GETTING OUT OF THE RED The crisis in disability insurance

Social Security has millions retire early, live on the government’s tab

Social Security is primarily made of three insurance programs: old age insurance, insurance against on-the-job injuries (workers compensation), and insurance against career-ending disabilities (disability insurance). Old age insurance, being the bulk of Social Security, is what comes up in conversation most often. But the remainder of Social Security is in dire need of reform as well, and if Congress paid a little more attention to Disability Insurance (DI) in particular, they might go a considerable way toward fixing the nation’s budget deficit.

DI is a federally administered program, but the decision of which workers are eligible for benefits is left to state-run medical boards. Workers are eligible to claim disability if they have not held “substantial gainful employment” (received wages greater than $1000 per month) for the past five months. The state boards then review the applicant’s medical condition, and make a decision as to whether the applicant is impaired to a degree that would prevent him or her from returning to gainful employment. If accepted, claimants can receive disability insurance benefits equivalent to their full retirement benefit from Social Security’s old age insurance program for the rest of their life. They are also eligible, after two years, to receive Medicare coverage as well.

The problem inherent in disability insurance is that not all disabilities are easily observable, and the state medical boards tasked with weeding the fakers from the truly disabled are quite poor at their job. In a study of DI, economists took a random sample of cases that were reviewed by state boards and resubmitted them to the same boards a year later, (with a different name attached to the application). The result was that the boards frequently failed to reaffirm their own decision — in nearly a quarter of instances, the board came to two different conclusions when given the same case twice.

As a consequence of the medical boards’ confusion, DI has attracted applications from several workers who are not significantly disabled, but merely want the government to pay for an extended vacation. These freeriders typically come out of the woodwork during recessions, but since they rarely ever leave after being accepted, the fraction of men choosing not to work has been slowly ratcheted upward. Between 1960 and 1980 (the immediate aftermath of DI’s passage), the labor force non-participation rate of working age men doubled, and the rolls of DI have only continued to swell ever since.

In 2009, the United States government spent $194 billion on disability insurance, $28 billion in administration costs $96 billion in direct payouts to disabled workers, and $70 billion in associated Medicare costs. These costs, absent reform, are projected to increase at a rate of more than 3 percent per annum. Within this program, there is a significant opportunity to reduce costs, while retaining care for the disabled.

To cut DI entirely would leave millions of truly disabled with miserable prospects. However, a careful trimming of DI’s generosity could go a long way in throwing out the bathwater while keeping the baby. If rejection rates by state medical boards were raised by 10 percent, and disability benefits were reduced by 10 percent, labor force participation rates among older men would go up by approximately 6 percent, cutting the rolls of DI almost in half, while retaining most of the program’s intended beneficiaries. The disabled won’t stop applying for DI just because the program becomes a shade less generous, but for those who have actual alternatives besides DI, a worsening of DI’s payout would have a marked effect on their decision making.

Were these cuts applied not just to future DI participants, but current ones as well, we would likely see two things: firstly, tens of billions of dollars in additional tax revenues as workers return to their jobs, and secondly, a reduction in Social Security costs of more than half a trillion dollars over the next ten years.

The cuts are not without a downside — raising the rejection rate will mean some additional disabled persons will not receive insurance, and reducing the program’s benefits will mean lower transfers to the honestly incapacitated. But with more than half a trillion dollars at stake, these are cuts that deserve to be made.

Action: Reduce disability benefits by 10 percent and reduce admission rates by 10 points. 10-Year Savings: Over $500 billion.