After World War II, the American dream became a reality. A large fraction of the U.S. population enjoyed a middle-class lifestyle while working, followed by a secure retirement with virtually no change in their standard of living.
This dream, especially its second part, slowly died over the past 40 years. Americans increasingly worry about retirement. Eighty-six percent of adults think the nation already faces a retirement crisis. Only 35 percent of Americans are confident or somewhat confident that Social Security will be around in the future.
Such worries are undoubtedly justified. Since 1990 there has been a steady increase in the percentage of Americans 65 and older who work. A large part of this increase stems from financial necessity. Much scarier are estimates (from the Center for Retirement Research at Boston College) that the risk of someone running out of money during retirement grew from 31 percent in 1983 to 52 percent in 2013.
Fears concerning retirement are also perfectly understandable. For decades, the pillars supporting Americans in retirement have crumbled. Comfortable retirement was possible in the postwar era due to income from three sources—individual savings, employer pension plans, and Social Security. Today, people lack adequate savings. They also lack pension plans that provide a steady income during retirement. Meanwhile, Social Security faces its own financial problems.
Instead of trying to fix these problems, Republicans have attacked Social Security as another failed government program that requires large benefit cuts. And they have blamed individuals for not saving enough, even though the problem is the Republican policies that made it harder for people to save.
Savings used to be one wellspring of a secure retirement. Today, most people struggle to save money. There is compelling evidence that many Americans live paycheck to paycheck, with little or nothing left over. A well-publicized Federal Reserve study found that 40 percent of U.S. households lack $400 in ready cash to deal with an unexpected expense. To obtain this sum of money, they would have to sell something or borrow. A Pew Charitable Trust survey found that one-third of American families had no savings, including 10 percent of families making more than $100,000, and that 70 percent of families could not cover a $2,000 expense.
Several decades of not saving have left people with little money for retirement. Those between the ages of 55 and 64 and nearing retirement have median savings of just a bit over $100,000. This could provide only $400 a month from a lifetime annuity. These monthly payments would not increase with inflation; after 10 or so years in retirement, the $400 would be worth only $300 in today’s money.
A second problem that threatens retirement is the lack of pensions. Starting in the 1980s, businesses stopped offering their workers defined benefit retirement plans and began providing only defined contribution plans.
With a defined benefit plan, workers receive a fixed sum of money each month once they retire. This is paid to them for the rest of their life. Firms were responsible for putting enough money into a retirement account and for investing it so that it would be able to pay the retirement benefits they promised. With a defined contribution plan, people are responsible for their own pensions. They must put away money and manage their retirement accounts. Firms only match employee contributions up to some limit.
In this brazen new world of retirement plans, if workers can’t contribute money, they are out of luck. With flat median real wages over the past four decades, few people had any extra money to contribute to their own pension plan. In addition, if someone lives a long life and therefore runs out of money, that is their problem. And individuals, as the managers of their retirement money, each bear the risk of large declines in the stock or bond market before they retire and need to rely on this money.
The changing nature of pension plans also explains why families can’t save. Defined benefit plans require nothing from workers. With defined contribution plans, workers must contribute something. Even if they manage to do this, less money remains for other savings vehicles to finance retirement.
This brings us to Social Security, whose benefits have been cut surreptitiously since the 1980s and are in jeopardy of further cuts in the future.
Created by President Franklin D. Roosevelt in 1935, the middle of the Great Depression, Social Security provided retirement benefits to retirees, as well as their spouse and children. For the first time, Americans had a safety net during retirement.
The program currently works as follows. Employees pay a fraction of their wages to Social Security; employers kick in an equal amount. Other income (interest, dividends, and capital gains) has always been exempt from Social Security taxes. For 2019, the payroll tax is 6.2 percent on employees and 6.2 percent on employers, up to income of $132,900. After that, taxes are zero. Self-employed individuals must pay the combined tax, or 12.4 percent on the first $132,900 of their earnings.
These taxes pay Social Security benefits. Most recipients are retired, but benefits also go to spouses and children of deceased individuals who paid into the system, and to children of low-income individuals collecting Social Security benefits. In 2019, more than four million children received Social Security benefits.
Initially, the benefits you received when turning 65 were what you would get every month. Due to inflation, this money would be worth less and less over time. Congress responded by periodically increasing benefits. Things got out of hand during the 1968 presidential election. Democratic candidate Vice President Hubert Humphrey proposed a 25 percent increase in Social Security benefits. Not to be outdone, his Republican opponent, former Vice President Richard Nixon, promised an even larger increase if he was elected. Victorious, and already worried about his reelection prospects, Nixon felt he had to make good on his promise. So he pushed large increases in Social Security benefits through Congress—15 percent in 1970, another 10 percent in 1971, and yet another 20 percent in 1972.
Nixon’s benefit hikes greatly improved the economic condition of retirees. But there was a downside—they created financial problems for Social Security. Congress responded by introducing automatic annual cost of living adjustments (COLAs) for Social Security recipients, starting in 1973.
Soon another worry surfaced—the retirement of the baby boom generation, resulting in fewer people paying into the system for each person collecting benefits. As baby boomers retired, the ratio of workers to Social Security recipients was expected to fall—from more than 3-to-1 between 1975 and 2008, to around 2-to-1 by 2030.
Seizing the initiative, in May 1981, newly elected President Ronald Reagan proposed a 50 percent cut in COLAs. Americans near retirement faced the prospect of living on less money than anticipated. The result was a public uproar and falling approval ratings for the president. Wanting political cover, President Reagan established a bipartisan commission with representatives from Congress, business, and labor. Alan Greenspan was chosen to head the commission. Its task was to propose reforms that would make Social Security financially solvent through the retirement of the baby boomers.
