The earnings test has failed - Social Security benefits

Nation's Business, May, 1991 by Joan C. Szabo

The Earnings Test Has Failed

Earl Tindall returned to work after being retired for several years because he wanted to stay active, he says, and because he and his wife, Nancy, needed the extra income and health benefits that his current job offers. Trying to make ends meet on Social Security and a small pension is not easy in today's economy, Nancy Tindall says.

Unfortunately, though, the job is taking its toll on the couple's Social Security benefits. The Social Security retirement earnings test requires the Tindalls to give up a portion of their Social Security benefits each year.

In 1991, the earnings test reduces Social Security benefits for working individuals aged 65 to 69 by 33 percent for every dollar they earn above $9,720. For those aged 62 to 64, the benefit reduction is 50 percent for every dollar earned above $7,080.

The Social Security earnings test does not affect individuals who are 70 or older, and it does not apply to nonearned income, such as interest or dividends from investments.

When the earnings test is combined with other federal taxes, the effective marginal tax rate for a worker earning just $10,000 a year rises to nearly 56 percent, and that rate does not include state and local taxes. Single people being paying federal income taxes when their income is over $6,400; for a married couple, the amount is $11,300.

There is also a Social Security benefit tax that affects some of the nation's elderly. Depending on their tax bracket, the working elderly who also are subject to the benefit tax can face a marginal tax rate that can go as high as 80.34 percent. (See the chart on Page 43.) The benefit tax applies only if one-half of Social Security income plus all non-Social Security income, including income from tax-exempt bonds, exceeds $25,000 for an individual, or $32,000 for a couple. (Under current law, a maximum of one-half of Social Security benefits is subject to taxation but is not automatically included in the ordinary income of the taxpayer.)

In Earl Tindall's case, it is the earnings test that has reduced his income.

Although Tindall says he will continue to work, a number of elderly people have opted not to do so because of the high effective marginal tax rates they must pay because of the test.

The effect of the test, according to those who oppose it, is to discourage retired workers from returning to work and to encourage elderly workers to leave the work force. Those aims may have seemed beneficial in the 1930s, when unemployment was high and the law was instituted, but the outlook for the work force today is quite different.

The pool of available labor is growing more slowly as fewer young people enter the labor force. As a result, many businesses are looking more and more to retired workers to fill job openings. In particular, companies inthe service, retailing, and health-care industries find retired workers especially valuable additions to their work forces.

To combat the barrier to working that many older Americans face, legislation has been introduced in both the House and the Senate to repeal the earnings test. One bill, the "Older Americans' Freedom To Work Act," would eliminate the test--and thus any loss of Social Security benefits--for people once they reach age 65.

The measure was introduced by Rep. J. Dennis Hastert, R-Ill., and has 230 co-sponsors. Hastert says his bill also would benefit business. "Older workers understand the work ethic, they are invaluable in training other employees, and they are a good example to have around whether in a big or small business," he says.

A similar bill has been introduced in the Senate by John McCain, R-Ariz.

Democratic opponents of such legislation, who have defeated previous attempts to eliminate the test, argue that repeal would result in a loss of federal revenue. They cite Congressional Budget Office (CBO) estimates that repeal would cost the government $3.6 billion in the first year and $26.2 billion over five years.

Proponents of repeal, however, say the CBO estimates are based on static revenue models and do not take into account the changes that would follow from repeal of the test. Lisa Sprague, manager of employee-benefits policy for the U.S. Chamber of Commerce, says repeal would encourage more elderly Americans to work. And that change in the work force would spur the economy, say the Chamber and other business groups, which strongly support legislation to repeal the earnings test.

Repeal would actually produce more revenue for the federal government, according to a recent-report, Paying People Not To Work, by Aldona and Gary Robbins. The two former Treasury Department economists say that if the retirement earnings test is eliminated, at least 700,000 elderly retirees would enter the labor market.

The authors state: "Our annual output of goods and services would increase by at least $15.4 billion. Government revenue would increase by $4.9 billion, more than offsetting the additional Social Security benefits that would be paid." The report was co-sponsored by the Institute for Policy Innovation, in Lewisville, Texas, and the National Center for Policy Analysis, in Dallas. Both are nonprofit research organizations.