposals from Republicans).

So, this is not a very specific criticism of Democrats or the proposal, but it will point out some of the design features adopted in this proposal that have been touched on in my macro classes over the years.

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What’s in the new proposal?

Increased taxes on working people. I hate to say I told you so, but …

Increased benefits for seniors. This is probably necessary to secure their support. It belies the fact that the wealthiest population segment in America is already seniors. On the bright side, it does increase social security payments to the poor by more than to the rich.

A particular bugbear of Democrats is the willingness to create additional tax brackets. The problem is the resulting complexity of the outcoming tax planning. This one is worse because it creates two tax bracket changes, one for the rich and one for the very rich, neither of which is indexed to inflation, making them more complex with the passage of time. This has been dubbed the “doughnut hole”. Do note that on top of this, the change in benefits from the previous paragraph is like creating an implicit third new tax bracket.

On a good note, the proposal does reduce the number of brackets that recipients in middle incomes face.

Probably most importantly, the reform would change the adjustment for inflation. We’ve known for about 25 years that using the CPI to adjust for inflation creates long-term problems because it overstates inflation rates. The new reform would make this worse by switching to a new measure of inflation known as CPI-E. This new measure actually results in higher inflation rates than the old one. So this is a sneaky way to amplify an old problem. This is pure politics again: if you choose a more accurate measure of inflation to use, because we’re too high that must be lower, benefits for seniors will grow at a slower rate. Lobbyists for seniors (like the powerful AARP) are the one who keep that sort of thing from going through, and they’ll love using the new index.

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Keep your eye on the ball here.

Social Security needs reform.

Reform will happen eventually. Both parties want to be the ones who get credit for it.

Each party proposes a set of compromises, looking for the set that will ultimately pass.

Those compromises will always have bad stuff in them, to get some good stuff too. This just happens to be the Democrats current bad stuff, and my honest opinion is, that increasing tax complexity and a preference for biased inflation adjustment are fairly normal for how they operate.