Bryan Caplan  

Replies on Means-Testing

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I'm happy to see all the feedback on my latest means-testing post, but I wish more readers engaged my original question.  After presenting one simple means-testing formula, I asked:
In the new political equilibrium, how much do you predict the full Social Security and Medicare benefit will fall?  Remember, this is the benefit that everyone below the median income gets.
My co-blogger David Henderson's not happy because I didn't revisit earlier critiques:
My point with this post is not to take back what Bryan persuaded me of. Rather, it's to try to persuade Bryan and others who share his view to admit the criticisms that many others, including Scott Sumner and I, have made. Bryan re-advocated means testing in his latest post without even hinting that these three problems I raised are indeed problems.
I think I responded to most of these complaints in an previous post.  In any case, though, the point of my latest post was not to defend means-testing, but to ask readers about the political economy of means-testing.

Kyle Thompson:
As a liberal who supports means-testing social security and Medicare, I resent the implication that I don't exist!
I only claimed that I don't know of any liberals I've converted, not that liberal supporters of means-testing don't exist.  Glad to have you with us, Kyle!

JLV:

Consider a world where SS and Medicare are means-tested.

Does Bryan Caplan (and his fellow libertarian means-testing advocates):

a) vociferously argue for the abolition of SS and Medicare

or

b) vociferously defend the means testing they argued for.


My bet is on a. So why bother with means testing, if we're going to argue about abolition anyway?

Why bother?  Because means-testing has far broader appeal than abolition.  As usual, I'm happy to meet people where they stand.

Lowcountry Joe:
I think it is completely immoral to means-test old-Social Security and take away the opportunity for those who made the most contributions to get nothing. The 'insurance' was designed to provide benefits to those who outlived the mortality table. The only fair thing to do is to substantially raise the age at which people are entitled to full benefits and significantly reduce the benefit for those who take it early.
I agree that raising the retirement age is a good idea.  But why is it uniquely "fair"?  Your reform advantages people who are longer-lived, who tend to be rich, non-black, and female.  And it's not like Social Security or Medicare is a "promise" in any meaningful sense when a simple act of Congress has always been sufficient to change the benefits.

The noble Scott Sumner:

I think this would be a bad idea. The numbers make no sense unless you are referring to income levels of the retired. Suppose a couple saved a million dollars during their life and turned it into a $50,000 annuity on retirement. Also suppose they earned $50,000 combined from Social Security. If the million dollar nest egg puts them in the top 10% of retirees, they lose almost all their Social Security. That's a huge disincentive to save. And recall that the tax system already has other saving disincentives built in, so it would make the bias against saving much stronger.

I presented a simple means-testing formula to focus attention on the political economy.  A lifetime measure of income is obviously better.

Scott continues:

Means testing is just another high implicit marginal tax on people who work hard and save.
"Just another high implicit marginal tax"?  Not really.

1. At minimum, means-testing is also a way to sharply reduce (or avoid increases in) payroll taxes.

2. It depends on the formula; if only the bottom decile is eligible for benefits, means-testing is a high implicit marginal tax on people with low income, and zero marginal tax on everyone else.

3. If you take behavioral economics seriously - and you should - it's easy to believe that the behavioral response to benefit reductions decades in the future will be far less than the behavioral response to taxes now.  

P.S. Thanks to Frank Howland and Peter for directly addressing the political economy of means-testing.  I'd be especially grateful for any additional feedback on this issue.


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COMMENTS (15 to date)
John David Galt writes:

Your reply to Scott Sumner changes the whole proposal to a seriously bad idea. Of course any means-test must be based on current income during retirement.

The whole point of any welfare-payment scheme is to help only those who need it. And the point of adding means-testing to Social Security is to try to replace the whole attitude "it's a pension and I'm entitled to get back what I put in plus interest" with the attitude that it's welfare.

