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How Biden's 'Donut Hole' Plan Could Undermine Social Security

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“Keep your eye on the donut, not on the hole,” so the saying goes. But in assessing President Joe Biden’s plan to fix Social Security’s longtime shortfall, it’s smart to keep your eye on the “donut hole.” Biden has proposed creating such a gap by not taxing earnings of between $142,800 — the current maximum subject to Social Security tax — and $400,000.

But Richard Johnson, director of the Urban Institute’s Program on Retirement Policy, argues that he has a better idea — one that would generate more tax revenue for Social Security benefits without creating a donut hole, he tells ThinkAdvisor in an interview.

“Increase the $142,800 tax max to something like $250,000 today and continue to raise it [based on] average earnings growth,” he recommends.

Part of Johnson’s reasoning is rooted in the presumption that if Social Security were to be perceived as only for low-income earners, political support for the crucial program would be diminished.

(Max Richtman, president and CEO, National Committee to Preserve Social Security and Medicare, told ThinkAdvisor that the Biden plan would raise the payroll tax cap over time, making the donut hole temporary.)

Johnson is an economist and senior fellow in the Institute’s Income and Benefits Policy Center. The nonprofit organization conducts a wide range of research to improve public policy. 

Among numerous studies, Johnson wrote the December 2020 report “Comparing Democratic and Republican Approaches to Fixing Social Security.” He speaks frequently on income and health security for older Americans.

In the interview, he discusses the severe impact the coronavirus pandemic has had on pre-retirees who have lost their jobs. Some are taking Social Security early and reducing their benefits for the long term; others are raiding their 401(k) accounts for money to live on.

Johnson argues that the sooner policymakers address the Social Security dilemma, the lower potential tax hikes and benefit cuts would be. He favors reducing benefits slightly for higher-income earners.

This year, the Social Security Administration will pay out more in benefits than it receives in revenues, Johnson says. The Old-Age and Survivors Insurance Trust Fund is projected to run dry as early as 2031.

Former President Donald Trump presented no plan to solve the Social Security problem. In fact, the last time Social Security’s financing woes were acted upon was in 1983, an emergency situation when the program was a month away from the inability to pay full benefits, Johnson says.

ThinkAdvisor recently interviewed Johnson, who was speaking from Washington, D.C., where the Urban Institute is based. Beyond Social Security, he discussed research he has conducted on retirement prospects for millennials (“Men are earning less; women are earning more”) and an investigation into what he calls “the enormous differences” in retirement income between Black and white Americans.

For example, “we’re trying to understand how much of the retirement wealth gap is due to discrimination that people face in the workplace. Part of it is not having access to the best jobs,” he maintains.

 Here are highlight from our interview:   

THINKADVISOR: What are the chief challenges to President Biden’s plan to solve the Social Security predicament?

RICHARD JOHNSON: The problem is that Biden’s plan would increase Social Security taxes on higher-income people — those earning above $400,000 [a year]. Now people pay the Social Security payroll tax on earnings up to $142,800. Under Biden’s plan, you and your employer would pay your Social Security tax up to that point and then, in addition, you would pay taxes on earnings that exceed $400,000. But you wouldn’t get any benefits on those taxes. 

What are the implications?

Because the higher-income people would get less for their taxes paid than lower-earnings people, it makes the plan a lot less attractive to higher-income people. You worry about the political support for Social Security. It’s extremely popular in that everyone feels they have a stake in the system. But if it’s seen only as a lower-income program, that support can erode.

To what extent would Biden’s plan enhance benefits?

It would increase the cost-of-living adjustments by tying them to changes in the Consumer Price Index for the Elderly, which tends to increase at a more rapid rate than the standard CPI. The CPI-E weights things like medical expenses more heavily. It wouldn’t be a huge increase, but over time it would accumulate; so it’s of significance to older people. Also, Biden’s plan would create an earnings credit for caregivers of young children and older people.

What do you think of the president’s plan?

Extending the payroll tax to higher earnings make sense. One reason is that when we last addressed Social Security’s financing problems back in 1983, the payroll tax rate covered 90% of earnings; and today it covers only 83%. That’s because there’s been so much growth in the top end of the earnings distribution.

How would you improve upon Biden’s plan?

Instead of the donut hole that he [proposes] — which is, you pay up to a certain amount, then “take a holiday”; and if you’re lucky enough to make lots of money, you pay additional taxes — I would simply increase the $142,800 tax max to something like $250,000 today and continue to raise it [based on] average earnings growth. And I would probably reduce benefits a bit for higher-income people.

What are your thoughts on the idea of again increasing Social Security’s full retirement age?

Other plans have proposed that. The challenge is that a lot of people with health problems can’t work beyond 62 or 65. So if you increase full retirement age, you have to think hard about strengthening the safety net for those who can’t work beyond those ages.

What would the higher taxes Biden proposes be used for, specifically?

To help finance the Social Security system by closing the funding gap, and much of it would be used to increase benefits. One way would be to create a meaningful minimum benefit. Right now, that’s so meager it doesn’t affect many people. It’s really meaningless. A lot of workers who earn low wages all their lives end up in retirement with a benefit that doesn’t pull them out of poverty.

How would Biden’s plan remedy that?

It would have a minimum benefit equal to 125% of the federal poverty level, which in 2020 was equivalent to about $16,000 a year. But that part of his plan would apply only to those who have spent 30 years in covered employment. A lot of people have only intermittent work histories over their lifetime. That’s one reason they end up with low Social Security benefits.

