Social Security Is No Ponzi Scheme (Note to Rick Perry): View
As Rick Perry campaigned in Iowa late last month, he made it clear that he doesn’t have much faith in Social Security, one of the most popular U.S. government programs.
“It is a Ponzi scheme for these young people,” Perry said. “The idea that they’re working and paying into Social Security today, that the current program is going to be there for them, is a lie. It is a monstrous lie on this generation, and we can’t do that to them.”
As we celebrate a holiday devoted to American workers, it’s worth asking whether, as the Texas governor and leader of the Republican pack claims, the retirement program created for those very workers is at risk.
The answer, as we have argued in this space, is yes … and no. Social Security’s finances need shoring up. But there is nothing wrong with the program that Congress couldn’t fix in a week. Gradually raising the retirement age to 69, changing the formula for cost-of-living increases, and raising the cap on wages subject to the payroll tax would close most of Social Security’s funding gap for the next 75 years.
Such changes would rely about 60 percent on tax increases and 40 percent on benefit cuts, and would mainly affect the wealthiest Americans by asking them to pay more and get less in return. In the end, Social Security would be more progressive and benefits for the very oldest and the very poorest retirees would be enhanced.
In May, the Social Security trustees reported that the government pension system will run dry in 2036. That means payroll taxes levied on workers in 25 years will cover only three-fourths of benefits. The program by law can’t borrow money to pay retirees, so recipients will face immediate across-the-board cuts unless something is done.
That something can only take two forms -- raising taxes or reducing benefits. Fortunately, there are many options within those broad categories that spread the burden widely.
We don’t think private accounts should be among them. If workers divert some of their payroll taxes to an investment account, that would decrease the flow of money into Social Security and deprive retirees of benefits of equal value. Bad investment choices, or bear markets that lower returns on stocks and bonds, could add to their woes. In other words, private accounts would only make matters worse.
Instead, a very gradual rise in the standard retirement age would be the fairest solution. When President Franklin D. Roosevelt signed the Social Security law in 1935, average life expectancy was 64 and the official retirement age was set at 65. As life spans have increased, the retirement age hasn’t kept up.
The official age of retirement -- 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 opt for early retirement and start collecting benefits at age 62, albeit at a lower rate.
President Barack Obama’s bipartisan deficit commission was correct to recommended indexing 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 physically can’t work beyond 62 could apply for hardship exemptions. Adjusting retirement ages alone would erase about 21 percent of the 75-year Social Security shortfall.
Adopting a more accurate measure of inflation to calculate cost-of-living adjustments is the next best method for closing the Social Security funding gap. The government now uses the standard Consumer Price Index. But the Bureau of Labor Statistics and many economists say the CPI overstates inflation because it fails to account for the product substitutions people make when prices rise.
Switching to Apples
A better index, called the “chained CPI,” models actual consumer behavior. Most consumers, for example, switch to apples when the cost of oranges goes up, and thus keep household expenses steady. Using the chained CPI would close an additional 25 percent of the funding shortfall.
With those two changes -- raising the retirement age and measuring inflation better -- we’re 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 savings, private 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.
An additional 14 percent could be raised by taxing Social Security benefits the same way that private pension income is now taxed -- that is, on the portion of the pension contributed by the employer -- phased in over 20 years. The employee portion would not be taxed because it was already subject to income tax. Yes, this would result in a tax increase for future beneficiaries, but those in lower-income brackets could be exempted to keep the payroll tax progressive.
Now we are just 9 percent short of our goal. We can close that gap -- with room to spare -- 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.
Helping the Poorest
We’ve now closed 107 percent of the 75-year shortfall. That leaves enough wiggle room to add benefits for the oldest and poorest retirees, who are often one and the same. By 2050, there will be 19 million Americans, up from 6 million now, over 85. Octogenarians often outlive their personal savings just as their health is deteriorating. To keep them 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.
The final tally? These changes would close 101 percent of the funding gap. Each of these suggestions, moreover, 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/.
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. It’s the core of the compact working Americans have with their government. And though it’s increasingly unstable, it can be fixed.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.