Month: June 2023

Preliminary Discussion of the Cassidy/King Social Security Reform Proposal

The Cassidy/King proposal to increase the full retirement age for Social Security benefits would reduce benefits for most future retirees. A gradual phase in of the higher retirement age would not prevent required automatic benefit cuts under current law.


Introduction:  Two United States senators, Angus King of Maine, and Bill Cassidy of Louisiana, have announced plans to create a Social Security reform package.  The preliminary discussion of their plan stresses two changes to the current system, an increase in the full retirement age from the current age of 67 to age 70, and the creation of a sovereign wealth fund that would invest resources for Social Security in equities. 

A short article on aspects of the Cassidy/King proposal can be found here.  A short press release, mentioning the desire to create a plan that maintains the early retirement age at 62, is found here.  

The primary reason for the Social Security reform proposal is to prevent automatic reductions in Social Security benefits after depletion of Trust Fund assets.  The trustees of the Social Security trust fund believe these automatic benefit cuts could start in 2033.

The purpose of this post is to provide a quick impression of the admittedly preliminary Cassidy/King proposal.

Analysis:

Comment One:   The articles and the press releases pertaining to this preliminary proposal do not contain or refer to an explicit analysis of the impact of the policy change on benefits.  However, the headline of the yahoo new article  “Under latest social security reform proposal millions receive more  and no one receives less” appears misleading. 

An increase in the full retirement age to 70 and the retention of 62 as the early retirement age would lead to a decrease in benefits for everyone with the exception of people who retire at age 62.   The combination of a change in the retirement age and no change to the minimum age for retirement will also reduce the incentive for older people to remain in the workforce and/or delay claiming their Social Security benefit. 

The current full retirement age for people born after 1960 is 67 and under current law people born after 1960 will receive a 30 percent decrease in the retirement benefit and a 35 percent reduction in the spouse’s benefit if they retire at age 62 instead of age 67.  

This publication from the Social Security Administration reveals that under current law a person eligible for a $1,000 benefit at the full retirement age will receive $700 if she retires at age 62 and $1,240 if she retires at age 70.  

An increase in the full retirement age to 70 would reduce the benefit at age 70 to $1,000, which is a 24 percent reduction in benefits.

Under current law, a person born after 1960 gets an annual increase in benefits of 7.4 percent for each year of delaying claiming Social Security between age 62 and 67. 

The annual increase in benefits under Cassidy/King is 4.6 percent.

This means a person retiring at age 67 under Cassidy King would get an annual benefit of $875.

The Cassidy/King proposal (or at least my understanding of it) would result in a 12.5 percent in reduction for benefits for the person retiring at age 67.

Comment Two:  The final Cassidy/King plan could also include other modifications to the benefit formula, specifically a change in the number of years worked on final benefits.  This change could offset benefit cuts from the change in the full retirement age for some workers and augment it for other workers.   An analysis of policy change would require information on past lifetime work histories and might require assumptions on how the policy change impacts retirement and workforce participation. 

Comment Three:  Most politicians advocating Social Security reform stress that their plan should not adversely impact benefits of people nearing retirement.  An abrupt change in the full retirement age would abruptly change benefits.  The Cassidy/King proposal would have to be phased in to avoid abrupt benefit changes, however,a gradual phase in would not avoid the projected mandatory 2033 benefit reductions described here.

Comment Four:   Alicia Munnell points out that the Cassidy/king proposal for the creation of a sovereign wealth fund to increase returns and decrease cost of funding Social Security cannot be achieved by diverting funds from the current trust fund, which is nearing its depletion date.   Any diversion of funds from the trust fund would speed up the date of automatic benefit cuts. 

Concluding Thoughts:  Any viable Security reform that deals with the impending automatic benefit cuts without reducing benefits for people nearing retirement will have to include both new revenue and gradual alterations to the benefit formula.  Plans for Social Security reform should also account for the fact that young adults are, for a variety of reasons, not saving enough for retirement.  Go here for an article on the need for linking Social Security reform to policies that would increase savings by young adults.

Modifications to the Biden Student Debt Policy

A one-time discharge of student loan debt will not mitigate long term problems associated with excessive student debt. These proposals will reduce student debt burdens and encourage savings by young adults, a necessary prerequisite to Social Security reform.

Introduction:

A previous post evaluated several of the Biden Administration’s domestic policy agendas, including the Administration’s proposals on health care and insurance, student debt and college costs, retirement savings, and the fiscal condition of Social Security.  

The evaluation of the Biden Administration’s student debt policies reached the following conclusions.

