Social Security’s Insecurity
Under current rules, the Social Security Trust Fund is likely to be bankrupt by 2041.
Question 4. Ask the Candidate:
Why not fix much of Social Security’s long-term solvency problem by making Social Security taxes apply to higher levels of wages?
"To extinguish a Debt which exists and to avoid contracting more are ideas almost always favored by public feeling and opinion; but to pay Taxes for the one or the other purpose, which are the only means of avoiding the evil, is always more or less unpopular. These contradictions are in human nature."
—Alexander Hamilton
Without reform, Social Security probably could pay 100% of scheduled benefits through the year 2040, but beginning in 2041, it probably could pay only 75%. Matters get worse thereafter if present actuarial forecasts hold. This prospect is unlikely to distract most of today's card-carrying seniors, who figure they'll be beyond fretting about such worldly matters in 33 years. But it surely should distress the 20- and 30-something crowd. On average, they will have several hundred thousand dollars riding in the system (their own taxes plus matching ones by their employers) by the time 2041 arrives. They could be severely short-changed.
The Countdown to Crisis
All Social Security taxes are paid into the Social Security trust fund, which pays Social Security benefits. The trust fund currently earns interest on its substantial surplus, a surplus that is still growing. In 2017, however, the numbers are expected to begin turning negative: Projected benefit payments will exceed Social Security tax revenues. Still, benefits will be paid in full because the tax revenues will be supplemented by surpluses in the trust fund and by the interest the surpluses earn.
In 2041, however, if reforms have not been made, the trust fund is expected to have exhausted all of its assets. Yes, it will be empty. Benefits then will be paid solely from on-going Social Security taxes. If that happens, benefits will have to be cut by 25%,[1] and by more in each ensuing year. Imagine how seniors would feel if a cut of that magnitude occurred today. The average monthly benefit of a retired worker this year is about $1,080. You wouldn't want to be the one to tell her that next month she will receive only $810.
If these figures don't worry you, here's another way to look at the long-term deficit problem. If, today, Congress wanted to fix Social Security's projected deficits over the next 75 years, it would have to find, somewhere, $6.8 trillion to deposit in the trust fund.[2]
Are these figures imagined by some modern Wizard of Oz who delights in scaring us? Hardly. They are published with the approval of the trustees of the Social Security trust fund, who just happen to include the Secretary of the Treasury, the Secretary of Health and Human Services, the Secretary of Labor, and the Commissioner of Social Security, not exactly wild and crazy types.
Their figures are only estimates, of course, not predictions. No one can know with certainty what the predicament of Social Security might be 25 years from now, let alone 75 years. These estimates, however, are based upon historical experience and projections of the most likely trends in the size of the work force and future wages, tax revenue, life expectancies, and other economic factors.[3]
A responsible Congress would have addressed the Social Security problem years ago. Surely the danger signs have been around long enough: The number of beneficiaries will climb rapidly as the baby boom generation begins to retire in a few years. By 2030, about 20% of the population is expected to be 65 or over compared to about 12% today. Currently there are about 3.3 workers for every beneficiary; by 2035, there will be only about 2.1 workers per beneficiary. And seniors will live longer and longer.
Saving Social Security Makes Sense
Following his re-election in 2004, President Bush was convinced that the time was ripe to capitalize on growing concerns that Social Security no longer was the preferred safety net for younger generations. Around the country he went, insisting that workers would be better off if they could allocate a portion of their Social Security taxes to private accounts. Workers then could invest these private accounts in the stock market, which historically has outperformed U.S. bonds--the exclusive investment of the Social Security trust fund.
Most Americans, however, rejected the idea of diminishing the promises of Social Security for the risks of the marketplace. As Ted Marmor and Jerry Mashaw have written, "Social insurance is part of the essential social glue that holds an individualistic polity together and that makes the economic risks of a market economy tolerable."[4]
Specifically, critics of Mr. Bush's famously failed initiative believed that the creation of some private accounts would be the first step toward privatizing all of Social Security, which they strongly opposed; that most workers would not have sufficient sophistication to know how to invest their funds; that the investments might not outperform and could under-perform U.S. bonds; that disabled beneficiaries would suffer badly under Bush's plan; and that removing any significant share of Social Security taxes from the trust fund would require workers to pay significantly more Social Security taxes in order to satisfy obligations to existing and new beneficiaries.
