Jane the Actuary General Interest, Retirement

Forbes post, “A ‘Living Wage’ Of $34,000? Bad Data, Or Bad Math, Will Stand In The Way Of Social Security Reform”

Originally published at Forbes.com on February 1, 2021

 

Yes, I have been calling for a comprehensive Social Security reform ever since I began writing at this platform. And, yes, that plan calls for a change from the current formula to a flat benefit for all, or, as I’ve also called it, a “basic retirement income.”

The catch, of course, is this: how do you decide what that right income level is?

The federal government gives us a number that seems reasonable enough by its name: the “poverty guideline.” This works out to $12,880 for a single person, or $17,420 for a household of two. True, you’d have to decide whether a household of two gets twice the single person’s benefit or only the two-person-household benefit, and you’d have to decide whether two people cohabitating count as a “single household” or not, but then the hard work of deciding what an “anti-poverty” benefit should be is finished.

Now, there’s a small wrinkle here: the federal government has two different calculations, the “guideline” and the “threshold”: the former is used for benefits eligibilities and the latter for counting how many people live in poverty — and, for what it’s worth, the threshold for an individual over 65 is $1,000 less than someone younger.

But the “poverty guideline” is ultimately just a metric used for other calculations — eligibility for Food Stamps is not “below the poverty line” but “below 130% of the poverty line.” And the calculation itself is based on the rather arbitrary assumption that people spend 1/3 of their income on food, so it’s not a particularly “scientific” measure of the amount of money needed to keep someone out of material deprivation.

But the promise President Biden has made with respect to expanding Social Security is to boost benefits to a minimum of 125% of the poverty level — and, it appears, to do so on an individual basis, so that households-of-two would get what works out to 180% of the poverty level. Is this enough?

Let’s do some more math: the current federal minimum wage is $7.25 per hour, which works out to $15,080 per year, based on a 40 hour week. Biden wants to boost this to $15.00 per hour, or $31,200, because, he says, that’s the level needed to prevent people from living in poverty (see his speech on his spending plan). Is it necessary to keep Social Security benefits in line with the minimum wage?

Lastly, there are (at least) two “Living Wage” calculators that purport to calculate the wage truly needed to cover the “basic needs” of families or a “subsistence living” income level.

The first of these is at MIT. To take some representative numbers:

In Peoria, Illinois, a single adult working 40 hours a week would need a wage of $10.70, or $22,256 per year. Two adults sharing expenses would need a total of $35,734.

In Chicago, those wages/incomes increase to $28,288 and $43,513, respectively.

(The “living wage” climbs even higher for parents; a single adult supporting 3 children would need to earn $39.31 per hour or $81,756 annually, according to their calculations, but that’s not really relevant when it comes to old-age/retirement benefits.)

The second of these was produced at the Economic Policy Institute. It does appear somewhat outdated, using 2017 data, but it produces considerably higher calculations.

Here, in Peoria, they calculate annual expenses of $33,994 for a single adult and $47,785 for a couple.

And in Chicago, they calculate a single adult needs to earn $36,917 and a couple, between the two of them, needs $50,006. Again, the numbers are even higher with children — $101,140 with three children.

But, it turns out, the basis for their calculations is questionable, at best.

According to the MIT documentation, the calculations assume that families prepare all their food at home (no eating out) according to the government’s “low cost food plan.” They calculate average health expenses based on typical premiums for employer health insurance and out-of-pocket costs from national government surveys. For families with children, they assume families elect the lower-cost option between family and center child care (but use average costs for each type).

But they base housing costs on the HUD Fair Market Rent estimates, that is, from HUD data for the 40th percentile rent for “standard quality units.” Why would a family living at a basic, subsistence level, rent an apartment at nearly the average rent for the area? They calculate transportation expenses based on average spending across all consumers, adjusting only to reflect purchasing used rather than new cars. They (appear to) calculate “other” expenses, again, by using average Americans’ spending on such items as clothing or personal care products.

