Immigrants Enjoy Better Social Security Returns than U.S. Natives

"For their first two decades of work in the United States, immigrants earning $10,000 or more per year receive 70 to 80 percent of the Social Security benefits paid for a full work life by native born Americans."

Social Security is often billed as an insurance plan for retirement that bases the benefits paid out squarely on the contributions paid in. But there is also an element of redistribution within the system. The formula is meant to help people with low lifetime earnings, but its effects can be haphazard. A recent NBER Working Paper aims to inform policymakers about one such transfer, that between U.S. and foreign born participants.

In Social Security Benefits of Immigrants and U.S. Born (NBER Working Paper No. 6478), Alan Gustman and Thomas Steinmeier investigate the application of the Social Security benefits formula to immigrants and U.S. natives. They show that under current rules, immigrant workers realize a higher rate of return on payroll tax contributions than U.S. natives. This difference cannot be justified on grounds of income or wealth differences.

The combination of two features of Social Security lead to this anomaly. First, the Social Security formula transfers benefits toward those with low lifetime covered earnings. Second, all years that an immigrant spends outside the United States are treated as years of zero income. To calculate benefits, Social Security uses a simple average of lifetime earnings, the mean of the highest 35 years of covered indexed earnings. Low lifetime earnings may be the result of a low earnings level in each year of work. They also can result from limited years of covered employment. The formula treats immigrants who have spent only part of their working life in the United States as having lower average earnings than they enjoyed in each year they worked.

This means that each dollar of payroll tax contributions generates higher benefits for foreign born than U.S. natives. Gustman and Steinmeier compute Social Security benefits for both groups at representative ages and for comparable earnings. Much of their work is based on a sample of the population of those born between 1932 and 1941 -- and thus close to retirement -- from the Health and Retirement Study (HRS). The paper applies a series of money's-worth tests to show that the benefits formula replaces a higher fraction of total earnings for immigrants than for the native born. Taking those aged 51 to 61 years in 1992, foreign born men at retirement will have paid on average 76 percent of the taxes paid by U.S. born. But they and their family will receive 83 percent of the benefits.

High earning immigrants who have worked in the U.S. for between 10 and 20 years benefit most from these procedures. For their first two decades of work in the United States, immigrants earning $10,000 or more per year receive 70 to 80 percent of the Social Security benefits paid for a full work life by native born Americans.

This transfer between U.S. and foreign born is not justified on the basis of need. Average income and wealth accumulation for immigrants in the HRS sample are very similar to the comparable means for U.S. natives. The mean income of immigrants exceeds the mean income of U.S. born by 3 percent. Gustman and Steinmeier say that there is no rationale for applying an across-the-board formula that benefits immigrants. There are far more efficient ways to help poor immigrants.

The researchers explore an alternative policy proposal, whereby Social Security benefits are pro-rated based on the fraction of the worker's life actually spent in the United States. Under such a system, an immigrant and a U.S. native who have the same earnings in each year would receive the same return on their Social Security taxes. This would reduce Social Security benefits paid to immigrants in the sample by 7 percent. Pro-rating based on a 35-year base period would reduce the present value of benefit payments to the 1932-41 born immigrants by $7.5 billion. Foreign born men on average would pay 76 percent of the taxes paid by U.S. born, and would receive 78 percent of the benefits for their families. Thus, redistribution towards immigrants is much reduced. But progressively higher benefits for low-wage workers, both U.S. and foreign born, are maintained.

Despite enjoying a higher return than native born, immigrants in the HRS group just reaching retirement age will, on average, have paid in slightly more in taxes than they will receive in benefits. However, the difference between taxes paid and benefits received for native born members of the HRS cohort will be even larger than it is for immigrants. Because immigrants make an overall net positive contribution to Social Security, it is in the selfish interest of native born to include immigrants in the Social Security system, even though the system favors immigrants relative to U.S. natives.

-- Andrew Balls

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