Most unconvincing was Mr. Bush's claim that his "plan is particularly good for low-income people, particularly low-income women" and would help "spread the idea of ownership beyond just the so-called ‘investor class.'"[5] The president's plan, however, required a worker at retirement to convert her personal account into a lifetime annuity if withdrawing the funds in a lump sum "would result in [her] moving below the poverty line."[6] That often would be true for a low-income worker. A lifetime annuity would mean that her account would die with her, along with any notion that a private account was her ticket into the ownership society. Moreover, if she became disabled or died, Social Security promises benefits to her or her young dependents, a crucial element of her safety net, whereas her private account would not.[7]
Yes, workers should be encouraged to develop personal investment accounts, but outside the basic Social Security program. Let's now turn to explanations for Social Security's insecurity and how best to address them.
The Wage Threshold: A Major Source of the Funding Crisis
Many people are unaware that Social Security taxes never have applied to all wage levels. From 1937 through 1949, the tax applied only to the first $3,000 of wages. Because the tax rate was 1%, no one ever paid more than $30 a year. That amount was matched by the employer--Social Security always has required matching contributions by employer and employee--bringing the grand total to $60. In other words, the combined contribution of employer and employee during the first 13 years of Social Security never exceeded $60. When the employee retired, however, he became entitled to substantial benefits, which created long-term deficits in the program.
The threshold began to rise sharply after 1949, and, since 1972, has increased annually in proportion to increases in the annual wage level. The tax rate also rose significantly over the years, reaching 6.2% for both employers and employees in 1990, where it remains today.[8]
This year, the wage threshold is $102,000. So a worker can pay as much as $6,324 ($102,000 x 6.2%) a year, with his employer paying another $6,324, for a total of $12,648.
The existence of any wage threshold, however, makes Social Security taxes regressive: They claim a greater percentage of the wages of workers who earn up to the threshold than of the wages of workers who earn more than the threshold. For example, if you earn $40,000, you pay the full 6.2% tax on it; if you earn $400,000, you pay the full 6.2% on $102,000 but 0.0% on the next $298,000, or an average of only 1.6%. On the other hand, Social Security benefits are progressive: They provide a higher percentage of the wages of lower-income workers than of the wages of higher-income workers. More on this later.
Medicare and Social Security used to have identical wage thresholds. In 1990, however, Congress was sufficiently concerned about Medicare's long-term solvency that it raised Medicare's wage threshold; and, in 1993, Congress eliminated the threshold altogether. Ever since, Medicare's 1.45% tax has applied to all wages, even those of the highest-paid executives.
To summarize, Social Security and Medicare taxes, totaling 7.65%, apply to $102,000 of wages this year, but only the 1.45% Medicare tax applies to wages above $102,000.
What Congress Should Do
Congress must address both parts of the "long-term" projected deficits of Social Security. By "long term," I am referring to the projected deficit over the next 75 years as estimated by Social Security actuaries.[9] The first part of the deficit is the "legacy deficit"--the significant deficit attributable to Congress's failure to require early beneficiaries to pay sufficient taxes. This large bill has been inherited by current and future generations, an unfair but unavoidable burden on them. The second part of the long-term deficit arises because Social Security taxes and the anticipated wages of workers today and in the future are insufficient to address the shrinking ratio of workers to retirees and the longer life expectancies of current and future beneficiaries.
If Congress acts promptly, the solution, which can be a balance between revenue increases and benefit decreases, need not be drastic.
