When I type the phrase “social security crisis” into a Google search bar I get 654,000,000 results in 0.5 seconds. It seems safe to say that the impending shortfall (if nothing is changed) in the Social Security system is clearly a hot topic. As it is motivated to do, the financial press amplifies the tension by writing about the “coming crisis” as often as possible. Each year the Social Security trustees release an annual report on the program’s financial status at the end of March. The latest report showed that the system is fully funded even without any changes until about 2035. This annual report is routinely followed by a plethora of headlines about the fund’s impending “bankruptcy”. These headlines are highly misleading, or deliberate scare tactics to generate clicks or to sell services. This is not to say that there is not a problem – only that the word “crisis” is completely out of control. Perhaps a bit of history can be useful here.
A bit of context
From 1935 to 1983 the Social Security system was a “pay as you go” arrangement. This just means that funds paid in, were paid out in fairly short order. There was no trust fund to empty, because there was no trust fund at all. This was in keeping with the original idea that SOCIAL SECURITY was not a “savings plan”, even though it may feel that way. It was a wealth transfer. That’s why its call a “TAX” and not an “investment”. Much of the anger about Social Security stems from the fact that many (and perhaps most) people think of it as a savings or investment account. That is why we hear statements like, “I paid into the system for 30 years, and I want my money back after I retire.” This generates a deeply emotional response to the idea that the system will be “bankrupt.”
The trust fund was designed to be emptied by about 2035 and is behaving exactly as planned. Let me explain. Administrators during the Reagan years saw that there was going to be a glut of retirees when the Baby-boomers reached retirement age, and that the “pay as you go” approach would not work for that group. More specifically, what they saw was that around 2006 boomers would start retiring en-masse and this elevated demand for payments would continue to about 2035. Thus, some padding was needed to get through this period.
In order to address the issue the Reagon Administration roughly doubled the Social Security tax rate. You read that right. The man most famous for stating that government was too big, and that the size of the government was the real problem, doubled the size of the program because common sense demanded it. The Social Security administration took the excess funds raised and placed them into the Social Security trust fund. The projections were that this fund would reach its maximum value around 2006 and would be exhausted by about 2035 when the surge of boomer-retirees would end. The fact that this is happening is not a crisis. This is not theft. This is not some unplanned mess. This was a deliberate, well thought out approach to a problem that anyone able to count saw coming a mile away.
This trust fund reached a maximum of almost 3 Trillion dollars and is now being spent to cover the gap between inflows and outflows until 2035. This doesn’t mean that there is no problem. It just means that the political name calling about how the other party is bankrupting Social Security or that there is no way to fix the problem that the other side made is the usual political noise meant to terrify and inspire burning down the system.
Solutions are Real – Just not Easy
So how do we fix this? There are at least three major ideas to address the projected shortfall that are pretty easy to understand, and intuition suggests that some combination of these 3 will eventually be approved – but not before both sides blame the other for a few more years for “declaring war on the middle class.” The three ideas (in a nutshell) are: 1) Increase or remove the cap on taxed earnings, 2) increase the retirement age to reduce benefits, and 3) don’t make payments to those that don’t need it.
Currently, Social Security taxes are only paid on the first 160K (roughly) of income. If this cap were simply removed, the system would be flush with cash for the foreseeable future. However, high earners would have to pay more money, which is why they don’t like the idea. As it stands now, if you make 160K, you pay 6% of your income for this tax – or about 9.6K. On the other hand, if you make 160 Million. You pay – wait for it – 9.6K. That’s right Bill Gates, Warren Buffet, etc. pay the same amount of Social Security taxes that the worker making 160K does. That 6% for the guy making 160K becomes about 0.006% for the billionaire. That’s pretty regressive – meaning that lower wage earners pay a much higher percentage of their wage for this tax.
Approach 2: Raise the retirement age. Roughly 20% of Social Security funds are paid to retirees between the ages of 62 and 65. If the lower bound is raised to 65 the problem is resolved. This will be hugely unpopular for several reasons. First, it will be seen as breaking an old promise. Second, it’s a pretty bad deal for many people in physically demanding jobs whose body starts to break down with age. Third, it flies in the face of many private, local, and state plans that allow workers to retire with full benefits after 30 years of service. Many people starting work after high school or college get a full pension by the age of 58 or 62, so raising the minimum age to 65 will be seen as a very raw deal.
Approach 3: Benefits can be “Means tested.” This means that those with high incomes from other sources, including investment income, would receive reduced payments. This will be very difficult to implement politically for the simple reason that rich people won’t like it. And for some reason, if the rich don’t like it, it has a funny way of not happening.
At the end of the day, some mix of these approaches will have to be accepted to solve the problem. Intuition suggests that the cap on the amount taxed will rise some, the tax rates will rise a little, and some clever scheme will be introduced that has the effect of reducing benefits for higher income earners. Painful – yes! A political mess – definitely! A crisis – I think not.