How Today's Short-Term Crisis Response Might Inadvertently Cause Us to Improve Social Security

by Neil H. Buchanan

As most people are aware, Congress managed to pass an economic disaster relief bill, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which Donald Trump signed on March 27.  I supported that bill, even though it provides far too much opportunity for corruption.  Actually, it was perversely because of the inherent corruption in the bill that it could be passed, because without the opportunity for the already comfortable to wet their beaks, Republicans would not have allowed anything to move forward.

Barely two weeks later, we now know -- predictably but still unfortunately -- that the positive provisions in the CARES Act are being administered very badly (if at all).  Trump, meanwhile, has openly flouted the oversight provisions to guard against corruption that Democrats had managed to include in the bill.

Indeed, we already need another relief bill, especially for state governments, which the party that claims to believe in federalism and states' rights might not have been expected to resist.  Oh well.  What matters now is that states quickly be given an infusion of federal funds, to prevent cuts in Medicaid and other essential state programs.

Those are the headline issues.  There is, however, an issue that flew below the radar that could end up having a very big impact in a few years as the country recovers from this crisis.  That issue is retirement, because an obscure CARES Act provision allows people to empty their 401(k) accounts.  That will be bad, but there is an odd upside, which is that the now-all-but-inevitable depletion of retirement savings will increase pressure on a future Congress to strengthen Social Security.

Stick with me, please, as I walk through the logic that could end up doing what people like Senator Elizabeth Warren have not been able to do so far.

As it happens, this semester I am teaching a course in the University of Florida's graduate tax program called "Deferred Compensation."  The central issue in the course is the federal government's maddeningly complicated effort to provide security in retirement so that Americans can live out their final years with some dignity.  Because of my longstanding interest in Social Security, we spent the first one-third of the term discussing the way that people pay taxes during their working years in order to receive retirement benefits.  The remainder of the course covers private pensions, 401(k) plans, IRA's, 457's, and the rest of the "qualified" and "nonqualified" retirement savings vehicles that employers can provide -- subsidized by the federal government.

When the CARES Act was being finalized late last month, I did not know that Congress had already decided to make some changes to the rules for tapping retirement savings.  But I did see it coming, telling my students the day before it passed that Congress would surely soon start to allow people to draw down their retirement accounts -- and that this would cause a long-term problem.

Why was I so certain about this?  To be blunt, from Congress's standpoint, this is a freebie!  That is, all any politician has to say is that this is "your money" and that people should be allowed to use what is theirs.  If I am lucky enough to have built up, say, $125,000 in a 401(k) plan as a way to supplement my Social Security benefits in retirement, I did so thinking that I would be able to wait to use those funds.  If I need them now, why should I pay the usual penalties that are designed to discourage people from draining their retirement savings?  It is my money, dammit!

Moreover, this has no budget cost that a politician would have to justify.  If people pull $500 billion out of their retirement accounts, that is a half trillion "saved" by the federal government.  What politician would not love that?

Of course, this method of saving for retirement has always been grossly unequal.  A person who actually did have $125,000 in retirement saving in 2016 was in the top 20% of all retirement savers (see Chart 7 here).  How will that spread out over, say, 20 years of retirement?  Not well, and these are among the lucky few, because fully half of all Americans did not have even 8 thousand dollars in total retirement savings in 2016.

All of this means that the people who have any significant retirement funds to tap are the relatively affluent, but even many of them will certainly and unfortunately soon be in a position during this economic cataclysm where they will need to tap those funds (if they are not already).  The rest of the people will have to hope that Republicans in Congress cough up more than the $600-$1200 one-time relief checks in CARES.

How will this work? "The CARES Act allows investors of any age to withdraw as much as $100,000 from retirement accounts including 401(k) plans and individual retirement accounts this year without paying an early withdrawal penalty of 10%. They can avoid taxes on the withdrawal if the money is put back in the account within three years. If it isn't returned, taxes can be paid over a three year span."

It is easy to predict that much of this money will not be repaid -- which is to say, since we are talking about repaying oneself -- that people will be in the tough position a few years from now of not having the money to put back into their 401(k) accounts and will reluctantly take the tax hit.  Which will leave their 401(k)'s empty.

The most immediate response, of course, will be for Congress to extend the grace period and to lengthen the time to pay the taxes.  But that is not going to put the money back in people's hands that would allow them to replenish their savings.  At some point, we will notice that our system of tax-advantaged retirement savings -- which has long mostly served the interests of the upper-middle and upper classes who wish to shelter savings that they already could afford to set aside -- has become even more skewed, with middle-class retirement savers staring at accounts that they emptied in 2020 and 2021 (and who knows how much longer).

At that point, Congress will have a choice.  It might do ex post what it is refusing to do now, sending checks to people to replenish their 401(k)'s to their levels on, say, April 15, 2020.  That would mean that today's spending by people who are lucky enough to have 401(k) and similar accounts will not actually have been taken from those accounts.  It will have been "handouts" of the sort that Senate Republicans disparage even in this crisis, but it will take a few years to face up to it.

But unless there is at that point no longer any democratic accountability -- a scary prospect about which I have been warning literally for years (most recent iteration here) -- it will not be possible to shovel hundreds of billions of dollars to the top earners in the country in this way.  If the argument is that "we need to allow people to retire with some money to spend," then there will be plenty of people who are even more in need of extra money, because Social Security benefits are tied to how much money people earn before retirement.  That is, even though the benefit formula compresses inequality somewhat, higher earners already receive larger Social Security checks than lower earners do.

At that point, something wondrous could happen.  Spurred by the 2020 Congress's cheaping out on disaster relief, we could see a future Congress finally supplement Social Security to allow the program to support all people more fully.   With traditional pensions all but gone, and with even the inadequate tax-favored savings plans having been emptied, only Social Security will remain.

Again, this assumes that we will still have competitive elections -- or elections at all -- and that the anti-Social Security fervor on the right will be swamped by the needs of a country that has no other means of supporting decent retirements.  I no longer have confidence in making such predictions.  But the path on which Congress quietly placed us with the CARES Act is going to put the inadequacy of our retirement support systems under a harsh glare, very soon.