The Principal Reform. The principal reform should be to raise the wage threshold significantly. This would be fair because higher-income workers and their employers are most likely to be able to afford the tax, and because the tax threshold gradually has declined as a percentage of all wages. In 1983, the most recent year for major Social Security reforms, 10% of earnings exceeded the wage threshold that existed at that time. Today, over 15% of earnings exceed the current wage threshold.[10]
In fact, we could largely eliminate the Social Security deficit over the next 75 years if we immediately eliminated the wage threshold, according to a study headed by the deputy chief actuary of Social Security in 2003.[11] But it would be unfair to place the entire burden for the deficit on high-income workers and their employers and none of the burden on other workers and beneficiaries. An appropriate compromise would be to restore the threshold to cover 90% of all wages. This would raise the threshold today to about $185,000, which would affect about 6% of all workers. If Congress phased in this increase over the next ten years, thereby tempering its impact on high-income workers and their employers, this single reform would solve about 43% of the long-term deficit.[12]
You're perhaps wondering why this seemingly obvious option-substantially raising the wage threshold-has not already been acted on by Congress. Perhaps you know the answer: Higher-income workers have strongly opposed it. They know that, under the progressive benefit structure of Social Security, their additional tax payments would add relatively little to their total retirement payments.[13]
Social Security benefits have always been progressive because of Social Security's commitment to provide a minimum benefit to low-wage workers. Workers who have the highest average wages over their lifetimes receive the largest monthly benefits, but their benefits are a considerably smaller percentage of their average wages than are the benefits for low-income workers. For example, in 2005, Social Security benefits for a typical low-wage earner who retired at age 65 were about 57% of his average wage, whereas the percentage would have been 35% had he been a typical high-wage retiree.[14]
A progressive benefit formula for Social Security remains sensible today because about one-third of all people who are 65 and older receive at least 90% of their income from Social Security.[15] In other words, this bottom one-third has few other sources of income. By contrast, higher-income workers usually have substantial pension benefits and other investment assets at retirement that contribute to comfortable retirement incomes. These workers also have longer life expectancies, on average, than do other cohorts, which means they will receive Social Security benefits for more years than will other cohorts. Seniors who have lived in poverty have the shortest life expectancies.
Four Other Reforms. Along with raising the wage threshold, Congress should adopt four other reforms to address the long-term revenue gap. (These proposals do not resolve deficits that arise after the next 75 years. Eventually, these deficits, too, must be addressed.)
Add New State and Local Workers. Congress should move Social Security closer to universal coverage by including all new state and local workers. Today, about 4 million state and local government workers are not covered by Social Security; rather, they earn benefits under their employer's program. State and local workers are, on average, well paid and should share some of the responsibility to address Social Security's financial problems. If Social Security included all future state and local employees, it would solve about 10% of the deficit anticipated over the next 75 years.[16]
Adjust Benefits for Longer Life Expectancies. Social Security benefit levels should take into account increases in life expectancies.
From the inception of Social Security through the year 1999, the age at which a worker was entitled to receive full benefits was 65. But to help reduce the long-term deficit, Congress extended that age, beginning in the year 2000. The age now is 66, and will, in stages, move to 67 by the year 2027. Still, a portion of the long-term actuarial imbalance of Social Security remains the failure of the benefit calculation to take fully into account that, over the next 75 years, beneficiaries will live longer and longer.
It makes sense then, to help address the long-term imbalance, for Social Security monthly benefits to be reduced somewhat for workers who retire when they first become eligible for full benefits. (If a worker continues to work beyond then--for example, if he reaches age 66 this year but continues to work--the increased Social Security taxes he would pay may avoid any benefit reduction.) Because of the modest benefits paid to people with modest wage histories, Congress should make these adjustments only for benefits above a certain minimum amount.
At the same time, Congress should eliminate a rule that blatantly discriminates against many young workers. In computing a worker's average wages over his working lifetime, Social Security doesn't credit him with wages earned before he reached age 21. For many young workers, those wages could add considerably to their ultimate pension, particularly if they have to retire earlier than expected because they are injured or laid off.