The EPI documentation indicates other ways in which numbers they claim to be “basic expenses” are really just “average survey expenses.” For all metro areas, they assume parents choose daycare centers, despite their higher cost, and, again, spend the average amount on daycare. For transportation, they again use average American transportation spending, adjusting only to reduce vehicle miles travelled assuming less discretionary travelling. For “other” expenses, they again use survey data on actual spending rather than calculating necessary spending, with the primary adjustment being the assumption that families don’t spend any money on “entertainment” or the survey’s “other” category.

In addition, this calculation uses ACA/Obamacare exchanges to calculate health insurance costs but doesn’t take into account the Obamacare premium subsidies. And the tax calculations don’t appear to include Earned Income Tax Credits or Child Tax Credits (though this could be a result of calculating such high costs that the hypothetical family wouldn’t qualify).

Did MIT and EPI intentionally seek to inflate the living wage calculations? It stands to reason that groups advocating for boosts in the minimum wage would construct these calculators in a way to produce results that are invariably higher than minimum wage, but when they produce values that are so much in excess of what is reasonable, they weaken their case instead of strengthening it. After all, consider that the median individual income is $36,000; does it really make sense to say that the majority of Americans are living at a below-subsistence level?

Or is this a result of data limitations? A typical exercise in a high school Personal Finance course is to collect information on food costs, rent costs, and so on, from various sources, and construct a budget on this basis, but that’s not easy to replicate for families nationwide. One also imagines that there’s a certain fear that calculating such a spending budget might be misunderstood as casting moral judgement on the poor.

And, of course, these calculations are all based on spending for working families, not retirees, who are, as a practical matter, likely to spend less on clothing or other discretionary spending, who have the large majority of their medical spending covered by Medicare and the entirety covered by Medicaid for those below federal thresholds.

At the end of the day, this rabbit hole discussion shows that it is by no means easy to figure this question out — neither for those affected by the minimum wage nor for those affected by discussions of what the right level of Social Security benefit is.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Farewell, FICA – And Other Basic Retirement Income Details”

Originally published at Forbes.com on September 19, 2019.

 

Since I’m on my soapbox again about Social Security reform, here are some questions and answers on my preferred approach, a Basic Retirement Income.

How’s it paid for?

To start with, the key point is how it’s not paid: a move to a new Social Security system would enable ourselves to eliminate the FICA tax.

After all, there’s general agreement that the FICA tax is regressive, hitting low-wage earners at a greater rate than wealthy folks who have exceeded the year’s ceiling. For this reason, a “payroll tax holiday” is a popular recession-fighting move (proposed by the Trump administration to ward of a feared recession now, and implemented in 2011 – 2012), but because of the need to keep money flowing into the Social Security Trust Fund, Congress redirects an equivalent amount of funds from general revenues (that is, borrowed funds) into the Trust Fund.

Eliminating the FICA tax, and funding a Basic Retirement Income with general federal revenues (for instance, a tax hike on all income) would remedy this issue.

And, in fact, of the three systems I profiled earlier this week, the Netherlands has a payroll tax similar to ours, except with a much lower ceiling, Ireland has payroll tax which exempts low-income workers, and Australia has no specifically-dedicated tax for their Age Pension at all.

Now, what the proper marginal tax structure should be, I won’t opine on, except to express a general preference for a system in which everyone pays something and wealthier folk pay relatively more, but we take care not to let “fair share” rhetoric evolve into imagining that the wealthy can pay for everything.

Is this an undeserved benefit for those who cheat the system and don’t pay their taxes?

Well, sure. And I’m all for stepping up enforcement on nannies, day laborers, and everyone else who works under the table in the shadow economy, which was estimated by one course at $2 trillion. But the benefits gained from restructuring the system are meaningful enough to accept this. And is the prospect of future Social Security benefits really motivating people to report their taxes, who otherwise wouldn’t? There are so many other advantages for dishonest workers and employers, in terms of unpaid income taxes, boosted eligibility for means-tested benefits, ability for employers to skip workers’ compensation and pay a subminimum wage, and for a segment of the workforce, ability to work without legalization to do so – all of which still exist and still warrant greater enforcement of the law than we’re doing at present regardless of whether or not Social Security/state-provided retirement benefits are tied to reported and taxed income.

