Social Security’s Unsustainability

Social Security, Disability Insurance and Hospital Insurance are unsustainable. This chart shows how these programs will go bankrupt in future years.

These are the same programs the Democrats claim ‘do not have a problem’ and therefore refuse to even talk about reform. Their simple solution is to raise taxes.

(The following quotes come from this article by Michael Tanner)

Eliminating the cap would give the United States the highest marginal tax rates in the world, higher even than countries like Sweden. Studies suggest that it would cost the United States as much as $136 billion in lost economic growth over the next 10 years, and as many as 1.1 million lost jobs. And, it is important to note that the Patient Protection and Affordable Care Act (PPACA) already raised payroll taxes on families earning more than $250,000 per year by 0.9 percent.

Eliminating the cap could also lead to the perverse result of actually providing a huge increase in benefits to the wealthiest retirees. That is because the benefit formula is partially based on the level of wages taxed. We could end up sending Bill Gates or Warren Buffet Social security checks for thousands of dollars each month.

Yet even this enormous tax increase would do relatively little to increase Social Security’s long-term cash flow solvency. A 2010 CBO report found that eliminating the cap completely while also changing the benefit formula so as not to provide any additional benefits would only extend the date at which Social Security begins to run a cash-flow shortfall to approximately 2030.

Raising taxes simply takes more money out of the private economy reducing jobs and economic growth while doing very little to actually sustain the program.  We need another solution!

Another approach is to cut benefits.

Cutting Social Security benefits, however, would have a positive impact on both the system’s finances and the government’s general balance sheet. Of course, there are many different ways to reduce future Social Security payments with very different impacts on recipients. The bipartisan Commission on Fiscal Responsibility and Reform, for instance, has recommended a broad array of benefit changes, including raising the retirement age to 69 by 2075, with the early retirement age rising to 64 over the same period, reforming the formula for annual cost of living adjustments (COLA’s), and trimming benefits for high-income recipients.

A better approach would be to change the formula used to calculate the accrual of benefits so that they are indexed to price inflation rather than national wage growth. Since wages tend to grow at a rate roughly one-percentage point faster than prices, such a change would hold future Social Security benefits constant in real terms, but eliminate the benefit escalation that is built into the current formula. Estimates suggest that making this change alone would result in a 35 percent reduction in Social Security’s currently scheduled level of benefits, bringing the system into balance by 2050. Variations on this approach would apply the formula change only to higher income seniors, preserving the current wage-indexed formula for low-income seniors.

Other benefit reductions that have been discussed at one time or another include: increasing the number of years included in income averaging as part of the benefit formula from 35 to 38 years, restructuring spousal benefits, and various means/asset-testing schemes. But, Social Security taxes are already so high, relative to benefits, that Social Security has quite simply become a bad deal for younger workers, providing a low, below-market rate-of-return.

Neither raising taxes or cutting benefits is appealing.  (Note:  If nothing is done benefits will be cut, by law.)

So what approach offers an advantage?  Allowing personal savings accounts is an approach adopted by Chile and demonstrated to work!  (The problem is that costs actually rise during the transition.)

It makes sense, therefore, to combine any reduction in government-provided benefits with an option for younger workers to save and invest a portion of their Social Security taxes through individual accounts. A proposal by scholars from the Cato Institute that combines the wage-price indexing proposal described above with personal accounts equal to 6.2 percent of wages, was scored by actuaries with the Social Security Administration in 2005 as reducing Social Security’s unfunded liabilities by $6.3 trillion, roughly half the system’s predicted shortfall at that time. If the Cato plan had been adopted in 2005, the system would have begun running surpluses by 2046. Indeed, by the end of the 75-year actuarial window, the system would have been running surpluses in excess of $1.8 trillion. At the same time, SSA actuaries concluded that average-wage workers who were age 45 or younger could expect higher benefits under the Cato proposal than Social Security would otherwise be able to pay. While there is no more current scoring available, there is no reason to presume that savings or benefits would be substantially different today.

Personal accounts would also solve some of the other problems with the current Social Security system. Under the current system, workers have no ownership of their benefits; they are left totally dependent on the good will of 535 politicians to determine what they will receive in retirement. Moreover, benefits are not inheritable, and the program is a barrier to wealth accumulation. Finally, the current program unfairly penalizes African Americans, working women, and others. In short, it is a program crying out for reform. By giving workers ownership and control over a portion of their retirement funds, personal accounts are the only reform measure that deals with those issues.

Of course opponents of personal accounts have pointed to the recent struggles of the stock market to suggest that they are too risky to be relied on for retirement. The reality, however, is that despite recent volatility in the market, long-term investment represents a remarkably safe retirement strategy.

The failure of President Bush’s disastrous campaign for personal accounts is widely believed to have taken the idea off the table for the foreseeable future. None of the recent deficit commissions included personal accounts in their recommendations. However Rep. Paul Ryan (R-WI) included a proposal for personal accounts in his Roadmap for America’s Future, although this proposal did not make it into later iterations of the Ryan budget plans. This proposal would allow workers under age 55 the option of privately investing slightly more than one third of their Social Security taxes through personal retirement accounts. The Congressional Budget Office estimates that Ryan’s proposal would gradually reduce Social Security’s budget shortfall and, ultimately, restore the program to cash-flow solvency by 2083.

It seems pretty obvious that we should avoid raising payroll taxes to make S.S. sustainable.  Merely cutting benefits by adjusting the COLA calculation or applying a ‘means test’ will make S.S. a ‘bad deal’ for younger workers so that the payout is actually less than they could have expected from normal investment.

To provide a ‘safety net’ and potentially better returns and thus more income in retirement we should combine ‘means testing’ with a partial allocation of payroll taxes to ‘personal savings’ accounts.  The portion allocated to ‘personal savings accounts’ are ‘inheritable’ and any unused portion can be passed on to the person’s descendents just as any other personal savings would be.  By limiting the portion allocated to ‘personal savings’ to approximately 1/3 of the total S.S. tax there is still a ‘safety net’ of funds that is protected from the volatility of the stock market.

Chile has adopted this program and proven that it works and provides better benefits than their older program which was essentially what we have today.  Here is an earlier post on the Chile program.

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