Scrapping Private Retirement to Save Social Security?

Social Security is facing a crisis. This is not news; we’ve known that our Social Security benefits were at risk for a long time. Many millennials (my own generation) and Gen Z workers simply assume those benefits won’t be available when we reach retirement age, but that doesn’t mean we shouldn’t be trying to fix the problem. In 'The Case for Using Subsidies for Retirement Plans to Fix Social Security,' Alicia Munnell and Andrew Biggs contend that getting rid of the tax benefits employers and employees currently enjoy in private retirement plans would boost payroll tax income and give Congress time to fix the looming crisis. The authors make their case by answering a series of their own questions, but their chosen scope and selective use of source material make this proposal difficult to take seriously. Below, I analyze the proposal's main points while trying not to be too sarcastic about it.

Who gets tax expenditures?

Munnell and Biggs assert that the distribution of tax benefits in the private retirement space is too unequal. They reference a study that shows the top quintile (the top 20% of earners) receiving 59.2% of the gross tax benefit in 2020.

More than half of the qualified plan tax expenditure going to the top 20%? That doesn’t seem fair… until we take a look at how much that same group pays as a percent of the total income tax collected. According to the IRS’ summary of 2020 income tax data, the top 25% of earners in the US paid 88.5% of the total federal income tax. The top 10% of earners alone paid 73.7% of the total. The bottom 50% of earners in the US paid only 2.3% of the total income tax in 2020, but roughly that same group (the bottom 3 quintiles of earners, so 60%) received 37.4% of the qualified plan tax benefit in 2020.

Taken in appropriate context, the distribution of tax benefits in the private plan market is positively rosy. The lowest income groups, who contribute just over 2% of the total income tax collected in America, receive more than a third of the total tax benefits afforded to retirement plans. If you want to make an argument to end incentives for programs based on equity, maybe you should make sure you aren’t targeting one of the more equitable programs first.

Do tax expenditures increase saving?

Right off the bat, let’s clarify what Munnell and Biggs are referring to when they talk about ‘saving’ in this section. The authors are equating ‘saving’ with ‘national capital formation,’ which is the sum of government saving and saving by individuals.

They are not asking “Do qualified plan tax expenditures increase the ability of individuals to save money in private retirement plans?” to which the answer is a resounding and clear ‘yes.’ Rather, they are asking, “Do qualified plan tax expenditures increase the ability of individuals to save enough money to offset the amount the government is missing out on saving?” Their answer is, probably not.

Well, what about it? That does not sound like something the individual taxpayer and saver should be expected to worry about. In fact, most taxpayers should be overjoyed that they do not have to rely on the government to save money for them. We can pull major government programs out of a hat, and the odds of finding one that is managed prudently are about the same as being struck by lightning on a cloudless day- it happens, but no sensible person plans their life around it.

The authors reference several other studies and make several conjectures in this section, but in my opinion the premise of the opening question makes this whole portion moot. But just for fun, let’s see what they have for us.

The authors cite a 2022 study produced by a Harvard Professor named John Beshears and four other academics who probably all have impressive titles and at least 30 degrees between them. Munnell and Biggs refer to a point made in the Beshears study, specifically an analysis of a DOD savings plan, wherein automatically enrolling employees at a steadily increasing percentage ‘had little or no effect’ on participants’ net worth. I read the study and found that Munnell and Biggs accurately presented this point.

Then something strange happened.

In the very next paragraph, Munnell and Biggs referenced a different study to demonstrate national tax subsidies’ lack of impact on saving behavior. This study was undertaken with Danish tax data from the nineties. “Kenneth,” I hear you saying, “a Danish study from the nineties? But Denmark has less than 6 million people, multiple counties In the United States have larger populations, it’s entirely monocultural and its economic system and laws are markedly different. Is this really a useful way to understand retirement policy in the United States?” No, but if the authors want to use this study to prove a point, it's fair game.

The Danish study’s authors showed that a small reduction in the tax benefit for saving into private retirement plans did not adversely affect saving behavior in a significant way.

But that isn’t the strange part. Imagine my confusion when, in reading that Danish study, I came across the words “…policies that raise retirement contributions if individuals take no action – such as automatic contributions to retirement accounts – increase wealth accumulation substantially.”

Like you, I was bamboozled. Which was it? Did automatic enrollment and sustained contribution to retirement plans have no effect on wealth, as Professor Beshears and his colleagues demonstrated? Or do these practices substantially increase wealth, as our Danish friends showed long ago? The truth is, the answer is unclear. In some places and times, automatically enrolling employees into a retirement plan will increase wealth. In others it won’t. Munnell’s and Biggs’ certainty appears to come from an advanced and little-known academic practice known as ‘cherry picking.’

Do the tax expenditures improve coverage?

Munnell and Biggs admit that there is very little data available on this subject, but this just gives the authors an opportunity to say what they want, and they seize it.

One statement in particular struck me: “It is important to remember that retirement plans existed before the income tax, so tax benefits are clearly not the only reason employers sponsor retirement plans.” This sentiment is manifestly true, but it does not follow that what this statement implies (that employers today would continue to set up private retirement plans in the absence of existing tax breaks) is also true.

Of course, Munnell and Biggs would never explicitly make the claim that employers would continue setting up and maintaining retirement plans if there were no tax benefits available, because they know it’s probably false. However, they don’t seem to have a problem with letting you believe it.

Anyone who works in the private retirement space knows what would really happen if tax benefits for retirement plans were removed: new plan creation would all but dry up, and many existing plans would start their termination paperwork. Noble sentiments about providing for employees aside, the folks on the ground know why the industry as a whole flourishes.

Final thoughts

We should remember that this proposal is not meant to ‘fix’ the Social Security shortfall, only to give congress more time and flexibility to act, as Munnell and Biggs make clear. However, this begs the question: is that a good idea?

Since 1994, sixteen Social Security Trustee reports have predicted a shortfall, and many before 1994 expressed concern. The total number of binding actions taken, of any kind, to address this shortfall?

Zero.

I am not being overly selective here: since Reagan’s first term, Congress has not taken a single step to address this looming crisis.

Munnell and Biggs want to give congress more time, but based on all available data, Congress won’t do a darn thing with it. If this proposal were enacted, the most likely outcome would be a shortfall in, say, 2040 instead of 2033, but this time we’d be looking at a Social Security crisis with no private retirement option to fall back on.

All of this matters because this proposal isn’t just some marginal idea bouncing around the echo chamber of academia, it’s being discussed seriously in policy-influencing circles at a time when national concern for Social Security has never been higher.

This approach is part of a larger trend wherein Social Security policy discussion is centered on what many see as the almost sacred nature of Social Security: taxpayers fund their own future benefits through payroll taxes, so the only way to address shortfalls is increased payroll taxes, reduced benefits, or a combination of the two.

Social Security is a hand to mouth operation, and it’s getting harder for Americans workers and companies to subsidize the government’s commitments to retirees. Combine that with slowing population growth and increased life expectancies, and the math becomes starkly simple: if demographic trends continue, Social Security in its present state will never leave a state of crisis. What we need is an understanding that if we want Social Security to survive and thrive, the money is simply going to have to come from somewhere else. Even as you read that last sentence, a potential source probably came to mind, and I bet it’s a better idea than torpedoing the entire private retirement sector.