Most experts on our nation’s financial problems say fixing Social Security is relatively easy. However, for reasons summarized below, it is hard to fairly fix Social Security.
First, many people argue that no fix is needed because Social Security is “fine” for the next 30 years. In reality, with the possible exception of the next few years, expenditures will exceed cash inflows indefinitely — with the annual deficits gradually growing. Past surpluses have been loaned to, and spent by, the federal government. There is no “trust fund” with any assets of value. The federal government, which recently had its credit rating downgraded, would need to borrow or tax more to make future promised benefit payments.
Second, unlike Medicare, Social Security’s tax and benefits structure is straightforward. You’re taxed when you work and you get checks in retirement. There are no deductibles or co-pays to muddle the picture.
Third, and possibly most significant, Social Security is the “third rail of politics.” A majority of seniors (who vote in large numbers), many of whom cannot work, rely on Social Security for most of their income. Accordingly, Rep. Paul Ryan, R-Wis., proposed changes to Medicare and Medicaid but punted on Social Security.
Since the mid 1950s, with the possible exception of the very wealthy, the individual total tax burden has changed little in inflation-adjusted terms. Thus, there is no basis to argue one age group should be favored over another. The Social Security tax rate has gradually increased over the years from its original rate of 1 percent (on employer and employee). Since 1990, the combined Social Security and disability trust fund rate has been 6.2 percent. (For 2011 only, a 4.2 percent rate applies to employees.) But life expectancy has increased.
Largely because the tax rate increases have outweighed the longevity increases, the average individual return on investment (ROI) rate — i.e. the earnings rate on contributions to produce benefits — has gradually diminished over the years. Beneficiaries born in 1925 have averaged a 5 percent return. Those born since 1960 generally will get less than 2 percent.
Over many years, Social Security has been pitched by many politicians as an investment. The benefits formula is significantly skewed in favor of lower income workers. Basically, earnings during working years are indexed for inflation and then subjected to a progressive benefits structure — with 90 percent of the first $749 of those monthly earnings, 32 percent of the next $3,768 of monthly earnings and 15 percent of any additional monthly earnings payable in benefits. Once payable, annual inflation adjustments are applied to benefits. Thus, some higher income workers experience a negative ROI. But lower income workers generally have shorter life expectancies than higher income workers, thereby negating some of the progressivity.
Because life expectancies have been increasing, many people espouse simply increasing the normal retirement age to fix most or all of the problems. The president’s debt commission recently made such a recommendation.
From an economic perspective, many would agree that changing the system so that a constant ROI would be produced for people of similar earnings history would be fair. Using a true trust fund, such a fix should be attainable.
Other possibilities that would solve the problems include doing nothing to the tax system and letting benefits fall in line with revenue, reducing benefits (possibly only for higher income persons), raising taxes and holding a national referendum to decide between a benefits cut and a tax increase.
Doing nothing to the tax system and allowing benefits to correspond to revenues would allow people to slowly adapt to lesser benefits (over decades, roughly 25 percent less), while giving people not close to retirement time to save more. Because of the cash flow and financial problems enumerated above, a private accounts solution is impractical.
Bill Clinton once said: There are a number of ways to fix Social Security, but they all involve a tax increase or a benefits cut. With the possible exception of a combination, President Clinton was right.
Allen Buckley is the author of the 2009 Bureau of National Affairs Inc. article titled “Fixing Social Security: What is Fair and Practical?”
About the Author