What about the benefits I already have owed to me?

A move to a flat benefit would inevitably have a very long transition period. However true it may be that one has no legal right to Social Security benefits, we’d fail at the overall objective of a system in which Americans have reasonable living standards in retirement, if we leave middle-class folk counting on a higher benefit, high and dry. There are 35 years in the averaging period for Social Security earnings; this suggests that we’d transition to the new system over 35 years, during which time workers would get prorated benefits from each system.

Why not just boost minimum benefits and keep the system as-is otherwise? Or better yet, boost benefits for everyone?

Here is the key:

We know that a pay-as-you-go system generous enough to provide middle-class levels of income is not sustainable. Worldwide, countries which had provided such generous systems are reforming them because of the burden it places on their budgets. In Canada, which as an exception to the rule, has actually increased benefits just recently, they are funding the increases through a real investment fund, setting contributions in an actuarially-correct manner, and phasing the increase in to ensure that it is fully funded through this investment fund – all of which are much more difficult conditions for the American system to follow, not just because we’re accustomed to “free lunch” promises but because Canada is so much smaller than the U.S., and the Canada Pension Plan investment fund invests in American companies such as Petco, Univision, and Neiman Marcus.

At the same time, Democrats have proposed a number of variants on supplemental savings programs, either mandatory (with employer or employee contribution mandates and with or without opt-out options) or voluntary, such as OregonSaves, or the Theresa Ghilarducci/Tony James Rescuing Retirement plan.

As you might imagine, Republicans oppose these sorts of government mandates, but many of them likewise support some variant of a privatized Social Security, though it’s never fully fleshed out.

But rather than making progress on reform, we are still endlessly wringing our hands about the coming Trust Fund insolvency.

How do we get from here to there? Not by more partisan debates. Not by one side or the other finding their way to an unassailable supermajority. But by incorporating a new mandatory savings program into the overall understanding of “What Social Security Is” as a second layer in a hybrid system, so that the savings mandate is just as acceptable for a new generation as paying FICA taxes are now.

And, yes, that second layer could not be a simple 401(k) account. We need new visions for ways to incorporate forms of risk-sharing and investment-return smoothing, so as to not provide a rock-solid guarantee, which, if we’re honest, simply isn’t realistic, but instead a system that balances all concerns.

Which is, incidentally, a significant part of the reason why I’m watching for updates in the PBGC multi-employer plan insolvency threat; aside from the financial losses participants will experience, and which will be all the worse if remedies aren’t found, multi-employer plans are the closest sort of arrangement we currently have to what should one day, with a lot of work put into reforming the structure of the plans, be a mainstream retirement plan for all Americans.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Let’s Talk “Basic Retirement Income” Social Security Reform – What Would It Look Like?”

Originally published at Forbes.com on September 17, 2019.

 

Last week, I promoted, in contrast to Elizabeth Warren’s Social Security plan, a basic retirement income. That’s not a pipe dream. In various other developed countries, it’s a perfectly normal way to provide Social Security benefits.

So let’s take some examples from the world of state retirement systems outside the United States, drawing from the Country Profiles in the OECD Pensions at a Glance 2017 and Social Security Programs Throughout the World (plus other knowledge I’ve acquired along the way). This is, of course, in addition to the system in the United Kingdom that I profiled some time ago.