What’s perhaps the biggest challenge that Biden’s plan faces?

There are a lot of other areas in society that need more funding too, such as infrastructure, the coronavirus pandemic, climate change, college graduates’ student-loan problems. There are many issues. So how much of the available tax revenues might there be to put into Social Security? 

Why does the Social Security system need to be fixed?

This year Social Security will pay more in benefits than it receives in revenues. It can use the Trust Fund that has accumulated over the years to make up that shortfall. But the fund is going to eventually run out of money. The trustees say that will be in 2035, and because of the pandemic, it could be a year earlier. The Congressional Budget Office says the Trust Fund will run out in 2031. So there’s a looming problem, and the sooner policymakers address it, the better. Any tax increases or benefit cuts they might have to implement would be less deep the sooner they take action.

What’s the main hang-up?

Republicans and Democrats see very different approaches to fixing the problem. The fact that Republicans have been reluctant to tackle it or even think about how they might address it is concerning. The last comprehensive plan in Congress from the Republican Party was in 2016.

I believe that former President Trump presented no plan while he was in office. Correct?

That’s right. We last addressed Social Security’s financing problems back in 1983. [President] Reagan and Congress did so only when Social Security was on the verge of not being able to pay full benefits. The month before that would have happened, really sweeping changes were made to how the system was financed, including raising the retirement age. Full retirement age is going up from 66 to 67 in a few months. It used to be 65. The age increases went into effect in 2000 even though they were legislated in 1983.

How has the pandemic and resulting economic decline impacted pre-retirees?

We’re seeing an increase in early Social Security claiming by those who have lost their jobs or are reluctant to go to work [in person] or who can’t work from home because of the pandemic. That has long-term impact on retirement security because they’re suffering a reduction in monthly benefits by taking Social Security early, particularly if they start collecting as early as age 62. 

What about people who lost their jobs before they reached Social Security age and therefore aren’t eligible to collect benefits?

They’re dipping into their retirement savings early, such as their 401(k) plans. That creates an even worse problem once they hit retirement age.

Is there anything that can be done to offset all these losses?

The best way to improve your retirement-income security is to work longer, but one of the challenges is that we don’t have a very good safety net for people who lose their jobs at older ages. Unemployment insurance doesn’t replace much of your income. The one hope is that, when the health situation [pandemic] and economy improve, people will go back to work, though we know that employers are reluctant to hire older people, for a variety of reasons.

Pre-pandemic, surveys showed that most workers hadn’t saved enough for a financially secure retirement. But they have in fact been saving since the pandemic hit. Are people putting some of that money aside for retirement? Or will they spend it as soon as the economy reopens?

I’m not sure that there’s evidence that a lot of the savings is going into retirement plans. And it’s yet to be seen that if health conditions improve this year, we’ll see people going on spending binges. I don’t expect that we’re going to see a long-term change in retirement-savings behavior just because of the pandemic. I think people will go back to their old patterns.

In 2017, you wrote a paper, “Retirement Prospects for the Millennials,” looking at that  cohort up to the early 30s in age. You found that “many recent trends threaten future retirement security.” What are some of the findings?

One concerning trend we found is that earnings are lower now for the median person in their 30s than it was for previous generations, certainly for boomers. There’s more wage inequality than in the past; men, in particular, are earning a lot less. Women are working more and earning more. That’s a continuing trend we’ve seen for several decades. Women have more retirement savings in their own name, which will surely help the retirement outlook overall.

It’s hard to reconcile how women are earning more but are still earning less on the dollar — about 81 cents — than men. What’s the explanation?

That’s absolutely right. The gender gap in earnings is smaller than it was 20 years ago, but it’s still substantial. A lot of it can be explained by differences in occupation. But even within occupations, women still tend to earn less than men. It’s something that economists haven’t been able to explain. Yet it’s so persistent.

What do economists conjecture?

There’s a lot of speculation that women aren’t as good negotiators as men, that maybe they don’t stand up for themselves as much as men do in negotiating pay and are more likely to accept what the employer offers than men do. 

What else?

Some say that women, on average, don’t work quite as many hours as men, and maybe that’s why they’re seeing lower pay. But the differences in hours and occupations don’t fully explain the gap. Neither do educational differences since young women, on average, are better educated than young men now. They’re more likely to go to college.

What did you find regarding homeownership among the millennials you studied?

It’s way down. That’s another concern because that’s the way many people accumulate wealth. Social Security is an important source of wealth-building; then comes homeownership. With the millennials, we’re seeing that home ownership is much lower than it was for, say, the boomers at the same age.

What research are you conducting now?

One of the things we’re starting to research is the enormous racial differences in retirement income: Blacks have much lower retirement wealth than whites. Part of it isn’t too surprising given that there’s so much earning discrepancy, and what you receive in retirement depends on how much you’ve earned over your lifetime. 

What do Blacks’ lower earnings lead to in their later years?

Bigger discrepancies, even though lower-income people get a better return on Social Security than higher-income people do. That is, the benefits relative to earnings are higher if you make less. But that’s not enough to offset the differences in retirement savings in 401(k) plans and other pensions.

Do you think racism plays a role in any of this?

We’re trying to understand how much of the retirement gap between Black and white workers is due to discrimination that people face in the workplace. But discrimination is hard to define. A big part of it is not having access to the best jobs as well, same as with the male-female gap — not having as much access as men do to the high-paying jobs.

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