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How Do We Save Social Security

January 07, 2014

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:

  • It is by definition fair because everyone is treated the same and no one receives special treatment.
  • It will restore balance to the ratio between working years and retirement years and recognize, at least in part, the increase in life expectancy.
  • It will preserve the disability benefits in Social Security because changing the retirement age will not affect disability payments.
  • It will provide an incentive for labor force participation among the elderly. Older workers can contribute not only to their own welfare but also to overall economic output.

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.

Michael Gombola is professor and head of the finance department at LeBow College of Business. He will reach early retirement age next year and full retirement age in 2017.

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