The Netherlands

The Dutch provide a flat benefit of EUR 14,650 per year, or about $16,200 at today’s exchange rates, for a person living alone, or EUR 10,265 ($11,300) for a person living with another adult (the system doesn’t care if you’re married, cohabitating with a romantic partner, or sharing expenses with a roommate; the only exception is your parent or child). This benefit is paid without any regard for earnings history; it is only adjusted for immigrants or others who have lived outside the country, with a proration for less than 50 years of residence. This is funded by a payroll tax of 17.9% of pay up to EUR 33,994 (about $37,500), paid by employees only (that is, there is no employer portion). The benefit is also paid beginning at age 67 (as soon as a short phase-in is finished); there is no such thing as an early retirement benefit.

In addition, the vast majority of employers (about 90%) provide either a defined benefit or a defined contribution pension plan, either sponsored by the employer or by the industry in a way similar to (but far more successful than) American multiemployer plans. Unlike in the U.S., their defined contribution plans do not involve employer matching of voluntary employee contributions, but are fixed contributions. And for the segment of the population that has insufficient postretirement income (e.g., immigrants without reciprocal benefits from other countries they’ve lived in) there are supplemental anti-poverty benefits.

Another distinctive feature of the Dutch pensions is that, because the Social Security benefit is flat, the employer benefits include in their formulas an offset so that the pension is designed to replace marginal income above what’s replaced by the government benefit.

Ireland

The Irish benefit is based on work history, but not, as in the United States, a formula based on average pay in one’s working lifetime. Instead, all that matters is having had earned income for a sufficient length of time. To receive the maximum annual benefit of EUR 14,252 ($14,250), or EUR 13,380 ($14,800 if living alone), one must have had 40 years of full-time employment; however, time spent unemployed and looking for work, or not working due to disability or while caring for a child or a dependent adult, can be counted towards this 40 year requirement. The benefit is paid at age 66, rising to 67 in 2021 and 68 in 2028, with no early retirement option. Additional benefits are provided for those with financial need.

Employee contributions are paid at the rate of 4% on all earnings (no ceiling); however, the first EUR 18,304 annually ($20,200) is exempt from taxes; upon earning that next dollar, the full contribution kicks in but with a credit that phases out so that a worker who gets that next pay raise that boosts his income up to EUR 18,305 pays tax of EUR 108.16 per year. Employers contribute 8.6% of payroll for workers with earnings of EUR 19,552 ($21,600), or 10.85% for workers with earnings above this level. In both cases, these contributions also fund disability, unemployment, and other benefits. (More information is available at Citizens Information.ie.)

This benefit is often paired with an employer plan but that’s not as prevalent as in Ireland; the OECD says that about half of workers have employer-provided plans. As in the United States, defined benefit plans had been prevalent until they became too expensive; now defined contribution is the norm.

Australia

Australia’s our model if we get nervous about providing benefits to wealthy Americans, because they means-test their flat pension, called an Age Pension. For a single individual, the maximum benefit amounted to AUD 22,677 in 2016 ($15,600). For couples, the benefit is reduced to AUD 17,094 ($11,700). This benefit is reduced based on both assets and income, in a gradual manner; currently the OECD reports that 58% of retirees receive the maximum benefit and 42% receive a reduced benefit. As with Ireland and the Netherlands, there is no early retirement option; benefits are payable at age 65, increasing to age 67 in 2023.

If benefits are phased out over time for higher-income retirees, wouldn’t that cut into incentives to save? Australia solves that problem, in part, by mandating savings, through its Superannuation Guarantee, or “Super” (you can read my earlier description here), a mandatory employer contribution to a defined contribution plan of 9.5%. And, yes, even though that’s an employer contribution, it’s generally acknowledged that this is actually an amount coming out of employee paychecks indirectly. That contribution amount is scheduled to increase to 12% over the period from 2021 to 2025, but it’s an open question whether this increase will actually occur, precisely because of the acknowledgement that these increases will come out of workers’ pockets. In fact, there have even been calls for Super participation to be optional, with the extra cash going into worker’s pockets, for low-income workers – or at least one call, from a senator this past summer.

Why not here?

