What Does "Means Testing" Mean to You?

An ABC News poll dated July 17th asks "adults" (not voters) what they think about the debt talks in Washington.  Question 20 asks: "In order to reduce the national debt, would you support or oppose [ITEM]?"  Items include raising taxes on hedge fund managers (64% approve); raising taxes on those earning over $250,000 a year (72%); cutting spending on Medicaid (26%); and raising Medicare premiums for wealthier retirees (61%).  This last item is referred to as "means-testing."

As the debt arguments have progressed, I have noticed a rise in the use of the phrase "means testing" (especially in relation to Social Security and Medicare.)  What I haven't heard or read is a clear explanation of how this "test" would be applied in "real life"?

For example, given how most IRA accounts and home values have been decimated by the economic recession, and how dicey the markets will be going forward, it seems unreasonable to assume that the average retiree could necessarily count on income other than Social Security from year-to-year.  So one assumption is that benefits would get paid to everyone and the "means test" would be part of the income tax returns process.  But I don't know if this is correct. 

Or does it mean we have to create a new reporting system -- that considers medical benefits as "income" -- even though other insurance pay-outs are tax-exempt?  Since most insurance pay-outs are the result of unforeseen circumstances (whether damage to one's home or car or body) why would Medicare (as health insurance) be taxed differently from other insurance?  And why is civilian insurance (Medicare) "means tested" while VA benefits are off limits?  Especially since all workers pay into the Medicare system, while members of the armed services don't.

Or one could change the funding of Social Security to include all taxable income (not just the current $109 K "wage base") so those in the upper 2-3% contribute more equitably to a system from which they derive basic income "security" should their situation change after retirement.  (See my earlier blog entry for more details.)   In the poll, 66% of those interviewed approve this option.

You can see that one can travel down a very circuitous road when dealing with the realities of what seems to be a simple and reasonable limitation to "entitlements."

So I ask for clarification:

What is meant by the term "means testing" and how would it be applied in "real life"?

I look forward to your thoughts on this topic.

Image information:
March 13, 2008, Blairsville, Georgia; AARP Tax-Aide program offers free one-on-one counseling.

Credit: Janice Boling, Writer/Photographer for the North Georgia News

Thought Experiment: Life Expectancy & Social Security "Reform"

OK, I'm listening to various arguments going on about ways to cut spending and reduce the growth of the costs for Medicare and Social Security.  Most of the proposals (excluding Ryan's non-starter) center around increasing the eligibility age over the course of time.  Since the average life expectancy is rising over time, this seems logical.  It's simple: If we delay the starting date for providing benefits, we save federal outlays in both systems. 

However, the life expectancy data do not hold up well under close scrutiny.  Averages are made up of a broad range of ages and genders and socio-economic situations.  For instance, the gap in life expectancy between African-Americans and their white counterparts has been narrowing over the past few decades.  That's good news – and it's a piece of data that backs up the proposed increases in the eligibility age for Social Security and Medicare.

But wait.  When we cut the data based on income, we find that the gap between those at the upper end of the economic spectrum and those near the bottom is actually growing, not narrowing.  That is, the wealthy are living to an older age than their counterparts who earned less over their work-life.  This means the wealthy, as a group, collect more benefit from Social Security and Medicare than their less-advantaged peers.

Social Security is funded by taxes on the employer and employee up to a designated "wage base."  Income beyond this base amount are not taxed for Social Security.  The wage base has been $106,800 since 2009.  This means that no matter how much someone earns above that amount, no further tax is paid to support the Social Security system. 

A person earning federal minimum wage ($7.25 per hour), working a 40 hour work week, and working 50 weeks a year makes $14,500 a year.  Although this sounds like an unrealistically low income, in 2007 19% of households earned less than $20,000.  The total income for this 19% of households represents only 3.1% of all earnings in the United States. 

That same year, 77.9% of households (earning up to $95,000 a year) held 47.3% of the total US income.  All this income was subject to the existing Social Security tax (the wage base in 2007 was $97,500.)

Twenty percent of households earned between $95,000 and $250,000, representing 40.8% of total US income.  And last (but definitely not least) the top 1.9% of households (making more than a quarter of a million dollars) brought in almost 12% of all income.  However, for both these brackets, no Social Security tax was paid once income exceeded $97,500.

So the relatively poor pay Social Security tax on 100% of their income, while those in the upper brackets clearly do not. 

The actuarial tables tell us those at the lower end can expect to collect Social Security benefits for about sixteen (16) years, while those at the upper end will collect about twenty-one and a half (21.5) years after age 65 years.  And this 5.5 year gap is growing (it was less than one year difference about 30 years ago.)

Based on this data, I would propose that those who are wealthy, who will generally live longer than their low income colleagues, could reasonably be asked to pay more into the system. 

There are a couple of ways we could do this.  We could simply raise the wage base again a few thousand dollars.  But this would continue to tax the lower and middle classes which do not benefit from the system as much as those at the upper end.  While I would prefer a progressive tax (hitting those at the upper end with a higher Social Security tax rate than those with less income) I don't think that would earn enough votes to pass Congress.  So I propose that we eliminate the concept of the Social Security "wage base" and simply include all earnings when calculating the Social Security taxes due.

Your thoughts are appreciated.

Photo Source
Cultural Health News Blog, November 30, 2010