Social Security and Debt Reform: A Laureate’s View

Peter Diamond won the Nobel Memorial Prize in Economics in 2010 and was interviewed by The Washington Post over the weekend. The interview focused on Social Security reform and the federal debt problem. Diamondis believes that Social Security needs to be reformed to restore actuarial balance, and his preference is to reform it by a combination of gradual benefit reductions and tax increases. He also believes that we have a national unemployment crisis but only a debt problem. We need to work on fixing the unemployment crisis first, he says. But he’s hoping all this can be done in one grand bargain soon in which there is an agreement to reform Social Security, restore economic growth, and establish a path to reduce federal debt. Much of the interview focuses on reform plans put forward by Mitt Romney and Paul Ryan.

What do you make of the criticism that raising the age for full Social Security benefits would disproportionately hit those at the bottom of the income scale, who haven’t seen life expectancy rise as much?

It’s a mostly a red herring. Let me elaborate. The way I think about increasing the age for full benefits is that it has nothing to do with retirement. Maybe some people will retire later because it’s a signal in some form, but I’m skeptical that that matters a whole lot. People are thinking about different ages to retire and for any age that you retire there’s a smaller benefit if the age for full benefits is higher. So increasing the age for full benefits reduces the benefit level at any age at which you retire. You think of retiring at 62 now, you get an actuarial reduction of 25 percent from the current full benefit age of 66. If the age for full benefits is 70 the benefit is lower – a 45 percent reduction. Instead of 75 percent of full benefits, you get 55 percent. So it’s a particular way of cutting benefits for people retiring at different ages.

What I don’t like about it is that while it’s fairly close to a uniform across-the-board cut the way benefit reductions for early benefit claiming is structured, it isn’t exactly that and if you look at it, it’s a bigger benefit cut to people retiring at 62.