Social Security Pays Excessive Benefits to the Highest Income Earners: A UK Comparison

Reducing benefits for higher income earners to keep program costs in check is a better alternative than raising taxes on current workers

Photo by Nick Fewings on Unsplash

When it comes to government provision of retirement benefits, differences abound. Comparing the United States Social Security program to the United Kingdom’s state pension illustrates a stark contrast. While both countries promise an old-age safety net, the US Social Security benefit for the highest-income earners looks more like a golden parachute than what President Roosevelt referred to as “some measure of protection to the average citizen and to his family…against poverty-ridden old age.”

Andrew Biggs writes at Forbes:

This year, a two-earner couple who each earned the maximum taxable salary over their careers can retire with combined Social Security benefits topping $96,000. That’s two to three times more than the maximum benefits offered in [the United Kingdom, Canada, Australia and New Zealand]. It’s not remotely needed to prevent poverty, and simply displaces real savings high-earners would do on their own. That in turn reduces economic growth.

As staggering as this figure is, it’s even higher than that. According to the Social Security Administration, in 2024, the maximum benefit for an individual earner, who claimed benefits at age 70 and who earned at least the maximum taxable amount for 35 earnings years would be $4,873 per month. That amounts to nearly $117,000 per year for a two-earner couple where both spouses meet the maximum benefit criteria.

Let’s compare this maximum Social Security benefit to the UK state pension.

A similarly situated UK couple that retired after 2016 could collect a maximum state pension of £21,202.40 today (this amount is expected to increase by 8.5% in April to just over £23,000 a year). If we translate that amount into the equivalent number of US dollars, using the World Bank’s purchasing power parity conversion rate, we arrive at $31,122.22 ($33,760.97 from April on). Purchasing Power Parity (PPP) compares the relative value of currencies by considering the cost of a basket of goods and services across different countries. Converting the state pension benefit from UK pounds into US dollars, using a PPP measure, gives us a better idea for the equivalent amount of dollars needed to achieve a similar living standard in the US.

Roughly $34,000—that’s how much the UK high-earning couple will collect from the state pension in US purchasing power terms. The US couple will collect more than three times the benefit they would receive in the UK. That’s a staggering difference!

The key to understanding this discrepancy is that the US Social Security benefit is an earnings-related benefit while the UK state pension now offers a largely universal flat benefit.

Under an earnings-related scheme, people with higher earnings over their lifetime receive higher benefits. Social Security’s benefits follow from a complex calculation that factors in a worker’s highest 35 years of earnings, indexes those earnings to wages, and then runs those earnings through a formula, with so-called bend points, that’s structured to be progressive. This design is intended to replace a higher share of pre-retirement earnings for lower-wage workers than for higher-wage workers.

Despite that built-in progressivity, the highest income earners end up collecting the highest benefits in the US (while also paying the highest taxes, in absolute terms). See this Urban Institute report comparing lifetime taxes to benefits for different income groups.

An earnings-related scheme tends to be more expensive because it pays higher benefits to medium and high-income earners. It’s also more complicated to calculate and thus makes it harder for people to figure out what their Social Security benefit will be when they retire. And to the extent that it discourages greater individual savings, it hurts investment and economic growth.

Under a universal benefit regime, everyone who qualifies for a full retirement benefit receives the same amount. That’s the case in the UK, where the state pension was established to be just above the ‘basic means test’ or what we might refer to as the poverty level in the U.S. Such a flat-rate regime simplifies retirement planning as everyone knows what they can expect from the system and plan for it. Depending on the level at which that universal benefit is set, such a regime can save taxpayers’ money by providing antipoverty protection in old age at a lower cost than an earnings-related regime would.

Andrew Biggs wrote elsewhere:

Social Security reform could more cheaply and effectively protect against poverty in old age, but this would require rethinking how Social Security has traditionally worked….an earnings-based program also locks in what Social Security produces today: unnecessarily generous benefits for the highest earners, who easily could save more for retirement on their own, while shortchanging the Americans most at risk of poverty in old age because they received low pay during their working years. It’s not clear what important public policy problem this is the solution for.

For Social Security to maintain its current benefit structure would require large scale tax increases that would most likely fall on working Americans through an across-the-board payroll tax rate increase. This would reduce incentives to work, especially among lower-wage earners, and put a damper on economic growth. Congress could also raise payroll taxes to shore up Social Security by lifting the payroll tax cap, which would impose a punitive 12 percent marginal tax increase on higher income earners. Or Congress could resort to other revenue sources, using general revenues instead of dedicated payroll taxes, to make up for Social Security’s funding shortfall. All these options involve serious tradeoffs, reducing Americans’ incomes and economic growth.

A better option would return Social Security to its stated goals of old age poverty protection by shifting from an earnings-related benefit to a flat benefit that is predictable, transparent, and more effective at providing insurance for struggling seniors. The UK used to feature an earnings-related benefit in the past but connected the dots that this was an ineffective and excessively costly way to provide seniors with poverty protection in old age. So, in 2014, the UK adopted the new state pension, shifting to a flat benefit model that raised benefits for seniors with low lifetime earnings and reduced benefits for those at the upper end.

Keen readers will observe that reducing higher income earners’ Social Security benefits after the fact will amount to a de facto tax increase by reducing the amount these individuals will receive in old age without changing the payroll taxes they were required to pay. They’re not wrong.

This is why previous proposals emphasized returning at least a portion of payroll taxes to workers to allow them to save and invest these funds in accounts they owned and controlled. The unfortunate truth is that US legislators procrastinated for too long, allowing the Social Security system to run into the red with a $120 billion annual cash-flow deficit as of 2023 and a $23 trillion long-term unfunded obligation. What remains is to stop the bleeding. Reducing benefits for higher income earners to keep program costs in check, and especially as part of a more fundamental rethinking of the proper purpose of an old-age-income support program, is a better alternative than raising taxes on current workers. It will inflict lower economic costs and reduce uncertainty over future tax increases from allowing program costs to continue to grow on an unsustainable trajectory.

With Social Security’s trust fund demanding congressional action by 2033 to avert indiscriminate benefit cuts, it’s about time that US legislators connect the dots as well.