Tax Social Security Payments Like Pension Payments. Social Security payments should be counted as income on our tax return except to the extent that they have been previously taxed. Then, only the portion attributable to Social Security taxes deducted from a worker's wages would be exempt from tax. These Social Security taxes always have been included as wages on our W-2 forms. For example, if your wages last year were $20,000, the 6.2% Social Security tax you paid was $1,240, but the entire $20,000 would appear on your 2007 income tax return.
Only about 15% of all benefit payments, however, represent Social Security taxes previously paid by beneficiaries. If Congress taxed the remaining 85% as it taxes pension plan distributions, the entire 85% would be income. Yet under today's rules, all 85% is included in the income of only middle- and higher-income taxpayers. Under complicated formulas, low- and moderate-income beneficiaries exclude all of their Social Security payments from their income tax returns, while beneficiaries with somewhat more income pay a tax on a fraction of that 85%.[17]
As part of this reform, Congress should increase the threshold at which seniors begin to owe an income tax, to make sure that they have sufficient income to pay for necessities before the income tax applies.
If Congress phased in this change over ten years and deposited the additional revenue in the Social Security trust fund, Congress would eliminate about 15% of the 75-year deficit.[18]
Deposit Estate Taxes in Social Security Trust Fund. Congress should designate all estate tax revenues for deposit in the Social Security trust fund. This would help address the long-term Social Security deficit and may make extension of the estate tax more palatable to opponents of the tax.
Currently, the estate tax, which is added to the government's general revenues, is scheduled to be repealed in 2010, and then reappear in 2011. Congress is likely to resolve this crazy set of circumstances--the outcome of legislation in 2001--by continuing the tax on a small percentage of estates. If Congress retained the estate tax rules for 2009--which provide an exemption level of $3.5 million for each estate and a maximum tax rate of 45%--parents could leave $7 million to their children and grandchildren (or others) free of tax; spouses and charitable organizations would continue to be entitled to receive unlimited amounts free of tax; small farms and businesses inherited by family members rarely would be taxed; and less than 1% of all estates would be subject to tax. Yet the estate tax revenues, if added to the Social Security Trust fund, could cut Social Security's long-term shortfall by about 20%.[19]
Investing Trust Funds in the Stock Market
Some commentators and politicians have suggested that the long-term deficit problem could be addressed in part by allowing the Social Security trustees to invest a portion of the Social Security trust fund in the stock market. This strategy is highly controversial.
Currently, all the earnings of the Social Security trust fund consist of interest on U.S. bonds acquired by the trust with its surplus. Critics of investing some of the funds in the stock market worry about the market's volatility. They believe that stocks could do poorly for many years and even under-perform U.S. bonds, although historically stocks have outperformed bonds over the long run; that large government investments in the stock market could distort the market; and that politics, rather than sound investment principles, could skew decisions about trust investments.
Advocates of the stock market initiative believe that the potential for the stock market to outperform U.S. bonds is sufficiently promising--and can be managed by investments in a range of broad domestic and global equity indices--so as to outweigh the other concerns of critics. Stay tuned!
*******************************
So let's ask the candidates: How would you fix Social Security's long-term insecurity? By now, candidates, particularly anyone running for the Presidency, should have a clear idea about what revenues to raise and what benefits to cut.
[1] See "A Summary of the 2007 Annual Social Security and Medicare Trust Fund Reports, Social Security and Medicare Boards of Trustees," http://www.ssa.gov/OACT/TRSUM/trsummary.html.
[2] Ibid.
[3] Some experts argue that the long-term solvency problem for Social Security is far overstated because they believe that wages and our economy will grow faster than under the mid-level assumptions used by Social Security actuaries. See Dean Baker and Mark Weisbrot, Social Security: The Phony Crisis. Chicago: University of Chicago Press, 1999.
[4] Theodore R. Marmor and Jerry L. Mashaw, "Understanding Social Insurance: Fairness, Affordability, and the ‘Modernization' of Social Security and Medicare," Health Affairs, March 21, 2006, 1.
