It’s Fine to Embrace FDR’s Vision of Social Security

But You Don’t Need to Embrace Nixon’s and Carter’s

I’ve long been an advocate of a flat benefit structure for Social Security. That is, rather than acting as an increasingly expensive pension plan—where the top half of the income distribution receives almost two-thirds of total benefits—Social Security reform should follow other Anglo countries and gradually transition the retirement program into a robust but limited safety net for poor seniors.

Others disagree. For instance, four Brookings Institution authors recently criticized flat-benefit plans argues that Social Security should retain its traditional emphasis on wage replacement rather than poverty protection. I disagree, as its far, far easier for middle- and high-income Americans to save for retirement on their own today than it was in the world of 1935. The need for high Social Security benefits for the rich has passed.

But here’s another take: even if one wanted to preserve Social Security in the wage-replacement model exactly as it was envisioned by FDR, I would take the deal. Why? Because the Social Security retirement system of 1935 was far more modest than the program paying benefits nine decades later—not simply in dollar terms, but even on the wage-replacement basis that flat-benefit critics think is most important.

What makes Social Security so expensive today—and increasingly expensive in the future—is not the benefit formula that first started paying benefits out in 1940. It is a series of benefit increases enacted mostly in the 1970s by politicians seeking reelection, supported by a small group of policy leaders who envisioned a far more expansive program than FDR or ordinary Americans did.

What “Benefit Increases” Really Mean

When experts speak of Social Security as a “wage-replacement” program, they are saying the program should focus less on dollar amounts than on the “replacement rates” the system offers. A replacement rate measures Social Security benefits as a percentage of the retiree’s prior earnings.

In passages that follow I’ll cite SSA figures on Social Security replacement rates. For those interested, I’ve added a technical note at the bottom on SSA’s definition of replacement rates. SSA’s definition has important implications for measuring benefit adequacy, but it’s not hugely important for this discussion.*

When Social Security first paid benefits in 1940, a medium-wage worker retiring at 65 would have received replacement rate of about 24 percent. This means that their retirement benefit was equal to about 24 percent of their pre-retirement earnings. A very low-wage worker, who earns about one-quarter of the national average wage, retiring in 1940 would have received a replacement rate of 42 percent, while someone earning the taxable maximum would have received about 16 percent.

How Replacement Rates Rose—Before the 1970s

Social Security’s original benefit formula wasn’t indexed to inflation or wage growth. Congress would step in occasionally—typically in even-numbered years—to give benefits a boost.

By 1950, inflation had eroded benefits and the medium-earner’s replacement rate had fallen to 19 percent. Congress responded with ad hoc benefit increases, raising the medium earner’s replacement rate to 27 percent in 1951 and to 30 percent by 1959. That figure varied only slightly through 1969, when a middle earner received a replacement rate of 29 percent.

In other words: Social Security grew in its early decades, but moderately. A middle earner’s replacement rate in 1969 was about 22 percent higher than when the first benefits were paid in 1940.

Then, in the 1970s, the barn door was left open.

From 1969 to 1981, replacement rates for medium earners rose from 29 percent to 54 percent—an 86 percent relative increase in wage replacement, over and above the rise in the dollar value of benefits driven by increasing pre-retirement earnings.

Politics and the Push for Expansion

Part of the explanation is straightforward: politics. In 1970, benefits were increased by 15 percent. In 1971, President Richard Nixon and a Democratic Congress approved another 10 percent increase. In 1972—an election year—benefits rose by 20 percent, followed by another increase in 1973. Richard Nixon was no small-government conservative, but he did like to win elections.

These benefit increases were described as addressing the effects of inflation, as automatic Cost of Living Adjustments do today. But they also increased the initial benefits that retirees received.

But politics alone doesn’t tell the whole story.

Within SSA and the Department of Health, Education and Welfare, some senior officials saw FDR’s Social Security as only a starting point. They favored much broader public provision of retirement income and worked with both parties to expand benefits.

