June 19, 2018
Growing life expectancy in the U.S. is a positive development, but it creates two potential problems for Social Security, which provides income to retirees and certain disadvantaged individuals from a trust fund that working individuals pay into.
The first problem Social Security faces as lifespans grow is an increased financial burden on the Social Security Trust Fund. As people live longer, they spend more time drawing checks from the Trust Fund and the program’s overall costs go up. In 2018, the Social Security Administration reported that the Trust Fund used to finance the program will be depleted by 2034.
The second problem relates to the progressivity of the Social Security system as a whole. Although social security was designed to be a progressive policy that provides a safety net to low-income and retired Americans, it is becoming less progressive over time. Gains in life expectancy are not enjoyed equally across all income groups. Higher earners have seen larger increases in their life expectancy than have lower income people. This means that high-income individuals also receive more cumulative benefits from Social Security than low-income Americans.
This paper contributes to the discussion about Social Security reform by developing a new measure of the progressivity of a Social Security system. The authors use this new measure to show that the growing gap in life expectancy between low-income and high-income Americans reduces the progressivity of the Social Security system by approximately three-quarters.
To restore the financial sustainability of the program and maintain the progressivity of the Social Security system, we offer two potential policy reforms:
- Increasing the Social Security tax rate more for those who experience the largest gains in life expectancy than for those who experience smaller gains,
- Cutting benefits more for those who experience the biggest gains in life expectancy than for those who experience smaller gains.
These two reforms to Social Security present different trade-offs to policymakers, yet both improve social welfare if individuals value Social Security as insurance in the face of uncertainty about their lifetime earnings. Using a common macroeconomic technique called a life-cycle model, the authors find that rational, forward-looking individuals would give up 0.8% of their lifetime consumption to live in a world with targeted tax reform to the Social Security system and 3% of their lifetime consumption to live in a world with targeted benefit reform. These findings suggest significant welfare improvements may be possible with the potential reforms discussed.