I don't think disincentivizing saving is a problem for two reasons. First, as part of enacting means testing, the public needs to be told that the days of Social Security "being a pension" are over and will never come back. And second, the very fact that we're even considering changing Social Security in any way is proof that nobody should be making big decisions, such as not to save, on the assumption that government will keep its promises. Government is not answerable to you or me if it breaks its word, so its word is never to be trusted.

But I draw the line at any attempt to change the benefit formula that is NOT a function of current income while retired (such as Scott's idea to base it on lifetime income, in place of the "best 10 years" formula now used). That would be too unfair.

Henry writes:
2. It depends on the formula; if only the bottom decile is eligible for benefits, means-testing is a high implicit marginal tax on people with low income, and zero marginal tax on everyone else.

Given that deadweight loss increases nonlinearly with increased marginal tax rates, couldn't it be possible (or even likely) that a small increase in marginal tax rates on everyone would produce a smaller deadwight loss than a large implicit marginal tax rate on a few and none on many?

Jim Glass writes:

I'm a big fan of Sumner generally, but his objection here misses the boat by a lot, IMHO.

First, in my mind, no academic paid by a college or university has standing to object to means testing without first noting how the family of every student on his campus has gone through full means testing -- income, assets, savings, retirement accounts, home values, the works -- to determine how much the college is going to collect from that family to pay that academic's own salary. I've gone through this for two kids so far and will again.

Means testing is unfair/ unworkable /a tax on savings, success and work/distorts behavior? I don't take such objections as fully genuine when coming from someone paid by FAFSA form unless one has made them already about the FAFSA form. It seems to work fine for millions a year. And colleges use means testing as price discrimination to maximize revenue. I'd think saving the government from bankruptcy is an even more worthy purpose.

As to...

"Means testing is just another high implicit marginal tax on people who work hard and save."

... Social Security's cash flow going forward is underfunded by 1.5 points of GDP annually. That gap must be closed by either spending cuts or tax increases or some combination of them, and it will be -- the Iron Law of Arithmetic dictates so.

Considering a spending cut to be an implicit tax increase on who takes the cut is fine -- but as a rhetorical ploy used to argue against the cut on the grounds that it is a tax increase it fails, because the alternative is an explicit tax increase.

So Sumner's objection flunks the reality test: an implicit/explicit tax increase of 1.5 points of GDP annually is coming. His not liking it won't stop it and doesn't matter. What does matter is exactly who is going to pay that 1.5 point annual cost, and how.

If Sumner doesn't like means testing, that's fine -- so long as he proposes what he thinks is a better idea for who should pay that 1.5 points annually, and how.

Saying "I knock down your proposal to solve the problem but have no alternative to contribute", contributes zero to solving the problem, and a zero score grades out as an F.

(Of course, double the scale of all the above for Medicare.)

Randy writes:

I think that, within the next thirty years, means testing for Social Security and Medicare payouts is a certainty.

1. Raising the retirement age will not work. We're not getting old later, we're just living longer as old people. Those who are not eligible for Social Security in their early to mids 60s will simply become eligible for other more costly programs (disability, food assistance, etc).

2. It will not be possible to raise taxes higher on a generation already saddled with high taxes, the collected debt of preceding generations, and the burden of an expanding population of elderly.

So means testing it is (and should have always been). Might as well start phasing it in.

Scott Sumner writes:

Jim Glass, I strongly disagree with your claim that I have no right to comment on this issue without first discussing college financing issues.

Second I do have an alternative---a progressive payroll tax.

Third, all supporters of sound economic policy should oppose all taxes on capital, as they double tax money that is saved. They are both inefficient and profoundly unfair.

I disagree with Bryan's argument that we need to take behavioral studies seriously. These studies are done in very artificial settings, and often do not hold up in the real world. I am confident that the sort of means testing he proposes would significantly impact savings rates.

If one plans on means testing, it should be done on the basis of lifetime wage income, not total income. That would be acceptable, as it wouldn't double tax saving.

