Cut Working Seniors' Taxes

It would spur them to earn more

With big budget surpluses looming, a hot tax-cut battle is shaping up on Capitol Hill. On one side, the Republicans have resurrected plans for a hefty, broad-based cut; on the other, Democrats are calling for less massive tax relief and more stress on paying down the federal debt and investing in education and health care.

What could be lost in the shuffle, however, is a modest tax cut that has drawn support from experts and legislators across the political spectrum: doing away with penalties that reduce Social Security benefits for recipients earning more than prescribed limits. Intriguingly, a recent economic study indicates that such a change would not only induce seniors to work more but also, in the long run, do so at little if any cost to the government.

Today, Social Security pensioners lose $1 for every $2 they earn over $9,600 if they are under 65 and $1 for every $3 they earn over $15,500 if they are 65 to 69--with the limit for the latter group rising to $30,000 in 2002. When they hit 70, of course, people can earn as much as they want with no penalty. But till that age they face marginal tax rates of at least 40.95% to 57.65% (counting payroll taxes)--and as high as 80% for some seniors who also pay income taxes.

Does the earnings penalty make any sense? One motive of its Depression-era designers was to induce old people to retire and make way for younger workers, and its defenders still argue that Social Security is mainly a social-insurance scheme for seniors with reduced earnings capabilities. Junking the limit, they say, would simply put cash in the pockets of affluent working seniors, reduce trust-fund assets, and might even induce some folks to work less.

Most economists today are unconvinced. For one thing, the combined prospect of a surging elderly population, longer and healthier life spans, and slowing labor-force growth have shifted economic-policy imperatives toward encouraging seniors to work longer and save more. For another, new economic research suggests that eliminating the earnings test would accomplish this goal at little cost.

In a recent National Bureau of Economic Research study, Leora Friedberg of the University of California at San Diego found big shifts in older workers' earnings patterns each time the earnings limit has been raised in the past 20 years. Specifically, a large number of men appeared to increase their work efforts so that their earnings rose until they hit the new limits.

Using an econometric model drawn from these data, Friedberg predicts that many such workers will boost their work efforts in 2002, when the limit will rise to $30,000 for workers 65 to 69. But she also finds that some high-wage earners who lost benefits in the past will now choose leisure over work and actually work a bit less--offsetting the increased hours put in by the first group. If the earnings test were eliminated entirely, on the other hand, she finds that total labor supply by affected seniors would rise by a healthy 5.3%.

As for the cost, Friedberg notes that under current law, those who lose Social Security benefits today because of the earnings penalty receive compensating increases in future benefits. Thus, while the immediate cost to the system of getting rid of the limits could run as high as $5 billion a year or more, the long-run cost would be minimal.

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