True Social Security Reform Will Stop Punishing Work

It is clear that President Bush’s Social Security plan is not getting traction politically — even many Republicans on Capitol Hill think it is on life support. One reason is that he has failed to make some arguments for reform that would buttress his case, such as the increase in economic growth from an expanded labor supply that would come from personal accounts.

Possibly the biggest macroeconomic problem with the current Social Security system is that it encourages workers to retire too early. Perhaps unwisely, most people start drawing benefits at age 62, the first moment they can, despite receiving 25 percent lower benefits for doing so.

Social Security rules effectively prohibit early retirees from working full-time, because they lose 50 cents in benefits for each dollar of wages they earn above $12,000. There is no loss of benefits for those above the normal retirement age, which is 65 years and six months this year. However, the normal retirement age is rising to 67, meaning that in future years more and more early retirees will lose benefits if they work.

I do not believe that we as a society can afford to have so many well-educated, experienced, highly skilled workers leave the labor force just so they can get their money’s worth out of Social Security. We don’t take private pensions away from those who continue working after they begin drawing benefits, and we don’t penalize those with interest or dividend income well above $12,000. We only penalize those who want to work.

This may have made some sense in the 1930s, when the government was trying to create vacancies for the unemployed. But today, it is crazy. It is doubly crazy when research shows that the key to living a long and healthy life is by continuing to work in some way. More and more companies are now doing what they can to accommodate the needs of elderly workers because they view them as a valuable resource.

But as long as we have a Social Security system that actively discourages seniors from working, there is a severe limit to what businesses can do to make it worth their while.

Of course, one can always game the system. A friend of mine “retired” from his regular job a few years ago and went to work for his wife, who had a small antiques business. His former employer contracted with her company to do my friend’s job, and she hired my friend to do the actual work. Her company was paid his old salary, and she paid him the amount he could receive without losing Social Security benefits. In the end, my friend kept on doing the same job for the same money, but in a rather roundabout way.

Not everyone has the flexibility or the resourcefulness of my friend and are faced with a difficult choice. They may want to work, but see it as a kind of tax if they don’t draw Social Security benefits as soon as they can. Suppose someone has gross wages of $30,000 and $24,000 after tax from working, has just turned 62 and could make $12,000 tax-free from Social Security for doing nothing. In his mind, his income from employment has just fallen by 50 percent, because he would only lose $12,000 by quitting work altogether.

One of the greatest benefits of a Social Security system based on personal accounts is that workers would never face a use-it-or-lose-it decision. They would never forego any benefits by continuing to work. They would just continue to build up wealth, providing more income when they do choose to stop working or providing a nest egg that can be left to children or a spouse at death. Consequently, personal accounts will greatly increase work by the elderly by removing penalties for doing so.

New research by economists Alan Gustman of Dartmouth and Thomas Steinmeier of Texas Tech quantify the impact. They find that adoption of something like the Social Security Commission’s second option, which is very similar to what President Bush is proposing, would reduce retirement at age 62 by 5 percent — a significant impact — by encouraging more seniors to stay in the labor force.

One reason for this result is that the Social Security Commission’s proposal would change the indexing of initial benefits so that they would remain the same in real terms, but not rise at a faster rate than inflation, as is currently the case. Consequently, if it is decided not to change the indexing formula, which most Democrats oppose, then it will substantially reduce the economic gain from reforming Social Security.

So far, there has been almost no discussion of the implications of Social Security reform for economic growth. The potential benefits, however, may be large and are an important reason to take action.