Social Security: Small Fixes, Big Impact...If We Deal with Problems Now

Social Security: Small Fixes, Big Impact...If We Deal with Problems Now

Iva Hruzkova/The Fiscal Times

The trustees of the Social Security system delivered their annual report for 2010 on August 5. Since the story it tells doesn’t change much from year to year, the report doesn’t tend to get a lot of attention from the media.

But for anyone interested in really understanding the magnitude of our nation’s fiscal problem – and why it makes sense to address Social Security’s problems sooner rather than later -- the trustees report is an essential data resource.

Starting with the basics, we see that in 2009 there were 53 million people receiving Social Security benefits: 36 million retirees, 10 million disabled workers and 6 million survivors of deceased workers. About 156 million people paid Social Security taxes during the course of the year and $686 billion in benefits were paid out.

These numbers are important to keep in mind as one thinks about making any changes to the program, either on the tax side or the benefit side. They make clear that many, many people will be affected. If nothing else, this assures that whatever is done to Social Security will be politically contentious.

It’s also important to understand that the great strength of the Social Security system has always been its egalitarianism and universality—everyone pays the same tax rate up to a maximum wage level and everyone who pays into the system gets a benefit regardless of how rich they may be.

Franklin D. Roosevelt and the others who founded Social Security were very, very insistent that it was an earned benefit, not welfare, and that everyone needed to be treated as equally as possible. Politically, that principle has protected Social Security from conservatives who would abolish it if they could, and also from liberals that would like Social Security to do more to redistribute income.

Liberals have always hated Social Security’s flat tax rate and wage cap that exempts the vast bulk of income of the wealthy. They would have much preferred that Social Security were financed out of general revenues in the first place or at least by progressive tax rates that took much more out of the pockets of the wealthy.

Because Social Security taxes only wage income and exempts all income from capital, it is essentially a flat rate consumption tax—the ideal tax from a conservative viewpoint. Yet, surprisingly, conservatives have always been quick to endorse gimmicky ideas for cutting the Social Security tax whenever the opportunity presents itself. They don’t realize that any alternative to the current tax is likely to be much worse from a conservative point of view.

Social Security would be transformed from a
pension program into a welfare program. And as we know,
welfare programs are very vulnerable, politically.

Historically, Social Security’s defenders have kept the liberals at bay by patiently explaining to them that the system as a whole is progressive—those with low lifetime incomes get back relatively more in benefits compared to the taxes they paid than those with high incomes. And any increase in taxes on the wealthy without a corresponding increase in their benefits would essentially eliminate any meaningful linkage between taxes paid and benefits received.

In short, Social Security would be transformed from a pension program into a welfare program. And as we know, welfare programs are very vulnerable, politically. In 1996, a Democratic president signed into law effective abolition of welfare at the federal level.

Unfortunately, Social Security cannot be left on auto-pilot. Although its financial problems are trivial compared to those of Medicare, it would be good to fix Social Security well in advance of any action-forcing event. This year, Social Security’s costs will exceed its income from taxation. In coming years, general revenues will effectively cover the difference between Social Security tax revenues and benefits paid.

The importance of general revenues to the maintenance of Social Security benefits is disguised by the Social Security trust fund, which is really nothing but an accounting device. On paper, it holds assets that earn income. But all of those assets consist of Treasury bonds and the income consists of interest that is paid out of general revenues.

In effect, the trust fund and its earnings simply represent budget authority permitting general revenues to cover the difference between Social Security tax revenues and benefits paid. Therefore, the trust fund and any earnings are completely irrelevant to Social Security’s finances except in a very narrow legal sense. If the trust fund were ever actually exhausted, it would take less than a day for Congress to change the law to permit explicit general revenue financing of Social Security.

What really matters is how much revenue comes in from the Social Security tax compared to benefits paid. According to the trustees’ report, the growing imbalance between these two rates is the basic problem that must be dealt with. Although the tax rate is fixed, the cost rate is rising from 13.09 percent of taxable payroll this year to 16.73 percent in 2035. In essence, the payroll tax rate would have to rise by almost four percentage points over the next 25 years to keep Social Security’s finances stable.

If the shortfall in Social Security taxes relative
to benefits were financed entirely out of general revenues,
then income taxes would have to rise by 13 percent.

It may be a little simpler to understand if one thinks of Social Security’s finances in terms of the economy as a whole. According to the report, Social Security benefits will rise from 4.8 percent of the gross domestic product this year to 6.1 percent in 2035, an increase of 1.3 percent of GDP.

Over the long-term, individual income taxes are expected to be about 10 percent of GDP, according to the Congressional Budget Office. If the shortfall in Social Security taxes relative to benefits were financed entirely out of general revenues and income tax rates were raised as a consequence, then they would have to rise by 13 percent.

Naturally, conservatives are keen to use Social Security’s financial problems as an excuse to cut benefits and transform the program into one in which one’s benefits depend largely, if not entirely, on one’s own contributions. They would like Social Security to be like an Individual Retirement Account rather than a traditional defined-benefit pension plan.

The problem conservatives have is that George W. Bush’s ill-conceived effort to privatize Social Security had nonexistent political support and the crash of the stock market—which conservatives would have everyone depend upon for all their retirement income—over the last two years would certainly make private accounts in lieu of general benefits a much harder sell.

Liberals would like to raise the cap on wages subject to tax and extend the tax to non-wage income—in other words, make the Social Security tax much more progressive. They would also like to means-test benefits—no more benefits for the Warren Buffetts of the world. The problem with this approach is that Social Security would be converted into a welfare program that would inevitably become politically vulnerable.

Neither side is going to get what it wants and each is staking out an extreme position so that the inevitable deal will be tilted as much as possible in their direction. The only option being discussed by both sides that seems to have potential is raising the normal retirement age from 67 to perhaps 70. But unless the early retirement age of 62 is also raised, the financial benefits of raising the normal retirement age are not as great as people think, as Henry Aaron explained in The Fiscal Times recently.

Since Social Security’s problems are not nearly as large or pressing as Medicare’s—the subject of another column—a package of small fixes would be sufficient to put its finances on track for the foreseeable future. (For a good list of potential options, see this July report from the Congressional Budget Office.) Yet, oddly, people seem to be more pessimistic about the future of Social Security than they are about Medicare. A July 20 poll from Gallup found that six in ten workers today expect to receive nothing whatsoever from Social Security when they retire.

Such pessimism is totally unjustified and very disturbing. It’s a good reason to do something to fix Social Security soon. However, it is such a political football—long known as the third rail of American politics—that it is hard to see either Republicans or Democrats taking the first step. I fear that the program’s problems may just fester for many years, past the point where small fixes are enough to deal with its problems. That means that major surgery will be required when the time comes that something absolutely has to be done. When that day comes, it’s going to be ugly.