Photograph by William Thomas Cain — Getty Images

The formula behind Social Security is up for debate.

By Henry J. Aaron
February 18, 2016
February 18, 2016

Social Security faces a financial shortfall. If Congress does nothing about it, current projections indicate that benefits will be cut automatically by 21% in 2034. Congress could close the gap by raising revenues, lowering benefits, or doing some of both. If benefits seem generous, Congress is likely to lean toward benefit cuts more than revenue increases. If they seem stingy, then the reverse could happen.

Given the split between the two parties on whether to cut benefits or to raise them, evidence on the adequacy of benefits is central to this key policy debate. Those perceptions will help determine whether Social Security continues to provide basic retirement income for workers with comparatively low earnings histories and a foundation of retirement income for most others or it will become just a minimal safety-net backstop against extreme destitution?

Down-in-the-weeds disagreements among analysts often seem too arcane for anyone other than specialists. But sometimes they are too important to ignore. A current debate about the adequacy of Social Security benefits is an example.

The not-so-simple question is this: are Social Security benefits ‘generous’ or ‘stingy’? To answer this question, people long looked to the Office of the Social Security Actuary. For many years that office published estimates of something called the ‘replacement rate’—that is, how high are benefits paid to retirees and the disabled relative what they earned during their working years. A 2014 retiree with median earnings had average lifetime earnings of about $46,000. That worker qualified for a benefit at age 66 of about $19,000, a replacement rate of about 41%. Replacement rates vary with earnings. Dollar benefits rise with earnings, but they rise less than proportionately. As a result, replacement rates of low earners are higher than replacement rates of high earners.

As you might suppose, there are many ways in which to compute such ‘replacement rates. Because of analytical disputes on which method is best, the Social Security trustees in 2014 decided to stop including replacement rate estimates in their annual reports.

In December 2015, the Congressional Budget Office (CBO) offered what it considered a better measure of the generosity of Social Security. It estimated that replacement rates for middle income recipients were about 60%–dramatically higher than the 41% that the Social Security Trustees had estimated.

The gap between the estimates of CBO and those of Social Security is even larger than it seems. To see why, one needs to recognize that to sustain living standards retirees on average need only about 75% to 80% as much income as they did when working. Retirees need less income because they are spared some work-related expenses, such as transportation to and from work. Those are only average of course; some need more, some less.

If one believed the SSA actuaries, Social Security provides median earners barely more than half of what they need to be as well off as they were when working. Benefit cuts from that modest level would threaten the well-being for the majority of retirees who are entirely or mostly dependent on Social Security benefits—and especially for those with large medical expenses uncovered by Medicare.

On the other hand, if one accepted CBO’s estimates, Social Security provides more than three-quarters of the retirement income target. Against that baseline, benefit cuts would still sting, but they would pose less of a threat, and not much of a threat at all for most retirees who have some income from private pensions or personal savings.

When the CBO estimates came out, conservative commentators welcomed the findings and cited CBO’s well-established and well-earned reputation for objectivity. They correctly noted that many retirees have additional income from private pensions, 401ks, or other personal savings, and asserted that there was no general retirement income shortage. By inference, cutting benefits a bit to help close the long-term funding gap would be no big deal. Social Security advocates were put on the defensive, hard-pressed to challenge the estimates of the widely-respected Congressional Budget Office.

But earlier this year, CBO acknowledged that it had made mistakes in its Decameter estimates and revised them. The new CBO estimate put the replacement rate for middle-level earners at around 42%, almost the same as the estimate of the Social Security actuaries, not the much higher level that had sent ripples through the policy community. One conservative analyst, Andrew Biggs, who had trumpeted the initial CBO finding in The Wall Street Journal, promptly and honorably retracted his article.

Two aspects of this green-eyeshade kerfuffle stand out. The first is that policy debates often depend on obscure technical analyses that are, in turn, remarkably sensitive to ‘black-box’ methods to which few or no outsiders have ready access. The second is that CBO burnished its reputation for honesty by owning up to its own mistakes — in this case, a whopping overestimate of a key number. Such candor is all too rare; it merits notice and praise.

But there is a broader lesson as well. Technical issues of comparable complexity surround numerous current political disputes. Is Bernie Sanders’ single-payer plan affordable? Will Marco Rubio’s tax plan cause deficits to balloon? To vote rationally, people must struggle to see through the rhetorical chaff that surrounds candidates’ favorite claims. There is, alas, no substitute for paying close attention to the data, even if they are ‘down in the weeds.’

Henry J. Aaron is a senior fellow in Economic Studies at the Brookings Institution.


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