– April 8, 2016

Since its enactment in 1935, Social Security has become an important feature of the retirement landscape for all Americans. But its finances are in need of repair, and we can’t simply ignore the problem.

Since 2010, the taxes paid into the Social Security system have been falling short of the benefits paid out. The Social Security system is consuming the surplus that was accumulated in earlier years and, as estimated by the Social Security Trustees, this surplus is expected to run out in 2034, at which point it will become impossible to pay the benefits at the level currently promised.

The problem is a demographic one. In 1960, there were 5.1 workers for every Social Security beneficiary. This meant that there was plenty of money coming into the system to support the claimants, even with Social Security tax rates much below today’s level. By 1990, that ratio had fallen to 3.4 workers for every beneficiary — still sustainable. By 2010, there were only 2.9 workers for every beneficiary, and the program started running a deficit. The problem is worsening, and by 2030 we are expected to have only about 2.2 workers per beneficiary.

Because Social Security is an important part of the financial life of nearly everyone in the United States, reforming it is a complex and often emotional topic. At the end of the day, there are only two ways to fix the problem: increase revenues or reduce the outlays in some fashion. Any reform will adversely affect some groups while helping others. Nevertheless, some reform is needed in the next few years, or Social Security will start imposing a significant burden on the federal budget.

There are many reform proposals out there, and it would be impossible to discuss them all in detail here. We discuss some of the major proposals in AIER’s Research Brief “Reforming Social Security.” Every option for reform has opposition, but it still should be possible to create a package of reforms that would fix the finances of Social Security. The advantage of the package approach is that the burden of adjustment is spread among all societal groups, so that no one is seen as clearly benefitting at the expense of others.

One example of a possible package of reforms:

  • Raise the cap on taxable earnings (closes about 30 percent of the program’s financial gap).
  • Gradually raise the retirement age (closes about 25 percent of the gap).
  • Change the indexation of benefits to the chained Consumer Price Index, which would reduce the annual cost-of-living adjustment (closes 10 percent of the gap).
  • Raise payroll taxes to cover the rest (the increase would be about 1 percent, split between employer and employee).

In this example, all major groups in society face some costs. Those who are working and are far from retirement age would face decades of higher payroll taxes, and the taxes would be much higher for high earners, because the taxable cap is raised.

Those who are close to retirement would not pay the higher payroll taxes for much longer, but they would have to accept a higher retirement age. And current Social Security beneficiaries would see lower cost-of-living adjustments in the future.

Sooner or later, lawmakers are going to need to confront this difficult question, and every year of delay makes it a more difficult choice. When the burden of reform is spread among all major stakeholders, the chances of such a reform being adopted increase. And if the reform is composed of several changes, each change can be made less drastic, making it possible for people affected by it to adjust more easily.

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Polina Vlasenko, PhD

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