Robert Myers, Social Security’s long-time chief actuary and more of a traditionalist on financing and benefit matters, warned in 1970 that SSA leadership favored a sweeping expansion:

“Certain of the top policy-making officials at the Social Security Administration (who are holdovers from the Johnson Administration) have strong beliefs in the desirability—even the necessity—of the public sector taking over virtually all economic security provisions for the entire population and thus eliminating private efforts in this area.”

Top officials at the time, Myers wrote, wished to expand Social Security “to be virtually monopolistic in economic security…. As a subsidiary matter, they would eliminate the private pension system.” Alarmed by what he saw, and by the Nixon administration’s seeming-failure to resist it, in 1970 Myers resigned his position.

The 1972 Amendments Blow the Doors Off

In the early 1970s, with rising inflation, there was movement to automatically index the Social Security benefit formula so that the purchasing power of benefits would not fall if Congress didn’t act affirmatively to adjust them.

The 1972 Amendments’ adjustment to the retirement benefit formula were at the time seen as mostly a technical fix. But as Congress soon found out, the revised benefit formula contained a flaw that made it wildly sensitive to different rates of inflation. Even a small increase in inflation relative to Social Security’s assumptions would cause replacement rates to increase.

Even had the inflation and wage growth assumptions as of 1972 held going forward, replacement rates would have increased slightly for middle-income workers and significantly for low-wage workers, while dropping for a worker earning the maximum taxable wage.

And, of course, the actual economy of the 1970s bore no resemblance to SSA’s 1972 assumptions. From 1973 to 1982, inflation averaged 8.7 percent while real wages fell. Social Security replacement rates exploded. By 1981, replacement rates for new retirees reached:

• 95 percent for very low earners

• 52 percent for medium earners

• 44 percent for maximum earners

These rising benefits soon would have pushed Social Security into insolvency.

Congress had little choice but to respond, which it did via the 1977 Amendments.

But here’s the key part: Congress only partially unwound the explosion of replacement rates ignited by the 1972 Amendments. The 1977 Amendments reduced a medium earner’s replacement rate from 52 percent in 1981 to about 42 percent by 1985. But that’s still 11 percentage points above the 31 percent typical in 1969, constituting a 35 percent increase in typical benefit levels.

This points to what Robert Myers warned of the “ratchet approach” favored by proponents of benefit expansion: “[T]hey know that once a certain expansion has been achieved, a retreat from it is virtually impossible.”

The rest of the cost gap was addressed by raising taxes, including both the payroll tax rate and the ceiling on wages to which the tax applies. That’s more or less the Social Security benefit and tax formula we’ve inherited today, with the exception of the 1983 increase in the retirement age to account for increased longevity.

It’s one thing to understand how we got here. But it strikes me as nutty to treat the current level of benefits as a sacred cow.

What did policymakers know? (And when did they know it?)

Now, if you understand Social Security’s benefit formula, the flaw in the 1972 Amendments is clear. For context, under the current Social Security benefit formula, for someone becoming eligible for retirement benefits in 2026, Social Security would replace 90 percent of the first $1,286 in average monthly earnings, 32 percent of monthly earnings between $1,287 and $7,749, and 15 percent of earnings from $7,750 up to the maximum taxable salary. Every year, the dollar values – the so-called “bend points” – are increased along with national average wage growth, but the replacement percentages stay unchanged.

The 1972 benefit formula got this reversed: the dollar thresholds stayed the same, but the replacement percentages were increased along with inflation. Over time, and in particular if inflation was high, Americans would receive more in Social Security benefits than they earned while working.

But how well understood was this at the time the flawed benefit formula was enacted?

The Hoover Institution’s John Cogan, in his fascinating history of income and entitlement programs, The High Cost of Good Intentions, hints at the same question:

How could such an error happen to the nation’s largest and most important domestic program will millions of senior citizens and disabled workers relying in its benefits? For all of its forty-year history, the Social Security program had benefited from expert financial advise, counsel and oversight. Professional actuaries inside and outside government carefully evaluated the financial impact of congressional legislation and made annual assessments of the program’s finances…. Yet somehow a fundamentally flawed formula that put the program on a certain path to financial insolvency had been enacted into law without anyone raising a public notice or comment that anything was wrong.

