Opinion | Before Slashing Social Security, Cut 401(k)s

Every few years, lawmakers and commentators begin publicly fretting about the future of Social Security. In these discussions, we typically hear that Social Security will soon run out of money and that the only realistic way to save the program is by steeply cutting old-age benefit levels. Self-described “deficit hawks” have seized on the upcoming need to raise the debt ceiling as the latest impetus to target Social Security.

There are a lot of strange aspects about this debate, but perhaps the oddest is that those who participate in it act as if Social Security is the only part of the U.S. old-age benefit system. The other parts of the system — including defined-benefit (DB) pensions, defined-contribution (DC) plans like 401(k)s, and individual retirement accounts (IRAs) — are rarely mentioned and completely spared from proposals to cut benefits.

Perhaps, you might suppose, these programs are ignored because they exist in the private sector — but they are actually heavily subsidized by the government. According to the Joint Committee on Taxation, the tax advantages for DBs, DCs and IRAs will cost the federal government $371 billion this year. There is no similar tally for state tax breaks, but including those would likely bring the total bill close to half a trillion dollars.

Given these tremendous expenses, it is initially hard to understand why people who seem so worried about the costs of old-age benefits choose to focus solely on Social Security. But it becomes easier to understand once you realize who benefits the most from the various parts of the old-age system.

DBs, DCs and IRAs are overwhelmingly skewed toward the rich, while Social Security is more heavily relied upon by low-wage workers. Low-wage workers are less likely to work for an employer that offers a pension and have far less surplus income to put toward a 401(k) plan or an IRA. Even when low-wage workers do participate in these programs, they receive less tax benefits for doing so because low-wage workers have lower tax rates than high-wage workers.

Whether it’s based on self-interest or political expediency, those calling to cut Social Security are asking more from the most vulnerable Americans, while letting the well-off off the hook.

According to the Congressional Budget Office, the richest fifth of Americans receive 58.1 percent of all the government subsidies provided to DBs, DCs and IRAs while the poorest fifth receive just 1.3 percent. Even the middle fifth receives only 10.5 percent of the subsidies, about half of what they would receive if the money were distributed evenly. This year, the poorest fifth of the population will receive around $5 billion of the $371 billion of federal tax breaks allocated to these programs. The middle fifth will receive around $39 billion, while the richest fifth will receive a whopping $215 billion.

Social Security provides benefits to all retired workers, but the benefits are far more significant to low-wage workers. These workers get relatively little out of the other old-age programs and therefore rely much more heavily on the floor provided by the Social Security program. Additionally, the Social Security benefit formula replaces up to 90 percent of the monthly wages received by low-paid workers. The income-replacement rate for higher-paid workers is much lower than 90 percent and is subject to a maximum cap currently set at $3,627 per month.

DBs, DCs and IRAs also provide significant amounts of fee revenue to Wall Street banks and other financial intermediaries who administer the tens of millions of individual accounts and pension funds. This aspect of the system periodically generates outrage when research is released showing that many financial institutions are basically scamming their account holders with shockingly high management fees. But when it comes to the debate about old-age programs, this gusher of cash for the financial sector no doubt helps to explain why these programs are never targeted, while Social Security, which provides no money to the financial industry, is always in the crosshairs.

Of course, it doesn’t have to be this way. The rules governing DCs, DBs and IRAs, as well as the massive public subsidies flowing to them, can be changed just as the rules governing Social Security can be changed. If we are seriously worried about the generosity of old-age benefits or the government’s debt, then surely everything should be on the table and the part of the system that most favors the rich should be front and center.

For example, the most talked-about proposal for cutting Social Security right now is focused on gradually raising the full retirement age to 70 years old. The CBO says that this would save $121 billion between 2024 and 2032. However, a similar amount of savings could be achieved by applying an annual 0.03 percent tax on the $34.5 trillion of assets held by DBs, DCs and IRAs. Such a tax could be directly collected and remitted by the financial institutions that manage these accounts without changing anything at all about the tax-filing obligations of individuals. For a person with a $100,000 IRA, the tax would amount to just $30 per year.

This is just one of many policies that could be used to trim this other half of the American retirement system. Although I personally don’t believe spending on old-age benefits is a pressing issue at the moment, people who do think that should give up their singular fixation on Social Security. If they do not, they can be safely disregarded as unserious and as motivated by things other than a sincere concern for retirement finances.