Maximize Liberty writes:

Bryan correctly notes that whether his proposed mechanism is another high implicit marginal tax "depends on the formula; if only the bottom decile is eligible for benefits, means-testing is a high implicit marginal tax on people with low income, and zero marginal tax on everyone else."

Recall that his actual proposal was that everyone up to the median income gets the same benefit, then everyone above it gets a 2% reduction in benefit for their every percentile above the 50th.

That means that there is zero marginal reduction in benefits (like a tax) for those below the median. For those above the median, we have to recognize that a 2% reduction in benefits has no direct correlation to any particular percentage of income. For someone moving from the 51st percentile to the 52nd percentile, I imagine that 2% of benefits is a larger percent of income than someone moving from the 91st to 92nd percentile.

So, the marginal rate of benefit withdrawal would be zero from the 1st to 50th percentile, be highest at the 50th-to-51st percentile move, and would fall from there.

That a little odd for anyone believing in progressive taxation. Therefore, in answer to Bryan's question, I would expect to see liberals attempting to make the benefit withdrawal appear more progressive, which would mean less total benefit withdrawal.

I would think that conservatives would be opposed to making this appear to be more of an income-redistribution program. Yes, I know it already is in lots of ways. But many people believe that they paid in what they are getting out. People who believe that would oppose this kind of transparent break. That opposition would appeal to the conservative who values an apparent connection between work and reward. That would lead me to expect that conservatives would want to start the benefit withdrawal earlier on the scale, perhaps at the 20th percentile. But being big-hearted fellows, they could not propose an pro-rata result, so they would probably also end up with something that looks like a progressive tax schedule. Applying thereduction to any of the bottom half of incomes would have the effect of increasing the reduction in aggregate benefits, but I don't think we could say ahead of time what the political compromise would be, so the total reduction is pretty ambiguous.

So, I would guess a very small reduction in aggregate benefits. Maybe 10%.

Max

mark writes:

I don't understand the full scope of your preference for means testing. What are you saying about the tax side of these programs. Particularly re Medicare because the income level for taxation is uncapped. Are you saying that high earners should still pay the taxes that support these programs but get less benefits? How could that be fair? That is just pure redistribution. Take Households A, which makes 50G a year and B which makes 1MM a year. B pays 20 times more Medicare tax than A. Assume they are of equal size and present equal risk of utilization. As things stand now, for the same coverage and risk, B is being asked to pay a premium 20 times greater than A. Now you would take even the coverage away? Then all you have is redistribution. It seems your only argument for doing so is, it's more popular than abolition. Even if true, how is that intellectually defensible?

Larry Willmore writes:

Scott Sumner, beautifully phrased. You saved me the trouble of drafting a response. But I would like to add one small comment.

Taxing (i.e. means-testing) lifetime wage income would work for the pension portion of social security, as there would be no disincentive to save, but I don't see how it would work for medical care portion (i.e. Medicare). Someone with a large lifetime income might find it difficult in old age to finance a 40 or 50% co-pay for a major illness, and private insurance is difficult for an elderly person to obtain.

It would be more reasonable to follow Scott Sumner's first suggestion of a progressive payroll tax: collect more taxes from the wealthy while they are working, rather than 'claw back' their pension and medical benefits when they are old.

MikeP writes:

Someone with a large lifetime income might find it difficult in old age to finance a 40 or 50% co-pay for a major illness, and private insurance is difficult for an elderly person to obtain.

If Medicare didn't exist, someone with a large lifetime income would probably buy themselves old age health insurance while they have high income.

It would be more reasonable to follow Scott Sumner's first suggestion of a progressive payroll tax...

It's almost as if it would be more reasonable to use the already existing progressive income tax to fund this! I assure you, if it wasn't called "Social Security", but rather was called "welfare" and was commensurately less generous, there would be little disincentive to save.

