Editorial Board

The Arithmetic and Politics of a Social Security Solution: View

Here’s a positive thought for the day: Social Security can be fixed.

Last month, the Social Security trustees reported that the government pension system will run dry in 2036. Because the program by law can’t borrow money to pay retirees, and because payroll taxes levied on workers in 25 years will cover only three-fourths of benefits, recipients will face immediate and harsh across-the-board cuts.

What should Congress do to fund the retirement program another 75 years -- most analysts’ definition of the long term -- and keep it on a sustainable path after that?

Well, there are only two ways to fix Social Security -- either by raising taxes or reducing benefits. Fortunately, there are many options within those broad categories that spread the burden widely while increasing payments to the very old and the very poor (see chart on the left).

Private accounts shouldn’t be among them. If workers divert some of their payroll taxes to an investment account, that would worsen matters by decreasing the flow of money into Social Security and depriving retirees of benefits of equal value. Bad investment choices, or bear markets that dent returns on stocks and bonds, could add to their woes.

The fairest solution would be a gradual rise in the standard retirement age. When President Franklin D. Roosevelt signed the law that created Social Security in 1935, the official retirement age was set at 65, one year beyond the average life expectancy of 64. As Americans’ life spans have increased, the retirement age has not kept up.

Wider Gap

The official retirement age -- when full benefits are paid -- is now 66 (due to rise to 67 by 2027), well below the average life expectancy of 78 years and four months. The gap is even wider for the 40 percent of Americans who start collecting some benefits at age 62, albeit at a lower rate. President Barack Obama’s bipartisan deficit commission had the right idea when it recommended that Congress index the retirement age to longevity by adding one month every two years, until 2075. That year, standard retirement would begin at 69 and early retirement at 64. Those who performed back-breaking labor and physically can’t work beyond 62 would be able to apply for a hardship exemption. Adjusting retirement ages alone would erase about 21 percent of the 75-year Social Security shortfall.

Delaying retirement would also help the U.S. economy by adding to the number of years that workers pay into the system. The American population is aging rapidly. Today, 53 million people collect Social Security benefits; by 2035, that number will jump 75 percent, to 93 million people.

Baby Boomers

Meanwhile, the prime working-age population -- ages 20 to 64 -- will increase only 10 percent, leaving employers desperate for workers as baby boomers leave the scene. The U.S. will not see a population decline, as is expected in Japan and Western Europe, but the meager increase in working-age population will slow economic growth and reduce income-tax revenue unless those over 65 delay retirement.

The next best method for closing the Social Security funding gap could come from adopting a more accurate measure of inflation to calculate cost-of-living adjustments in benefits. The government now uses the standard Consumer Price Index. But the Bureau of Labor Statistics and many economists say the CPI overstates the cost of living because it fails to account for the product substitutions people make when prices rise. A better index, called the “chained CPI,” models the ways consumers keep their expenses steady by switching to apples when the cost of oranges goes up. Using the chained CPI would close another 25 percent of the funding shortfall.

More Progressive

Those two changes would put us almost halfway toward the goal. To close much of the remaining gap, the best choice involves raising taxes on those in high wage brackets, thus making the system more progressive.

Currently, Social Security taxes are paid on wages up to $106,800, at a rate of 12.4 percent -- half paid by the employer and half by the employee. (The self-employed must pay the entire 12.4 percent.) Earnings above $106,800 are exempt, yet that’s where most of the wage growth has been in the past few decades. In the early 1980s, payroll taxes covered 90 percent of wages; today they reach only 85 percent.

To restore the 90 percent standard, Congress could raise the payroll-tax cap to $180,000. Such a change would hit high-income Americans whose personal savings, company pensions and tax-protected 401(k) retirement plans provide nest eggs far beyond what Social Security provides. This would take care of 38 percent of the shortfall.

Tax Benefits

The final 9 percent of the shortfall could be found by requiring newly hired state and local government workers to pay into the federal system. About 5.7 million public-sector workers don’t pay Social Security taxes because they are covered by state and local government pension plans. Requiring new government hires to join Social Security would also bolster the program’s role as a national pension plan in which all American workers have a stake.

Wealthy Americans

Taken together, the changes would rely 60 percent on tax increases and 40 percent on benefit cuts, and mainly affect the wealthiest Americans. They would create enough wiggle room to enhance benefits for the very oldest and the very poorest retirees.

Often these are one and the same people. By 2050, there will be 19 million Americans, up from 6 million now, over 85. Octogenarians often outlive their personal savings just as their out-of-pocket medical expenses are rising rapidly. To keep the very old from falling into poverty, lawmakers could create a minimum benefit of 125 percent of the federal poverty level (now about $1,100 a month), adding about 6 percentage points to the Social Security deficit.

Each of these suggestions has been endorsed or included as part of a menu of options by the president’s deficit commission and other economic research groups. The savings and cost estimates come from the Social Security chief actuary, the independent official who has analyzed the financial effects of dozens of proposals, all available at www.ssa.gov/oact/.

Worthy Alternative

A panel led by Alice M. Rivlin, a White House budget director under President Bill Clinton, and Pete V. Domenici, a former Republican senator from New Mexico, floated an alternative also worth considering: Subjecting the premiums paid by both employers and employees for group health insurance to Social Security and income taxes.

More than 50 million people now receive a Social Security check. It’s the main income source for more than half of all elderly households. To avoid causing a crushing hardship on the elderly of the future, lawmakers should fix the system now. The longer they wait, the harder it is to close the gap.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

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