  • The one-time debt discharge proposed by the Biden Administration may not be upheld by the Supreme Court for a variety of reasons.
  • A one-time student debt discharge does not alter the trajectory towards higher student debt levels and higher college costs.
  • The payment shock from the termination of the COVID-era student loan payment freeze will reduce consumer spending and could facilitate a recession.
  • The Biden Administration proposal for expanded Income-Driven loans is complex and less effective than interest rate reductions.
  • Low levels of on-time graduation remain an important factor in high student debt burdens.
  • Many student borrowers leaving school prior to the completion of a degree have a difficult time repaying their student loans.
  • Proposals for increased assistance for students at two-year college are useful but could reduce access to four-year schools by qualified low-income students.

The objective of this post is to provide and explain potential economically efficient solutions to these problems.

Student Debt Proposals:

Proposal One:  Issue an executive order restarting post-covid student loan payments at a 0 percent interest rate for two years and seek legislation permanently establishing a 0 percent interest rate for the first two years after the initiation of repayment of student loans.

Analysis: The recently enacted debt limit deal includes a requirement restarting the covid-era moratorium on student loan payments.   The abrupt restart of student loan payments will reduce spending and saving for retirement by many households and could facilitate a recession.  A permanent 0 percent interest rate for students starting the repayment of student loans would substantially reduce problems associated with excessive student debt.

Proposed response to the restart of student loans:

  • As per the recent debt-limit agreement, student loan payments restart this year.
  • A new executive order sets the interest rate on student debt at 0 percent for two years.
  • Seek legislation making the two-year 0 percent interest rate on student loans permanent.

Advantages of a temporary emergency elimination of interest rates:

  • I expect the Biden Administration’s student debt discharge proposal will be overturned by the Supreme court.  A temporary elimination of interest charges to mitigate adverse impact of payment shock from the end of the covid emergency is more easily depicted as an emergency measure likely to survive legal challenges than the Biden Administration’s proposal.
  • The restart of student loan payments would increase receipts to the Treasury reducing the need to issue debt.  However, the restart of student loan payments will have a substantial adverse impact on young adults with student debt and the overall economy.  These adverse impacts including lower consumption, higher wage demands by some workers and a likely recession could be mitigated by temporarily setting the interest rate at 0 percent on all student loans.
  • Under the proposal the entire minimum payment would be applied to the reduction in principle and the Treasury would receive substantial revenue.

Advantages of a permanent elimination of interest for first two years of student loan repayments:

A permanent 0 percent interest rate for two years after the initiation of repayment would result in several economic benefits.

  • Delinquencies would fall at the beginning of careers when workers tend to have lower salaries.
  • A lower interest rate and quicker repayment of loans would allow young workers to increase household savings, a necessary prerequisite for many Social Security reform proposals under consideration.
  • Quicker repayment of student loans by young adults should eventually reduce the number of older adults with unpaid student loan balances in retirement
  • An initial interest rate of 0 percent would reduce demand for Income Driven Replacement (IDR) Loan programs, which will benefit both student borrowers and the Treasury.

Proposal Two: Modify the standard 10-year and 20-year federal student loan contract to eliminate all interest charges at the maturity of the loan.

Analysis:  The current system requires student borrowers to choose between a standard loan contract and an IDR loan contract as soon as they begin loan repayments.  Some people make the wrong choice.  Features of The IDR loan contract encourage some people to increase the amount they borrow. A simple modification to conventional loans would reduce demand for IDR loans and make taxpayers and many borrowers better off.

Proposed changes to standard loan contract:

  • Set interest rate on outstanding student loan balances to 0 percent when the loan reaches maturity date.
  • Treat unpaid student loan balances after the maturity of the student loan as a tax obligation spread over 3 to 5 years.

Advantages of proposed changes:

  • The interest rate of zero at the maturity of the loan provides some relief for people who have had difficulty repaying their loan. 
  • This change will reduce the number of people who have their Social Security checks garnished because of outstanding student loan obligations.
  • The proposal creates an incentive for borrowers to select a standard student loan contract instead of an income driven loan contract which can benefit the borrower.  IDR loans create financial uncertainty for borrowers and potential lenders and often prevent borrowers from qualifying for a mortgage.  IDR loan discharges are potentially costly to taxpayers.
  • Under the modified student loan contract, the borrower with a larger loan will always repay more than the borrower with the smaller loan over the lifetime of the loan.  By contrast, under the IDR program it is possible an increase in initial student loan debt does not increase the amount repaid over the life of the loan.

Proposal Three:  Modify IDR loan programs to provide for gradual partial discharges of student debt instead of a complete discharge of the remaining balance at the maturity of the loan.