Randy writes:

That means testing would necessarily turn Social Security and Medicare into Welfare Programs is a feature, not a bug. A majority of the population has an interest in keeping the cost of Welfare Programs down - the opposite of the current situation. It can't happen over night. But it can and should happen - and I can't imagine a better time to start the transition than now.

Larry Willmore writes:

It's almost as if it would be more reasonable to use the already existing progressive income tax to fund this!

Yes, it is more reasonable to fund Medicare from general government revenue instead of payroll taxes. Also, it is more humane to provide Medicare to everyone, young and old, on a universal basis (without a means test).

Canada and other developed countries manage to do this. Is it unreasonable to expect the USA follow their example?

There is one difficulty, however. The US health care system is the most expensive in the world, and very inefficient. Reducing this cost is more urgent than deciding how to pay for it, but the two problems are related.

For an international comparison of health care spending, with graphs, see this post.

Jim Glass writes:

I should apologize to Professor Sumner, as my comment above reads much more snarky and personal than intended -- 3 a.m., having just had another round of FAFSA fun ... my internal monitoring circuits failed. Sorry, Professor. If you read this, I'm still among your biggest fans. It wasn't meant to be personal at all.

The point was that all "reform" and "solvency" arguments about SS resolve to just this: "who is going to get hit with paying the $20.5 trillion (I just checked it) unfunded liability?" That is the entire story. That is what *all* arguments about SS factor down to.

SS is different than other programs in that this cost *can't* be legislated away. So the issue isn't whether we "should" raise taxes, but only what kind of taxes we are going to raise, (including implicit-tax benefit cuts), who will pay them, when, and how. Thus, saying we shouldn't raise a tax is unhelpful -- one must specify what kind of tax we should raise in what amount.

OK now -- being that certainly means testing will be a portion of that $20.5 trillion, what kind?

If one plans on means testing, it should be done on the basis of lifetime wage income, not total income. That would be acceptable, as it wouldn't double tax saving.

The problem here is that "earnings record testing" is not means testing.

If Paris Hilton hasn't had much wage income in her life, she passes the means test and gets full benefits. While a hard worker who sweated to be at the top of the wage base his whole life, and then is struck down by misfortune not his fault, flunks the means test and loses his benefits. What kind of "means test" is that?

A real means test must measure both current income and current assets. A test based on just one or the other is ridiculously easy to game. And an earnings record is just an earnings record.

And *real* means tests are practical to do, we do them *all the time*: Medicaid and yes, colleges and universities via the FASFA form do them every year by the *millions*. For starters.

Are they awkward, and do they have unpleasant side effects? Yes, and yes -- but not so much that we don't do them already by the millions for lesser purposes. If one wants a *real* means test, this is what one *must* do ... and when one runs up $20.5 trillion in unfunded liabilities, what happier outcome does one expect?

I'm all for implementing policy as tax-efficiently as possible.

But one mustn't pursue tax efficiency to the point of destroying the policy. Policy comes first.

Just as it does with the means testing of Long Term Care-Medicaid and the FAFSA form.

Scott Sumner writes:

Jim, The easiest way to means test Social Security would be to give each person the same benefit, regardless of how much they paid in. That would dramatically reduce benefits received by wealthy people like Paris Hilton, without discouraging saving.

Randy writes:

Scott, Agreed. And the amount should be minimal - which would also reduce the amount that Paris would have to pay in.

Floccina writes:
In the new political equilibrium, how much do you predict the full Social Security and Medicare benefit will fall? Remember, this is the benefit that everyone below the median income gets.

Though I support means testing, I do think that it would erode the benfit over time but people seem to like to support old people through the government so I would expect it hold up better than some other programs for the poor. So I would only expect an erosion of about 25% in 20 years.

I think that more realistic politically than means testing would be to give everyone the same SS benefit payment. Currently the average SS benefit payment is over $1,000/month while many people get less that $700/month. If you gave everyone $800/month that would save more than 20% and would not be much of a disincentive to save.

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