Who Needs Social Security?

High income households are surprisingly dependent upon Social Security to maintain their living standards during their retirement years:

Americans' Dependency on Social Security, by Laurence J. Kotlikoff, Ben Marx, and Pietro Rizza, NBER WP 12696, November 2006  [open link]: Abstract This paper determines the standard of living reductions that young, middle aged, and older households would experience were the U.S. government to cut Social Security benefits (but not taxes) to deal with its ... long-term fiscal crisis. ... The analysis considers both stylized single and married households of different ages and resource levels as well as actual households sampled from the 2004 Federal Reserve Survey of Consumer Finances (SCF). The extent of current and future living standard reductions in response to announcements of future Social Security benefit cuts depends critically on the age of the household, when the cuts are announced, the size of the cuts, the income of the household, and the degree to which the household is liquidity constrained.

For our stylized households on the brink of retirement the complete elimination of Social Security benefits would entail retirement living standards reductions ranging from roughly one third to one hundred percent depending on the household's income. Our SCF findings also point to a strong dependency on Social Security. Indeed, 41 percent of older SCF couples and 33 percent of SCF singles would experience a living standard reduction of 90 percent or more were Social Security benefits eliminated.

A surprising finding is the major dependency of very high-income households on Social Security.

Take the highest earning couple in our stylized sample. This couple earns $500,000 per year from age 30 through age 64 when it retires. It enters retirement with over $2.3 million in assets. But given the length of its potential retirement, the modest real return it can safely earn on its assets, its off-the-top housing expenses, and its tax payments, this household is highly dependent on Social Security benefits, notwithstanding their taxable status. Indeed, were this household denied all its Social Security benefits on the eve of its retirement, it would suffer a 35.6 percent reduction in its living standard throughout retirement. ...

Conclusion Understanding the living standard implications for working and retired households of cutting Social Security benefits requires more than simply considering the size of these benefits relative to other resources. One needs to understand how Social Security benefits and other resources stocks and flows combine to determine a household’s living standard time path in light of taxes and borrowing constraints. This study ... examines how the living standards of both stylized households and households surveyed in the 2004 Survey of Consumer Finances would respond to 30 percent and 100 percent benefit cuts.

The findings indicate that the vast majority of today’s elderly, even those with very high levels of past earnings and large asset holdings, would experience very major living standard reductions from such cuts. Younger and middle aged households would be less affected in the short run by a 30 percent cut, since they are largely liquidity constrained. But such a cut would materially alter their living standard in retirement. The full elimination of Social Security benefits would, on the other hand, significantly reduce the current as well as the future living standards of today’s young and middle-aged households as well as dramatically reduce the living standards of most current elderly.

The paper also notes the importance of advance warning of benefit cuts:

The Importance of Advanced Warning Learning early that one’s benefits are to be cut can make a big difference... This is evident once one compares ... the percentage reduction in age-specific living standards contingent on learning about the future benefit cuts at ages 35, 50, and 65, respectively. In the case of the $30,000-earning married couple facing a 30 percent benefit cut, the retirement living standard declines by 17.8 percent if the household first learns about the cut at age 35, 23.3 percent if the household first learns at age 50, and 32.2 percent if the household first learns at age 65. Note that the 32.2 percent retirement living standard decline is almost twice as large as the 17.8 percent decline. ... Clearly, in delaying notification of this household that its benefits are to be cut, the government is giving the household less time to adjust by altering its saving. The upshot is a distortion in the life-cycle pattern of consumption. ...

Or, to put it another way, even with 30 years advance notice, a 30% benefit cut still causes this household to experience nearly a 20% fall in its standard of living during retirement. Without this much advance notice, the fall is even larger.