[5] See, for example, President Bush's speech to employees of the Nissan North America manufacturing plant in Mississippi, May 3, 2005.
[6] President George W. Bush, State of the Union Address, February 2, 2005.
[7] Social Security pays disability benefits to more than 6 million disable workers, to 2 million children of retired and disabled workers, and to nearly 2 million children who are survivors of deceased workers. Social Security Advisory Board, "Social Security: Why Action Should be Taken Soon," September 2005, introductory page.
[8] The 6.2% combines the OASI tax (5.3%) and the Disability Income tax (.9%).
[9] Under current laws, a large deficit arises as well after the next 75 years, but we will not address those issues here.
[10] Congressional Budget Office, "Budget Options," February 2007, 308.
[11] Alice H. Wade, deputy chief actuary, and Chris Chaplain, actuary, Social Security Administration, memorandum to Steven C. Goss, chief actuary, October 20, 2003, "Estimated Long-Range OASDI Financial Effects of Eliminating the OASDI Contribution and Benefit Base-Information."
[12] Social Security Advisory Board, "Social Security: Why Action Should be Taken Soon," September 2005, 36.
[13] Your Social Security retirement benefits are calculated as a percentage of your average annual wage over your top 35 years; for this purpose, wages in earlier years are adjusted to their value in the year of retirement. Different percentages-ranging from 90% to 32% to 15%--apply to different levels of average wages for calculating your benefit. If you retire in 2008, and if your average wage for 35 years is no more than $8,532, your benefit will be 90% of that amount, or a maximum of $7,679. If your average wage is higher, you will receive 90% of the first $8,532 plus 32% of the next $51,416; and if your average wage is even higher, you will receive 15% of the top portion. This 15% multiplier produces a very small return in exchange for the taxes paid on those wages, which is what concerns high-income earners.
[14] See endnote 12, 8.
[15] Congressional Budget Office. Baby Boomers= Retirement Prospects: An Overview. Washington, D.C.: GPO, November 2003, 4. See also National Institute on Aging and National Institutes of Health, Growing Older in America, The Health and Retirement Study. U.S. Department of Health and Human Services, June 12, 2007, Fig. 3-1, 58, and Fig. 3-2, 59.
[16] See endnote 12, 32. These newly covered workers eventually would receive benefits but the value of their tax payments would exceed the value of their benefits over the next 75 years. This proposal has minimal effect on the deficit that arises thereafter. This proposal excludes existing employees because transitioning them out of their state or local program could adversely and unfairly penalize them under their program.
[17] Each taxpayer begins by adding his income reported on his tax return (his "adjusted gross income") + any tax-exempt interest + 50% of his Social Security benefits. For an individual taxpayer: If the sum of those amounts is less than $25,000, none of his Social Security benefits are taxable. For example, if his reported income is $20,000, he has no tax-exempt interest, and his Social Security benefits are $8,000, the sum would be $24,000 $20,000 plus half of the $8,000 of Social Security benefits). For sums between $25,000 and $34,000, up to 50% of his Social Security benefits may be taxable; and for any amounts over $34,000, up to 85% of his Social Security benefits may be taxable. For joint filers, if the sum of those amounts is less than $32,000, none of their Social Security benefits are taxable. Between $32,000 and $44,000, up to 50% of their Social Security benefits may be taxable; and for any amounts over $44,000, up to 85% may be taxable.
[18] See endnote 12, 31. The Advisory Board indicated that this reform would address 17% of the long-term deficit, but I have reduced the figure to about 15% because of my proposal to increase the income tax threshold of seniors to protect them from tax until they have sufficient income to pay for necessities.
[19] Ibid.., 93-96. With a $3.5 million exemption for each estate, a father and mother together could leave a total of $7 million, tax free, to their children, grandchildren, or others, after all deductions, including an unlimited charitable deduction. See also Robert Ball and Thomas N. Bethell, Straight Talk about Social Security. New York: Century Foundation Press, 1998.