Is Social Security Unfair to the Poor?

By Jeffrey Liebman

Sunday, July 29, 2001; Page B07

The interim report of President Bush's Social Security Commission argues that the current system is unfair to low-income beneficiaries, particularly minorities, whose shorter lifespans mean that they receive benefits for fewer years. The true effect of Social Security on low-income groups is more complex, and the implications for Social Security reform are quite different from those drawn in the report.

The Social Security benefit formula is progressive, providing a higher level of retirement income relative to lifetime earnings for low earners than for high earners. But low-income people tend to have shorter life expectancies, offsetting some of this redistribution. Nearly all research on this issue, including a paper I wrote that was cited by the Bush commission, suggests that the system still accomplishes some redistribution from upper-income to lower-income households, but not nearly as much as would occur if everyone had identical life expectancies. For blacks, high mortality rates offset essentially all of the redistribution implicit in the benefit formula, so that blacks receive the same rate of return on their Social Security payroll taxes as whites, even though blacks, on average, have much lower earnings.

But rates of return are only part of the story. More than 15 percent of Social Security dollars pay for benefits for young survivors of participants and disabled people; minority families benefit disproportionately from these features. Moreover, the protections offered by Social Security against outliving one's resources and against inflation risk are particularly valuable to low-income beneficiaries, who often have no other retirement income.

How do we strengthen the progressive features of Social Security while addressing its long-term financial imbalance? First, because low-income households depend on Social Security for retirement income, it is critical that we add money to the system. Otherwise, the long-run gap will have to be closed entirely by cutting benefits, placing at risk the low-income elderly who depend most heavily on Social Security.

Second, Congress and the president should consider additional redistribution to groups with high mortality rates. This could be accomplished by making the benefit formula more progressive or by introducing a provision entitling the heirs of a retiree to benefits if the retiree does not live long enough to collect benefits for at least 10 years.

Both adding money and increasing redistribution could be accomplished without fundamentally changing the structure of Social Security. But in the current political climate, the only likely way to provide more money to Social Security is to introduce it through individual accounts. This raises the question of whether it is possible to design individual accounts that are fair to the poor. Recent research shows that the answer is yes, but only if five conditions are met:

The accounts need to be funded out of resources beyond the 12.4 percent payroll tax. Simply diverting existing payroll tax revenue from debt reduction to individual accounts does nothing to boost national savings, and therefore does nothing to increase our ability to pay future retirement benefits.

The accounts must be funded in a way that preserves redistribution to the poor. Since any sensible individual account plan will require workers to convert their account balances into annuities upon retirement, the same reverse redistribution from groups with short life expectancies to groups with long life expectancies will occur in a system with individual accounts. But it is simple to offset this with larger deposits, relative to earnings, into the accounts of low-earners.

Investment options need to be limited to a few large index funds, and administrative costs should be assessed in proportion to account size. Otherwise, most of the investment returns of low-earners would go to pay these fees.

The new system must provide protections for widows and divorcees similar to those in the current system.

Disability and young survivors' benefits should be exempt from any cuts to the traditional system, because their beneficiaries typically will not have accumulated enough in individual accounts to make up for benefit cuts.

If the Bush commission recommends individual accounts with these features, we will know the president is serious about strengthening Social Security in a way that protects its most vulnerable beneficiaries. If not, it will be clear that the commission's discussions of blacks and low-income groups are simply a cover for an attempt to dismantle America's social insurance system.

The writer, an associate professor of public policy at Harvard's Kennedy School, was special assistant to President Clinton for economic policy in 1998-99 and coordinated the administration's Social Security reform working group.

© 2001 The Washington Post Company