If you consider the nature of the American Social Security program, ever since its inception, politicians have told us that it’s an “earned” benefit – but at the same time, we know that in various ways, that’s already not the case (such as benefits for spouses, or even the basic benefit formula itself, giving a benefit to low-income workers that’s disproportionately high, considering their lifetime earnings relative to higher-income workers). What’s more the growing calls for eliminating the ceiling in order to have above-the-ceiling workers pay their “fair share” are based on the growing expectation that Social Security should be about redistribution of income rather than earning benefits.

And when we look at the diversity of welfare programs in America, they have one fundamental premise: their recipients should be employed, or looking for employment. Here’s the fundamental requirement for TANF (traditional cash welfare) here in Illinois: “Develop a plan for becoming self-sufficient and follow it.” For SNAP (food stamps), “We expect people who can work to try and do so.” Medicaid similarly requires that recipients be employed or engaged in seeking employment, job training or the like, though with various waivers available.

But once an individual has reached the age of 65, those requirements cease. SSI (Supplemental Security Income, for individuals whose Social Security benefits alone are not enough to stay out of poverty) requires only the attainment of age 65, not any past or present efforts to find work. (Why doesn’t this age increase in tandem with the Social Security retirement age? No idea.) We are collectively entirely comfortable with the government ensuring that, regardless of whether they worked hard, or hardly worked, during their younger years, Americans past a certain age do not live in poverty.

All of which adds up to this: the time is ripe for a flat Social Security benefit for all.

(How do we get there? How should the government help middle-class families who want more than simply staying out of poverty? I’ll get to that in future articles.)

 

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

 

 

Jane the Actuary Retirement

Forbes post, “Elizabeth Warren’s Social Security Proposal Doesn’t Go Far Enough: It’s Time For A Basic (Retirement) Income”

Originally published at Forbes.com on September 14, 2019.

 

Senator and presidential candidate Elizabeth Warren has a new – and expansive – proposal for Social Security. It’s a grab-bag of changes, as seems to be the norm these days, a list that includes the following:

  • A $200 flat boost to all recipients’ benefits. (Is the $200 a one-time boost, or does it grow with inflation, and why not integrate that into the formula itself?)
  • Cost-of-living increases based on the CPI-E, a version of the consumer price index that’s based on a “basket of goods” of a typical older person, with more weight given to healthcare, for example.
  • A caregiver credit based on the median wage, for each month an individual provides 80 hours of unpaid care to an under-age-6 child, a disabled dependent, or an elderly relative. (There seems to be no requirement that individuals be out of the workforce, so this would appear to boost benefits for all parents with below-median income.)
  • A boost to surviving-spouse benefits to 75% of the level the couple had been receiving when both were alive. (Is this “fair” or an unfair subsidy for married couples? You be the judge.)
  • A boost for surviving spouses with disabilities, by repealing age requirements.
  • Elimination of the Windfall Elimination Provision and Government Pension Offset for public workers. (Warren characterizes the WEP as unfairly “slash[ing] Social Security benefits”; the reality is that without the WEP, workers with both private-sector and non-Social-Security-participating public sector work years would get benefits more generous than people would judge to be fair. For instance, without the WEP, a full-career schoolteacher who works in the private sector in the summer would appear to Social Security’s benefit formula to have been poor and benefit from the relatively more generous benefit formula for the poor.)
  • Restoration of dependent (children’s) benefits for adult college students, and expansion through age 24.
  • A reduction by up to three years of the Social Security averaging period for individuals in apprenticeships and job-training programs, to boost average wage history and benefits. (Why give special treatment only to these programs? The 35 year averaging period already excludes 14 years from an adult working lifetime – ages 18 to 67 – to account for education, unemployment and other absences from the workforce.)
  • A minimum benefit of $1,501 for any worker – that is, 125% of the single poverty level plus $200, with 30 years of work history. (Note that this is actually more than the current average benefit. For a married or cohabitating couple, their combined benefits would be 220% of their combined poverty level; even for unmarried retirees, the benefit is slightly more than the eligibility level for Medicaid.)
  • And, like all such proposals, an additional tax on the upper middle class and the wealthy to fund it – expressed as a 14.8% “Social Security contribution requirement” on income above $250,000 plus a 14.8% investment income tax, this is really nothing more than raising marginal income tax rates and directing the income towards Social Security. (If this tax parallels the equivalent tax for Medicare, it’s unindexed and will affect more and more workers over time. Also, I will repeat again my observation that, even if you think there’s more “room” for tax hikes, there are opportunity costs to every tax increase – money spent on Social Security cannot also be spent on healthcare or childcare or parental leave. At the same time, Vox writer Matthew Yglesias explains Warren’s thinking differently: rather than spending the same pot of money half a dozen times, “The way Warren sees it, . . . economic resources are plentiful — they’ve just been captured by a small number of people at the very top.”) Unlike many such proposals which claim to achieve long-term solvency, Warren only goes so far as to say that these changes extend the Trust Fund solvency by 20 years, not permanently. (Recall that the Trust Fund is currently projected to be depleted in 2035 – and this, and future cashflow projections, are optimistically based on a future increase in fertility levels that may not happen.)