Syl Schieber and John Shoven, in their excellent book The Real Deal: The History and Future of Social Security, present evidence that Social Security’s leadership almost immediately understood the flaws in the 1972 changes to the benefit formula, even if the new formula wouldn’t come into effect until 1975. A 1970 budget analysis hinted obliquely at the potential problem, then Social Security’s 1971 advisory council was more direct. By 1974 an economist at the Department of Health, Education and Welfare connected the faulty benefit formula to the inflation rates that by then were surging ahead. Schieber and Shoven conclude that Social Security “was acutely aware of the serious flaws in the 1972 Amendments well before they became effective” in 1975.

My own look at the evidence from the time shows that SSA was aware of the potential risks even before the 1972 legislation was passed. For instance, in September 1970, two years prior to the Amendments being enacted, SSA actuaries produced an analysis of how the automatic indexing provisions would affect Social Security’s long-term finances under different inflation assumptions. The SSA analysis showed that if real wage growth were held constant while inflation was increased by one percentage point – from 2 percent to 3 percent annually – the average cost of benefits between 1975 and 2040 would increase by 21 percent and the system would no longer be solvent. For the average cost of benefits over 75 years to increase by 21 percent implies a much larger increase in future replacement rates, because replacement rates would increase over time and would take even longer to filter through the retiree population. That this change in replacement rates driven by a relatively small difference in long-term inflation went unremarked on is surprising, especially given that inflation in the previous decade had averaged 3.3 percent and wage growth 5.1 percent. SSA at least would have known this was a risk, but it’s not clear what they told policymakers.

Moreover, by January of 1973, less than three months following the passage of the 1972 Amendments, SSA had published an actuarial analysis of retirement benefit replacement rates, under the nondescript title “Some Aspects of the Dynamic Projection of Benefits Under the 1972 Social Security Amendments.” This memo detailed how sensitive retirement benefit replacement rates were to even tiny differences in inflation and wage growth.

Based on that 1973 SSA analysis, I estimated how Social Security replacement rates would have changed had inflation and wage growth post-1972 following the average from 1963 to 1972. These figures aren’t based on the unprecedented stagflation that was to follow, but on the economic conditions the country had already experienced over the prior decade. Replacement rates for maximum wage workers, after an initial dip, would have rebounded to their prior levels. The replacement rate paid to a median wage worker would have increased from 41 percent in 1975 to 52 percent in 2045, while replacement rates for low-wage earners would have increased from 57 to 83 percent. It is hard not to conclude the Social Security Administration knew that rising benefits could pose a risk to the system.

But, if you read the Congressional deliberations, which cover thousands of pages of testimony, I have yet to find a clear discussion of how the 1972 provisions would increase the Social Security replacement rate. In 1971 Congressional testimony, the former SSA chief actuary Myers noted that, under the proposed benefit formula, Social Security’s financial health would be “extremely sensitive to the assumptions made.” But the follow-up discussion didn’t hint at the mechanics of this sensitivity. And so my best guess is that Congress really didn’t know what they were getting themselves into.

It seems that the Social Security Administration broadly understood how even small differences in wage and price growth could drive up replacement rates and benefit costs, but didn’t convey those risks to the Members of Congress who were called on to vote on the 1972 Amendments. In effect, SSA was letting Congress walk into a minefield. In Myers’ read on things, these leaders didn’t much care, since they figured that Congress would end up paying for those benefits anyway. Which proved to be largely correct. And, those higher benefit levels would be locked in place for generations. And to the present, wishing to rethink those higher levels of Social Security retirement benefits, even for higher-income seniors, is seen as a betrayal of FDR’s legacy. It’s a fascinating bit of history that still has relevance today.

