The third rail of subway systems provides high-voltage electricity to the subway cars; anyone who touches it is likely to be burned to a crisp. The analogous "third-rail of politics" is Social Security, and yet Senator Johnson of Wisconsin seems willing to risk political electrocution. Famous for recommending Listerine for Covid, and claiming that climate change is a hoax, he now claims Social Security is bankrupt, and to cure this alleged fiscal condition he wants Congress to adjust Social Security payments annually. In other words, rather than use the system formulas for determining retiree benefits, Johnson would substitute congressional "discretion," shifting the Social Security program to an annual budget item rather than a permanent program. Before assessing Johnson's proposal, voters should be aware of how the Social Security system determines benefits now.
The program works under two arithmetic formulas, first, to generate revenue via the payroll tax, and second to calculate the benefits that workers receive upon retirement. These two formulas determine the obligations income earners have and the earned entitlement during their retirement.
The Payroll Tax
In 1935, President Franklin Roosevelt designed Social Security as a government-mandated retirement insurance program to reduce poverty in old age. He chose to finance the program with a payroll tax as a kind of insurance premium. This had the effect of stabilizing the system in the face of strong "conservative" opposition. Because program benefits are tied to worker earnings, voters do not perceive Social Security as “welfare." Roosevelt said: “We put those payroll contributions there to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my Social Security program.” To this day, any “damn politician” who proposes to curtail any aspect of Social Security can expect to encounter opposition from a huge majority of the electorate.
There is no mystery about the payroll tax withheld from earnings: it appears right on a worker's pay stub as the FICA (federal insurance contribution act) tax. This year, for example, the FICA tax rate is 7.65 percent (on the first $147,000 of earnings for the 6.2% deducted for Social Security; no income cap for the 1.45% deducted for Medicare). Both the employer and the employee pay this amount for a total of 15.3% (The self-employed pay both halves). In effect, this is an insurance premium.
The Benefit Formula
In addition to the payroll tax, the benefit formulas also add to the stability of the system. The method for calculating benefits is described at the website ssa.gov. In a series of steps, the method leads to the retirees' Primary Insurance Amount (PIA), i.e., the amount of the retiree's first monthly check. That monthly amount is adjusted for inflation to provide a rough estimate of a constant level of purchasing power. The United States of America has not missed one payment in the 82 years of the program.
Step one in the calculation of the PIA is the determination of the average indexed monthly earnings, or AIME. This is a tabulation of the worker's earnings during their top 35 earning years, up to a maximum amount designated for each year ($147,000 for 2022).
These past earnings are then adjusted via a wage index to reflect the average worker's contribution to the nation's productivity. This adjusts the past dollar earnings not only for inflation during the period between the performance of the work and the present, but also for productivity growth. In other words, the prosaic arithmetic is designed to reflect the worker's participation in the steady growth of labor productivity, which has averaged 1.5% annually. Using this wage index ascribes to past work the same purchasing power as if the work were produced in the current year.
The next step in establishing the PIA is a three-part summation. In the first part, each dollar of the average indexed monthly earnings up to the first $1,024 adds 90 cents to the benefit check; in the second part each dollar between $1,024 and $6,172 adds 32 cents; and finally, in the third part, each dollar above $6,172 adds a mere 15 cents. Note that while the benefit amount rises with earnings, the rate of increase drops very fast at the $1,024 and the $6,172 “bend points." The result of adding these three parts is the amount of the retiree's monthly check. This amount is adjusted for inflation beginning each May, and checks are sent for the remainder of the retiree's life.
Roosevelt's reliance on the payroll tax formula and the benefit formula manifests a social contract with carefully specified contractual terms. The payroll tax formula and the benefit formula are conditions of employment in the United States. They are part of what workers agree to when they accept their terms of employment.
For Johnson's proposal to have any meaning, he must be talking about reducing the benefits below the benefit formula that people have relied upon for their entire work life. In effect, Johnson would have the benefits reduced long after the work that earned those benefits had been performed and accepted by employers. The worker cannot reclaim the value of that work if the terms of the benefit formula are reneged upon after the work is performed, a portion of the value of that work will have been stolen.
William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.