Distributional Effects of Means Testing Social Security: An Exploratory Analysis
This paper examines the distributional implications of introducing additional means testing of Social Security benefits where proceeds are used to help balance Social Security’s finances. Benefits of the top quarter of households ranked according to the relevant measure of means are reduced using a modified version of the Social Security Windfall Elimination Provision (WEP). The replacement rate in the first bracket of the benefit formula, determining the Primary Insurance Amount (PIA), would be reduced from 90 percent to 40 percent of Average Indexed Monthly Earnings (AIME). Four measures of means are considered: total wealth; an annualized measure of AIME; the wealth value of pensions; and a measure of average indexed W2 earnings. The empirical analysis, based on data from the Health and Retirement Study, starts with a baseline benefit for each household, calculated as the product of the average benefit-tax ratio under the current system, multiplied by the taxes paid by the household. These means tests would reduce total household benefits by 7 to 9 percentage points, amounting to 15.4 to 16.4 percent of the benefits of affected workers at baseline. We find that the basis for means testing Social Security makes a substantial difference as to which households have their benefits reduced, and that different means tests may have different effects on the benefits of families in similar circumstance. We also find that the measure of means used to evaluate the effects of a means test makes a considerable difference as to how one would view the effects of the means test on the distribution of benefits.
- In a sample from the Health and Retirement Study, means tests of Social Security reducing the benefits of those falling in the top quarter of all households based on means, defined as Average Indexed Monthly Earnings (AIME), or total wealth, or pension wealth, would reduce total household benefits by 7 to 9 percentage points, amounting to 15.4 to 16.4 percent of the benefits of affected workers at baseline. The means test would reduce the replacement rate up to the first bracket in the Primary Insurance Amount (PIA) formula from 90 percent to 40 percent.
- As the basis for the means test is changed, different households are affected. It will make a great deal of difference, at least to some households, which definition of means is chosen.
- Which measure of means is chosen will make a great deal of difference to policymakers holding specific views as to how best to define means. For example, if a policy maker believes that wealth is the appropriate basis for a means test, but another basis for means testing is in fact selected, households that are held by the policymaker to have low means will nevertheless suffer a reduction of benefits.
- Many households labeled as having high means when ranked by a particular criterion, whether it is lifetime covered earnings, wealth, or pension wealth, will not have their benefits reduced by the same amount.
Gustman, Alan L., Thomas L. Steinmeier, and Nahid Tabatabai. 2014. "Distributional Effects of Means Testing Social Security: An Exploratory Analysis. " University of Michigan Retirement Research Center (MRRC) Working Paper, WP 2014-306. Ann Arbor, MI. https://mrdrc.isr.umich.edu/publications/papers/pdf/wp306.pdf
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Paper IDWP 2014-306