As America continues to struggle with its deficit and debt, one of the most frequently suggested solutions is to means-test America’s two most expensive programs – Social Security and Medicare. Although this populist approach might hold out some superficial appeal to many, if not most people, it also is subject to that old aphorism – i.e., the devil is in the details. Most people probably have a general understanding of what means-testing is (Wikipedia says it is a determination of whether someone is eligible for help from the government, based upon whether that person possesses the resources to do without that help), but the detail is how do you determine whether a person has adequate resources.
I recently encountered means-testing with my son’s federal application for college financial aid. Jimmy previously received aid based on my ex-wife’s finances, and this year when he shifted to become my dependent he was denied any aid. The denial was based on a federal calculation that I was expected to contribute more than twice as much to Jimmy’s college education as my ex-wife was expected. This calculation didn’t make sense to me because my ex-wife’s assets were comparable to mine. Furthermore, she is working while I am retired.
So I dug deeper and this is what I found:
- For purposes of financial aid, the federal government considers “resources” to be not just income, but also assets.
- Assets do not include home equity or retirement accounts.
Home equity is what distinguishes me from my ex-wife. When we got divorced, she took the house without a mortgage and I took an apartment and put my assets into a brokerage account. Although the equity in her house and the assets in my brokerage account are virtually identical, the federal government has taken the position that a parent won’t be expected to use any of that home equity to pay for your child’s college education. With my brokerage account, however, the federal government expects me to liquidate a portion of that every year to pay for college.
How is that fair? Why should I be expected to contribute more to my child’s college education than someone with $1 million equity in a house?
And fairness is just one aspect of means-testing. Another is the incentive or disincentive that it produces. The internet is replete with articles analyzing how means-testing, whether income or assets, tends to discourage people from earning or saving money. Although you may not think that people would decline to earn more money if it cost them government benefits, this has already been found to occur when applied to welfare and it is reasonable to expect seniors might do the same thing if earnings cut into their Social Security and Medicare benefits.
Unfortunately for me, I can’t figure out a way to avoid the harsh effects of the federal calculation for financial aid. I can significantly reduce my income by avoiding any capital gains, but unless I take the money out of my brokerage and buy a house or condo, the federal government has decided that I can do without any of their help. That is true, but so can a lot of other people who will get government assistance.
Incidentally, in discussions of means-testing for Social Security and Medicare, there are suggestions that an alternative that will produce fewer distorted incentives is to means-test lifetime earning instead of annual income or assets. That sounds promising.