Where would Social Security be without the blunders of the 1970s?

All of this raises the question: Where would Social Security be today if politics and ideology hadn’t combined to generate such significant increases in Social Security benefits? It’s possible to make a guess.

Using SSA’s stylized earners along with the agency’s estimates of the share of actual retirees who most closely resemble each earner type, I estimate that under current law the average Social Security benefit for a person retiring in 2026 at the full retirement age is about $27,087.

Had Social Security replacement rates simply been kept at their 1969 levels, and therefore missed the large benefit increases of the 1970s, the average benefit for a new retiree in 2026 would have been about $20,375, about 25 percent less.

That difference alone would have almost certainly avoided Social Security’s near-death experience in 1977, its brush with insolvency in 1983 and the projected exhaustion of the trust funds in 2032.

Retaining Social Security replacement rates to pre-Nixon levels also means that Americans would not be facing the largest peacetime tax increase in history in order to pay promised benefit levels.

What happened to Social Security in the 1970s really matters.

For those wanting to go further back to FDR’s time, if Social Security continued to pay the replacement rates that were paid to its first retirees in 1940, the average retirement benefit for a new retiree this year would be about $15,945. That’s easily affordable under current tax rates.

Or let’s imagine a hypothetical. Keep the increases in replacement rates for very-low and low-wage earners were retained, in order to strengthen the safety net. Replacement rates for middle-income retirees were moderated, by averaging the 24% replacement rate offered them in 1940 with the 40 percent replacement rate in 2026. For high-wage and maximum wage earners, 1940 replacement rates would be retained.

To be clear, this doesn’t mean that anyone would be paid 1940s levels of benefits. What we’re talking about is simply the ratio of benefits to pre-retirement earning that was paid to Social Security’s first cohort of beneficiaries.

Under that enhanced-safety-net scenario, in which Social Security replacement rates for lower-wage workers are maintained at current levels, the average benefit in 2026 would be about $20,303 – again, more than enough to keep the program solvent without tax increases.

The Bottom Line

The massive benefit expansion of the 1970s was not part of FDR’s blueprint. The increased Social Security replacement rates that were established in the 70s were not the product of a rigorous evaluation of how much retirement income government should provide versus amounts that households generate through their own savings.

Rather, those Social Security benefit increases, which largely continue through today, came about through the combination of political impulses of elected officials and ideological views of certain Social Security and other officials who had a far more expansive vision of social insurance than was outlined by FDR or embraced by the typical American.

Nothing requires policymakers today to enshrine those decisions forever—any more than they must revive bell bottoms, shaggy vests and poor personal grooming.

Today’s policymakers should ask themselves what they want Social Security to do; what goals government alone must accomplish, versus goals that government might merely facilitate, versus what frankly isn’t government’s business. And they should ask what the competing priorities for limited government resources are, and whether those priorities might prove more important than paying ever-increasing real-dollar benefits to already well-off seniors.

This doesn’t mean pulling the rug out from under current retirees. But Social Security reforms passed today will set the benefit formula out to 2100 and beyond, for people who haven’t even been born yet. Congress should design a future system for those Americans, rather than blindly maintaining a benefit formula conceived by people from a half century ago who you may not even have agreed with.

Social Security reform for the 21st century should reflect the realities of the 21st century, not the policy mistakes of the 1970s.

*The SSA measures replacement rates differently than do financial planners, who typically compare benefits to earnings just prior to retirement, or to economists, who tend to favor using career-average earnings adjusted for inflation. SSA, by contrast, measures Social Security benefits as a percentage of worker’s highest 35 years of earnings, where those earnings are first indexed to the growth of national average wages. This approach effectively compares Social Security benefits not to workers’ own past earnings, but to the earnings of workers in the labor force at that time. If we compare a typical retiree’s Social Security benefit to their own past earnings adjusted for inflation, replacement rates are about 10 percentage points higher than those reported by the SSA. For those interested, see my paper, “Replacement rates and the retirement crisis.”