AARP's fuzzy math on Social Security
The 'economic effect' of benefit payments isn't $1.4 trillion or nine million jobs. It's zero.

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Article Highlights

  • The recent AARP report that claims Social Security generates $1.4 trillion is fundamentally flawed.

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  • Last year, Social Security paid out almost $715 billion in retirement, survivors and disability benefits.

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  • AARP overlooks the money pulled out of the economy through SS payroll taxes to fund these benefits.

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  • For each dollar of taxes levied, workers have less to spend.

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  • But over the long term, the economic effects of Social Security are negative.

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  • Spending may give the economy a quick fix. Saving drives long-term economic growth.

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AARP—formerly known as the American Association of Retired Persons—recently released a report proclaiming that "Social Security Generates Nearly $1.4 Trillion in Economic Activity and Supports More Than Nine Million Jobs." As great as that sounds, AARP's study is fundamentally flawed.

Last year, Social Security paid out almost $715 billion in retirement, survivors and disability benefits. This money supports seniors, but according to AARP the gains don't stop there. Retirees spend their benefits on food, for example, creating incomes for the supermarket owner and employees, who then spend these incomes, and so on. The report concludes: "Because of the multiplier effect, every dollar of Social Security paid out translates to almost two dollars in spending in the United States."

Sounds like magic. But what AARP overlooks is the money pulled out of the economy through Social Security payroll taxes to fund these benefits. These taxes have what we might call a "divisor effect:" For each dollar of taxes levied, workers have less to spend, and that reduction is passed on throughout the economy. If workers spend the same percentage of their incomes as retirees, then the net economic effect of Social Security isn't $1.4 trillion or 9 million jobs. It's zero. The AARP report acknowledges that "A net analysis would subtract the economic effects of payroll taxes from those of the benefit payments." But that acknowledgment comes in a footnote.

The best defense AARP could offer for its reasoning is to claim that retirees spend a greater share of their incomes than workers. Therefore, transferring money from workers to retirees raises spending and, through the magic of the multiplier, still boosts the economy.

In the short term that may be true, though the economic boost at any given time would be far smaller than the trillion-dollar figure AARP touts. But over the long term, the economic effects of Social Security are negative. Spending may give the economy a quick fix. Saving drives long-term economic growth.

This point is fundamental. To quote one randomly-chosen macroeconomics textbook, titled "Macroeconomics," by Olivier Blanchard of MIT: "The saving rate determines the level of output per worker in the long run. Other things equal, countries with a higher saving rate will achieve higher output per worker in the long run." In other words, because of Social Security taxes, today's economy is likely smaller than it otherwise would be.

This isn't just theory. In a research paper published by the Brookings Institution in 1996, economists Jagadeesh Gokhale, Larry Kotlikoff and John Sabelhaus traced the decline in saving rates since World War II to the rise of Social Security and Medicare, which transfer income from savers (workers) to spenders (retirees).

Similarly, when the Congressional Budget Office in 2004 modeled the economic effects of proposed Social Security changes, it found that reforms that would cut benefits without raising taxes—such as the so-called price indexing of benefits—would lead to economic growth. Plans that raised taxes to pay promised benefits would reduce work, saving and economic growth. The entire U.S. economy would be roughly 5% larger in the long run if we adopted the cut-benefits approach instead of the raise-taxes approach, the CBO concluded.

AARP's conclusions about Social Security and the economy point people in a direction—raising benefits by raising taxes—that is most likely to reduce long-term economic growth. Unfortunately, AARP has published similar articles on the purported economic benefits of state and local government pension plans that are just as preposterous. But just as in grade-school mathematics, when you consider only one side of an equation, you're almost sure to get the answer wrong.

Mr. Biggs is a resident scholar at the American Enterprise Institute and former principal deputy commissioner of the Social Security Administration. He was on the staff of President George W. Bush's Commission to Strengthen Social Security.

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