Analysis: Current IDR loans promise a discharge of unpaid debt at the maturity of the loan, but loan discharges frequently do not occur on time because some borrowers fail to make required payments and some loan servicers fail to accurately report payments. IDR loans create an incentive for people to borrow more because in some instances the increase in the amount borrowed will not result in an increase in the amount repaid.  Both of these problems could be addressed by altering the IDR loan discharge provision. 

Proposed changes to IDR contracts:

  • Provide periodic partial discharges of student loans.
  • Discharge formula might involve 10 percent of previous 24 payments after receipt of 24 payments. 
  • Limit discharge at the maturity of the loan to 50 percent of the outstanding balance.
  • Undischarged loan balance will be restructured into a new short-term low interest rate loan.

Advantages of proposed changes to IDR contracts:

  • The quicker partial discharge gives borrowers an incentive to make payments on time to maximize debt relief.
  • The quicker partial discharge reveals potential problems with the recording of loan payments earlier.  Currently, payment problems are not revealed until maturity when the borrower apples for the complete loan discharge.
  • The limitation of the final discharge to 50 percent of the outstanding loan balance will cause borrowers with larger loans to have a higher debt at maturity than borrowers with lower debt.  This clause reduces the incentive for people to borrow more because monthly payments are determined by income rather than loan size and they anticipate the entire loan will eventually be discharged.
  • The incentive to reduce borrowing could also be achieved by taxing loan discharges.

Proposal Four:  Provide greater financial assistance to all first-year students with the goal of eliminating all student debt incurred during the first year of post-secondary school education.

Analysis:  Increasingly, some education after high school is necessary for career advancement.  Many student borrowers who leave school prior to the completion of the degree have great difficulty in repaying their loans.  Increased financial assistance for first-year students will increase access to higher educations for underserved groups and will assist people likely to have the most difficult repaying loans.

Proposed changes to first-year financial assistance programs:

  • Provide federal grants to institutions that agree to eliminate student debt incurred by first-year students.
  • All state and private institutions that agree to match the new federal/private funds are eligible for the new grants.
  • Participating institution are not allowed to provide federal student loans to first-year students.
  • Tax credits and/or deductions would be offered to taxpayers that contribute to funds providing matching resources for first-year students.
  • Benefit is available at both two-year and four-year institutions.
  • Additional benefits available for first year after transfer from a two-year to four-year college.


Advantages:

  • Program reduces payment problems and default rates by student borrowers that leave college early prior to the completion of their degree.  (Students leaving college without a degree after only one or two years of study tend to have an especially hard time repaying their student loan.)
  • Program will reduce typical college debt levels.
  • Absence of debt could allow a person to reenter school later in life when she is more prepared for higher education.
  • Proposed goal of a debt-free first year of post-secondary education is far less expensive than previous free college or debt-free colleges proposals. 
  • Program allows more highly qualified people to consider a four-year college. 
  • Prospect of additional assistance for transfer students could further reduce costs for students who start their post-secondary career at a two-year college and mitigate impact of credits lost through the transfer process.

Proposal Five:  Modify the bankruptcy code to allow for the discharge of private student debt in bankruptcy and to provide priority to federal student debt payments over all consumer loans in chapter 13 bankruptcy plans.

Analysis:  Student debt has always been difficult to discharge in bankruptcy.  The2005 Bankruptcy reform law discouraged Chapter 7 bankruptcy in favor of Chapter 13 and made it more difficult to discharge private student loans in bankruptcy.  Moreover, in most instances current law results in higher priority for consumer debt over all student loan debt in Chapter 13 bankruptcy plans.  Some student borrowers now leave chapter 13 bankruptcy plans with more student debt than when they entered.  More favorable treatment of student debt in bankruptcy could benefit both student borrowers and taxpayers.

 Proposed Changes:

  • Retain current rules governing access to Chapter 7 and Chapter 13 bankruptcy adopted in the 2004 Bankruptcy reform act.
  • Change bankruptcy code to make private student loan debt dischargeable in bankruptcy.
  • Provide priority to payments on federal student loan payments under chapter 13 bankruptcy plans.

Advantages

  • Retention of means test for use of chapter 7 bankruptcy discourages bankruptcy filings for many people who might be able to pay off their debts without bankruptcy relief.
  • Private student loans with high interest rates is similar to credit card debt and other consumer loans and should be treated accordingly.
  • Helps people leaving chapter 13 bankruptcy obtain a fresh start.
  • Helps taxpayers by increasing and speeding up student debt payments.  
  • Helps the most vulnerable student borrowers.  Should reduce the number of older taxpayers having Social Security garnished because of unpaid student debt.
  • Creates an incentive for lender to better evaluate the ability of borrowers to repay private consumer loans and private student debt.