Social Security And Immigration: A New Way To Model The Impact by Knowledge@Wharton

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A new federal budget modeling tool developed through the Penn Wharton Public Policy Initiative is being unveiled for public use today. Already it is producing new thinking around two areas very high on the public agenda: Social Security’s funding shortfall, and the economic costs and benefits surrounding immigration. In this interview with Knowledge@Wharton, Kent Smetters, Wharton professor of business economics and public policy, explains how none of the common fixes suggested for the Social Security shortfall will close the gap by themselves, according to the new simulator, and that the impact on the economy from providing a path to citizenship for undocumented workers is basically an economic wash for the U.S. The Penn Wharton Budget Model is a nonpartisan, online, interactive budget-modeling tool available at no cost to users. A demonstration of how the model works appears at the end of the video, or here for Social Security and here for immigration.

An edited transcript of the conversation appears below.

Knowledge@Wharton: Kent, there’s a lot of talk that Social Security just won’t be there for younger people. Will millennials receive the same Social Security benefits as their parents?

Kent Smetters: Under current law, the answer is no. In fact, we’re projecting that the trust fund will be exhausted by 2031 in just 14 years. So what the law actually says is that benefits across the board have to be cut in order to match the current payroll tax revenue that they’re getting at the time. That’s about a 30% reduction.

Knowledge@Wharton: If nothing changes then, Social Security benefits payments, monthly payments would have to be cut by 30% for everyone?

Smetters: That’s the key. It’s not just for new retirees, which could be a little less painful. But your 90-year-old grandmother, who’s maybe just surviving on Social Security, the benefits would be cut for her as well.

“If you increase [the Social Security maximum tax] from $118,500 all the way to $400,000 … it basically moves the trust fund exhaustion date from 2031 to 2036.”

Knowledge@Wharton: Of course, everyone’s scrambling to figure out what are some things that can be done about this. One of the common ideas is to raise the retirement age for Social Security. How much does that help?

Smetters: It doesn’t help much for the short term. In particular, it barely moves the trust fund exhaustion date from 2031. The reason why is that, in the current law, Social Security retirement age is creeping up to age 67. Even if you push it out to age 70, this idea that’s been batted around for a couple of decades in Washington, we just kind of waited too long to do it. And so it barely moves the trust fund exhaustion date. Over the long-term, it actually has a much bigger impact. But for the immediate term, on the Social Security trust fund, it barely moves it — simply because we waited too long to do it.

Knowledge@Wharton: What’s the difference between the immediate and the long-term? In other words, at some point we’d be better off, if not fully whole. But how long would the lag time be?

Smetters: The trust fund exhausts in 2031. Because we would phase in toward age 70 along the current path, which is about two months per year, it takes too long. So the trust fund barely moves. Over what’s called the 75-year window, which is how Social Security actuaries typically look at this, it helps improve the finances by almost 1/3. So it actually has a big impact over time. It’s just that it takes a long time for it to phase in.

Knowledge@Wharton: And the other solution often put forth is, “Well, how about if we increase taxes on people with high incomes?” Because there’s a cap right now on how much people pay.

Smetters: That’s right. In particular, you pay taxes up to the first $118,500. That’s indexed with wages, so it kind of grows over time. We call that the tax max. It’s the maximum income that your taxes are levied over. And so if you increase that from $118,500 all the way to $400,000, for example, it basically moves the trust fund exhaustion date from 2031 to 2036. Going above $400,000 has almost no impact, because there are just not enough people there. In fact, going from $250,000 to $400,000 has very little impact. So again, it can be part of a bigger solution, but by itself, it’s not going to solve the problem.

Knowledge@Wharton: What about reducing benefits for high-income people, who presumably don’t need the money as much as that 90-year-old grandmother does?

Smetters: That’s another idea that’s been discussed in Washington. A lot of people don’t understand that the benefit formula is actually extremely progressive. For poor people, we replace 90% of their average income before retirement. And that decreases quite a bit for middle-income and then higher-income households. So the idea has been, “Let’s keep poor people at a whole 90% replacement rate, but lower it for middle-class and upper-income households.”

Even a very aggressive, across-the-board change — for the trust fund by itself — it’s basically too late. It barely moves the trust fund. As far as the 75-year solvency, it again has a much bigger impact. In fact, if you combine that with increase in the retirement age, we actually solve the 75-year problem with those two combinations. However, we still would have to come up with a mechanism for the trust fund to somehow borrow against its future, essentially be able to not just hold assets, but be in debt for a while.

Knowledge@Wharton: You are saying there would be this interim when there would be a shortfall?

Smetters: There would be a shortfall. Depending on the exact policy combinations, it could be between 10 and 25 years.

“It turns out that the impact on the economy from legalization [of undocumented workers] is basically a wash.”

Knowledge@Wharton: So it might involve some [political] bartering….

Smetters: That’s right.

Knowledge@Wharton: The other item is the cost of living allowance, or COLA, that is provided each year — although there wasn’t one last year — based on inflation. And if that were adjusted, how much would that save? Of course, that’s cutting benefits if you cut that.

Smetters: It is. Under current law, what happens is that the Social Security benefits are adjusted every year for use in what’s called the CPIW [Consumer Price Index for Urban Wage Earners and Clerical Workers], which was just what they happened to choose at the time. And one of the concerns that economists have had is, that index doesn’t account for what’s called “substitution,” where you might have a product price that goes up on you, and you substitute toward lower prices. We’re seeing this, for example, with the Affordable Care Act. As a lot of plans get more expensive, people substitute toward cheaper plans.

And so a true measure of inflation would allow for that substitution. That’s called a chain-weighted index. That has been something that has been discussed a lot, ever since the Boskin Commission, and other groups. It actually turns out it doesn’t have

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