Fall/Winter 2011
Editor’s Note:
Social Security was created by the Federal Insurance Contributors Act — the FICA deduction in your paycheck. Currently, the federal government taxes workers and their employers at a rate of 12.4 percent on the first $106,800 of wage income. Social Security is now the single largest federal program, consuming 20 percent of the budget.
As the name implies, Social Security was set up as an insurance program for the disabled and elderly. The federal government, however, has used some of this money over the past 70 years to pay other bills and issued IOUs to the Social Security Trust Fund.
That trust fund faces tremendous deficits as more and more baby boomers stop paying the tax and start receiving benefits. Unless we...
Social Security has been able to generate a pay-as-you-go cash flow surplus until recently but faces huge deficits after 2030. Since the problem faced by Social Security is in the future, the solution must focus there as well. Lifting the cap on earnings subject to FICA taxes is an inadequate fix.
For example, Social Security’s chief actuary found that a proposal by Sen. Bernie Sanders (I-Vt.) to begin immediately taxing all earnings above $250,000 would keep the fund solvent to at least until 2090, but only as long as the government starts repaying its IOUs beginning in 2030. In addition, an aging population with fewer taxpayers supporting greater numbers of beneficiaries will require an increase in the tax rate well above the current 12.4 percent.
Consider possible behavior by government: Is the government most likely to: a) stop using money from the trust fund for other purposes; b) repay the money it already owes to the trust fund; c) raise taxes; d) none of the above.
Based on past behavior, “none of the above” is the correct answer, which is why the best solution is to reduce payments to future retirees, and to do so by raising the retirement age.
In 1940, when Social Security started paying benefits, workers reaching 65 had a remaining life expectancy of 12.7 years for men and 14.7 years for women. By 2010, life expectancy at 65 had risen to 22.5 years for men and 24.7 for women. By 2030, life expectancy will rise further. It is not a stretch to say that 70 will become the new 67, if it hasn’t already.
In 1983, the retirement age was raised from its original 65 years to the current 67 years. That change, combined with an adjustment in the benefits formula, made Social Security solvent for decades. Today, moving the retirement age to 70 has four merits:
Furthermore, cutting benefits is preferable to removing the cap on income subject to the FICA tax, because raising the income cap would only strengthen Social Security’s use as a device to redistribute wealth instead of an insurance program.
Social Security was named and originally described to Americans as an insurance program, and many Americans still regard it as one. But unlike other insurance programs, where benefits rise linearly with contributions, Social Security redistributes wealth in two ways: benefits are proportionately greater for recipients who have earned less and contributed less to the system; and benefits are subject to income tax. Social Security as a progressive insurance program is one thing; Social Security as a means of large-scale wealth redistribution is something else entirely.
The solution to saving Social Security is simple: cut spending, raise revenue or both. The details are the difficult part. Noneof the approaches is politically palatable and all have negative economic consequences. However, a phased elimination of the $106,800 cap on annual income subject to FICA taxes will provide firmer financial footing for Social Security and the U.S. structural debt than reductions in benefits. Here’s why:
Raising the cap is not simply soaking the rich. Far from it. If you pay into the system, no matter your income, you are entitled to benefits.
An infrequently mentioned part of the original bargain struck in 1938 is that we are all paying for the retirement income received by the generation that fought in two World Wars and survived the Great Depression, a.k.a. the “Greatest Generation,” whose sacrifices contributed to the peace and prosperity we enjoy today. Therefore raising or eliminating the cap altogether is asking those who are benefitting most from the oldest generation’s labors to pay a larger share of that original cost.
Admittedly, our lackluster economy could be slowed even further by a tax hike, so here’s what we do: Remove the cap on taxable income but initially exempt from the tax all income between $106,800 and $350,000; commit to gradually shrinking the exemption over the next 8 to 10 years; then move forward with no cap at all.
By removing the cap the Social Security trust fund will remain in the black until 2083, even with the longer expected lifetimes of the baby boomers and including the increased benefits for those who pay more into the system. If we remove the income cap but maintain the current benefit structure, i.e. no increase in benefits for those earning more than $106,800, the system is actuarially sound beyond the 75-year forecast range of the Congressional Budget Office.
Illustrations by Jack Unruh
