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April 14, 2014

Some reasonable Social Security reforms

April 14, 2014

Under current law, Social Security’s trust fund will run dry by the late 2030s. This doesn’t make Social Security a Ponzi scheme, and it doesn’t mean young workers will get no (or even dramatically reduced) benefits. But it does mean that we face a long-run shortfall.

Aside from dramatically restructuring the whole system, there are only two options, mathematically, to cover it: higher taxes or lower benefits.

The current default policy is across-the-board benefit cuts: sometime before 2040, the trust fund will be gone and monthly receipts simply won’t cover scheduled payments.

But making policy by default is rarely a good idea, and my colleagues have proposed and thoroughly analyzed many options for reforming the current system. Although each idea necessarily involves either lower benefits or higher taxes (or both), the three I outline below seem pretty reasonable, especially in combination.

I say reasonable because each would either bring us closer to policy similar to what we’ve agreed upon in the past or would address major demographic changes in our population. They’re reasonable, too, because one way or another we’ll pay for the shortfall; the choice is only whether we’ll do it with a thoughtful plan.

Here we go—it’s about to get wonky.

Increase the Social Security tax cap. Social Security taxes are capped: you pay taxes on all income you make up to $117,000 this year; any income above that cap is not subject to the tax.

In the early 1980s, the cap covered about 90 percent of all wages in the economy. Since then, rapid income growth at the top of the distribution means that the cap now covers only about 84 percent of all wages. If the share had remained constant, 2014’s cap would be almost $230,000.

Eliminating the cap altogether could reduce the long-term deficit between 70 and 86 percent, depending on whether high-income earners also received higher benefits in return for paying more tax. Raising the cap to cover 90 percent of wages again could lower the deficit by 28 percent, even if high earners receive higher benefits.

The tradeoff is that the higher taxes might discourage higher-income people from working, which would itself cost the system some solvency.

Increase the Social Security tax. Social Security payroll taxes increased steadily between 1955 and 1990. But for nearly 25 years, they’ve remained constant at 12.4 percent, split by law between employers and workers.

Raising the rate by just 2.7 percentage points would add 50 years of solvency to the system and reduce the need to lower benefits in the future. (That tax increase would be split between employers and workers, though employers would likely pass some or all of their burden on to their employees through lower wages.)

A drawback, again, is that higher taxes (or lower wages) may discourage work. It might also increase the regressivity of the tax. And it could reduce minimum-wage employment if employers hire less in the face of higher labor costs.

Increase the retirement age. Current law increases the full Social Security retirement age gradually from 65 to 67 for those born between 1938 and 1960. But it remains 67 for everyone born after 1960, despite a half century of health and longevity gains coupled with decreasing shares of physically intensive employment.

Compared with workers born in 1937, today’s workers can expect to spend seven or eight full years more in retirement, on average. Gradually increasing the retirement age from 67 to 69 by birth cohort and then indexing it to life expectancy gains would reduce the long-term deficit by 44 percent.

A huge drawback is that life expectancy gains and reductions in physically demanding work have not benefited all workers evenly. Many may simply be unable to work longer in their industry, or may not live long enough to benefit from a later retirement age.

So what? There are tradeoffs to all of those ideas, making meaningful reform politically difficult. But there is a huge tradeoff to doing nothing, too. If we thoughtfully plan how to cover the inevitable shortfall with a combination of the ideas above (and potentially others), we can also build in ways to mitigate potential harms along the way.

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Illustration by Tim Meko, Urban Institute

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