A new academic paper, unveiled at the 16th Annual Meeting of the Retirement Research Consortium held Aug. 7-8, concludes that the net benefits of Social Security combined with the tax benefits for retirement savings are larger as a share of income for lower-earning workers than for higher-earning workers. In short, the current retirement income system in the United States is progressive. Karen E. Smith and Eric J. Toder, two researchers at the non-profit, non-partisan Urban Institute, are the authors of the soon-to-be-released paper. The pair has teamed up before, including a past effort that provides solid evidence that low-income workers do, in fact, benefit from 401(k) plans.
In their latest paper, the authors estimate the net combined distributional effects of Social Security and the tax incentives for defined contribution plans for workers born between 1950 and 1989, the first time this has been done. The authors use the Urban Institute’s Dynamic Simulation of Income Model that simulates earnings, taxes and many life events to assume a reasonable level of Social Security benefits and retirement savings that individuals within different income and age groups can expect to receive.
After crunching the numbers, the authors conclude that the distribution of Social Security benefits net of Social Security payroll taxes are very progressive, as measured by a percentage of lifetime earnings. On the other hand, the authors acknowledge that the tax benefits from retirement savings generally favor higher-income workers. But just how much do the high-earners benefit from the tax incentives for retirement savings relative to everyone else?
That depends on how the tax incentives for retirement savings are assumed to be financed. The distributional effects of the retirement savings tax incentives are highly sensitive to how these incentives are financed because the retirement savings tax incentives are deferrals based upon the current progressive income tax system. To measure this sensitivity, the authors provide three different financing assumptions for these incentives (from a flat-tax to the current progressive income tax). Their work shows that if the flat-tax financing assumption is used, high earners benefit the most from the retirement savings tax incentives, while high earners benefit the least from the progressive income tax financing assumption.
Regardless, the authors’ work shows that no matter how the tax benefits for retirement savings are assumed to be financed, the retirement income system in total is progressive. These preliminary findings contradict the common narrative that the current retirement system primarily benefits the rich, a narrative which totally ignores the progressive distributional effects of Social Security.
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