So how do you make sense of this? Some of these change seems small-bore – special Social Security benefit provisions for apprenticeship students, for instance. Others are expansive, like the new much higher minimum. What nearly all have in common is the elimination or weakening of the link between benefits and lifetime wages. Canada provides caregiver credits by dropping years from the averaging requirement, so as to retain the link to an individual’s actual work history, but Warren proposes treating individuals as “median earners” for every year in which they can claim part-time caregiving. The surviving-spouse boost further increases benefit levels for couples vs. singles. The WEP elimination ignores a worker’s true employment history. The new tax on high earners purely injects more money into the system without any relationship to benefit accruals. The flat-dollar benefit boost and the new minimum benefit are obviously unrelated to income.

And maybe that’s fine – after all, the current system has a benefit formula heavily tilted in favor of low earners as it is. Politicians of various stripes will nonetheless tell their constituents that they earned their benefits fair and square, regardless – as Warren herself says: “Social Security is an earned benefit –– you contribute a portion of your wages to the program over your working career and then you and your family get benefits out of the program when you retire or leave the workforce because of a disability.”

But these are all half-measures.

If we really want to ensure that Social Security provides benefits to everyone sufficient to meet their basic needs, then the obvious solution is simply a flat “basic income”-like benefit.

And at the same time, Warren writes:

“For someone who worked their entire adult life at an average wage and retired this year at the age of 66, Social Security will replace just 41% of what they used to make. That’s well short of the 70% many financial advisers recommend for a decent retirement” –

suggesting to readers that she thinks that Social Security itself should fill that gap, something that places her well outside mainstream opinion that what’s needed is more attention to plans or programs that help middle-class Americans achieve this for themselves. (Though, for a couple, $1,500 x 12 = $18,000; x 2 = $36,00 which is 70% of $51,000, as another indicator of how high her minimum benefit level is.)

What we need, instead, is my comprehensive three-tranche Social Security reform, in which all Americans are kept out of poverty with a flat “basic income” benefit, structures are put into place for second-tranche-income retirement savings and risk-sharing life-income drawdown, and Americans make their own choices on upper-tranche income saving. The concept of income tranches means that no one is expected to save on that portion of their income that is just enough to meet their basic needs – as Andrew Biggs wrote recently at MarketWatch, the lowest earners may be better off not saving for retirement at all – but save only for retirement on that slice of income above this level. The flat benefit means that we can include every American but fund it through an income tax that leaves debates about the “fair share” of rich or poor taxpayers behind. And a second-tranche-income retirement savings program, by incorporating retirement savings into a wholly-redesigned Social Security program, likewise leaves behind debates about “privatization” or “unfair government savings mandates” for something new.

Or, on the other hand, maybe not so new.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.