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Tuesday, February 28, 2023

Expanding Social Security is a Bad Idea

Key Takeaways

• Expanding Social Security in the way Democrats are proposing would harm Americans in multiple ways
• It will expand government (both spending and taxes) to historic proportions
• It will hinder economic growth, resulting in at least a 1.1% reduction in GDP
• It will destroy billions, maybe trillions of dollars in wealth accumulation by crowding out high-income earners' retirement savings

In late January, Bernie Sanders met with President Biden in an effort to maneuver the current discussion about Social Security toward Sanders's preferred policy of a greatly expanded tax and transfer apparatus.

Sander's plan, while not provided in the detail required to do a full analysis, is to expand the payroll tax (and the Social Security retirement benefits) to cover incomes beyond the current max of $160,000. His opening offer is to pull in all income above $250,000; but some Democrats, mindful of Biden's campaign promise, want to extend only to incomes above $400,000. Not only that, but Sanders wants to tax investment income for Social Security, too.

Economy-Wide Effects

A score of The Social Security 2100 Act, which is not the same as Sanders's plan but was inspired by it, finds that this proposal will increase taxes as a % of GDP by 4.4 percentage points, and will increase spending by 6.2 percentage points.

Currently, federal taxes represent 20% of GDP and federal spending represents approximately 25%. This proposal would increase federal spending by 25%! It would increase taxes by 22%!

This proposal to expand Social Security, by itself, would increase the size of government by 25% and result in a government where nearly half of all federal spending goes to 20% of the population

Right now, 31% of the federal budget goes towards Social Security and Medicare--nearly one third. Meanwhile, 17% of the country is 65 years old or older. This proposal would make that benefit to population ratio even more lopsided.

I would be curious to see a rigorous analysis of this, but just including the Social Security changes would bring the 31% figure up to 37.2%--i.e. 37.2% of the federal budget would be dedicated to two programs--Social Security and Medicare. On top of that Medicare is expected to expand due both to increased health care costs and more beneficiaries as the baby boom generation continues to age. Does the nation really want an economic policy geared so heavily towards one demographic group?

At the same time, analysts also believe that this proposal would shrink the economy as a whole. The well-known Penn-Wharton model projects that the Social Security 2100 Act would shrink the economy 1.1% by 2050 and increasing over time.1

This proposal would shrink the economy by 1.1% by 2050 and even more the longer it's in effect.

Effects for Retirees

For a person who makes $300,000 every year from 30 until retirement. Every dollar they divert from their retirement will reduce their nest egg by over $10. Sanders wants to take another chunk of that person's salary every year. For someone earning $300,000, that would be $6,200.2 If all of that money that is now going to Uncle Sam was originally intended for retirement, he has just lost $63,000 from his nest egg. And that's just the taxes from a single year. Over 36 years, that adds up to be an $885,000 hole in their retirement account.

By trading a 6.5% return for a <2% return, Americans could lose $885,000 from retirement.

What is that $885k worth? Well, using the 4% rule, that would generate income of $35k/year for the rest of his life and leave a sizeable chunk for his heirs. But surely, now that he's paying so much more to Social Security, he'll get a great return from that, right? An additional $50k of annual income, after going through the Social Security formula, would produce a Social Security annual benefit of $51,469. That's total. Under the current rules, his benefit would be $43,970.

But, as I mentioned, the $35k income that the high-earner could expect in his retirement if he simply invests it in an index fund leaves a sizeable chunk leftover when he dies. We could better compare the two scenarios by assuming he depletes his retirement nest egg by the time he dies. If he dies at 87, the average life expectancy, and planned perfectly to have a steady income that ran out when he died, his annual retirement income generated only from the additional money Bernie Sanders wants him to pay in payroll taxes, would be $73,640.

In summary, this person will have just lost $73,600 in retirement income from investments, and Sanders plan will replace that with an additional $7,500 per year of Social Security Benefits. So, in effect, the Sanders plan would ensure that everyone making more than $150,000 is considerably worse off. Not just from the taxes themselves but in their retirement. It's also important to understand that the amount lost is not going to lower income beneficiaries, because most of this money came from the higher returns from investments. Those will no longer be in play.

Sanders's plan will erase 90% of affected retirees' income--not redistribute--erase.

By itself, that is greater than his entire Social Security benefit even with the expansion. In fact, there would be more money to go around for everyone if Social Security required high earners simply to invest that money, and then taxed the proceeds. At least then, the government wouldn't be destroying as significant a chunk of wealth.

Wrap-Up

Democrats spend every day talking about the great things they could do by increasing taxes on the wealthy. Is increasing Social Security benefits the best thing to do? Especially when expanding Social Security will end up shrinking the economy and limiting options?

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Footnotes

1Note that Prominent Democratic economics disagree.
2For the purpose of this illustration, I'm assuming that Sanders's plan will not tax income between 150 and 250k, but will begin taxing at 250 and above. So a person with a $300,000 annual income would have an additional $50k subject to the Social Security tax. Obviously, all of these numbers are in flux, and are meant to be representative of the effect.