The result was a compromise between those wanting to raise taxes and those seeking benefit cuts. Social Security taxes (10.16 percent at the time but scheduled to rise to 12.4 percent) were increased sooner. For the first time, the self-employed were forced to pay double Social Security taxes (as both employer and employee). Social Security benefits were to be taxed starting in 1984, with up to half an individual’s benefits (depending on one’s income level) counted as taxable income and the proceeds going to Social Security.
Benefits were also cut by slowly raising the retirement age from 65 to 67. The Greenspan Commission reforms also gave people options regarding when to start collecting benefits. You could begin at age 62, but it would cost you: benefits get reduced 8 percent for each year you collect earlier than your full retirement age. Still, many people grab this option. More than 55 percent of the population collect benefits at age 62, and nearly 95 percent collect by age 65 (even though the full retirement age is now over 66). Workers collecting Social Security starting at age 62 will get 24 percent less in benefits each month—on top of the 16 percent drop from raising the retirement age to 67.
Despite claims by the Greenspan Commission that its reforms solved the financial difficulties facing Social Security through the retirement of the baby boomers, the program still faces problems. Last year, 63 million people received $1 trillion through Social Security, and the system collected $1.003 trillion in revenue—$83 billion in interest income from past surpluses it had accumulated and the rest from payroll taxes. The Social Security Administration forecasts that revenues will fall short of expenditures this year and in each of the next 75 years.
The Social Security surplus starts falling this year. By 2034, all assets will be depleted. At this point, Social Security will be able to pay just 75–80 percent of what it has promised American workers. The options proposed to avoid this fate are raising Social Security taxes, cutting benefits, or both.
Despite these current problems, the Greenspan Commission did address the demographic problem facing Social Security. It may not have done the best thing, or even good things, to deal with the retirement of the baby boomers, but it did do some things.
On the other hand, it did not foresee the second cause of the financial problems facing Social Security. This is the same problem hurting U.S. households—stagnating incomes and rising inequality. Starting around 1980, almost all the income gains in the U.S. economy have gone to the wealthy. As a result of the earnings cap, a smaller fraction of total national income gets taxed by Social Security. Likewise, as wages have stagnated, more income takes the form of dividends, profits, and capital gains, which are not subject to Social Security taxes. Also, “tax reform” during the Reagan administration led to wage income being redefined as capital income, because capital income was taxed at much lower rates. Since only wages are subject to Social Security taxation, Social Security revenues decline further.
To help Americans be able to retire in comfort again, we must buttress the three pillars that supported retirement in the past.
Teresa Ghilarducci and Tony James have proposed that the government create a guaranteed benefit plan for all workers. Unlike traditional defined benefit plans, which apply only to one firm, this plan would be portable from one job to the next and backed by the government. It would be funded by a small tax (1.5 percent) on employees and a similar tax on employers.
In addition to the demise of defined contribution pensions and stagnating wages, rising debt levels keep households from saving. Conservative talking points blame individuals for overspending, but the real problem lies with conservative policies. Cutting aid to college students requires that they borrow more money for school and then pay more money back after graduation. A shrinking social safety net means that a bout of unemployment, or a cut in hours, forces people to use their credit cards to pay for normal living expenses. And the lack of inexpensive child care adds a large cost to families with children where everyone must work just to make ends meet. These deliberate policy decisions all followed from providing large tax cuts to the wealthy and then balancing the federal budget on the backs of everyone else—Americans who now struggle to repay their debts.
Increasing taxes on the rich to help revive the American dream of retirement will help future generations of retirees. But it will not help those who are retired, or near retirement, and lack adequate savings. This is why strengthening Social Security is so important.
Contrary to the views of most commentators, we don’t need to cut benefits or raise the regressive payroll tax in order to silence the Chicken Littles shouting that the sky is falling on Social Security. And given that most retirees have inadequate savings, this is not something we should even contemplate doing. There are other options.
For a long time it has been acceptable for the government to go into debt in order to give large tax cuts to the very wealthy. The same principle should hold for ensuring that Americans receive the retirement benefits they were promised. We can also use general government revenues to fund additional Social Security benefits, reversing some of the huge cut in benefits due to the Greenspan Commission.
And if Social Security payroll taxes are to be increased, this can be done without imposing large costs on low- and middle-income individuals. Bernie Sanders and Elizabeth Warren, among others, have suggested raising the Social Security cap. Sanders proposes instituting the payroll tax again when wages reach $250,000. I see no economic reason for not taxing wages between $133,000 and $250,000. This exempts nearly half the $500,000 income of a household with two working adults each making a quarter of a million dollars.
We can also subject investment income above some level to Social Security taxes, as Bernie Sanders has suggested. We can even pair this with eliminating the double taxation on small business owners and still generate more revenue for Social Security.
Perhaps most important is the need to deal with decades of lost Social Security revenues. One way to do this would be through a wealth tax. But, as I argue in the September 2019 Washington Spectator, this is a bad tax policy for many reasons. A better plan would be a small estate tax of a percentage point or two (a few pennies on each dollar, to steal Elizabeth Warren’s line) on estates exceeding $1 million or $2 million. This tax would be in addition to the current estate tax, with revenues going to Social Security. It should be viewed as a way to recoup revenues lost over decades of rising inequality and tax avoidance by the rich.
If we are going to revive the American dream of a secure retirement, it will be necessary for the state to help average Americans save. And it will be necessary to retire several decades of bad Republican policies.
The author is professor of economics at Colorado State University, author of Fifty Major Economists, 3rd edition (Routledge, 2013), and president-elect of the Association for Social Economics.