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SDec 2, 2011

Social Security Reforms: Like Putting Lipstick On a Duck

Scott Burns
Social Security Reforms: Like Putting Lipstick On a Duck

Only 25 years ago, Alan Greenspan declared that the reforms recommended by his National Commission on Social Security Reform had made Social Security secure for another 75 years.

He was wrong.

Social Security is in the hole again. The most recent Social Security Trustees report tells us that the current 12.4 percent payroll rate (employer and employee portions combined) would need to be increased by 2.1 percentage points to cover unfunded liabilities over the next 75 years. The tax would need to be increased by 3.6 percentage points to avoid a repeat of Greenspan’s error— a 75-year cure that goes bad in less than 25.

The 3.6 percentage point increase in tax rate that all workers would pay on the first $106,800 of income represents a 29 percent tax increase for every worker in America, a sure non-starter. Those in Washington, of either party, would prefer to disguise the tax increase.

The issue, however, is real. A recent report from the National Center for Policy Analysis in Dallas calls the needed increase a “solvency tax” since that is the amount the tax would have to increase to avoid benefit reductions now or in the future. The report examines the major proposals for changing Social Security to eliminate its revenue shortfall.

The first thing we learn in this report is that not having the employment tax rise by 3.6 percentage points does not mean taxes won’t rise. It just means our friends in Washington are searching for a mechanism that will allow them to reduce current benefit commitments. The slippery alternative is to reduce benefits for some people, at some time. Instead of everyone paying higher taxes, some workers will get less for their tax dollars than they are currently promised. Think of it this way: they are trying to figure out the best way to put lipstick on a duck.

The question is, who will bear the burden?

That’s where the NCPA study is instructive. Researchers Liqun Liu and Andrew J. Rettenmaier, both at Texas A&M, examine each of the four major proposals for change:

  • Eliminating the taxable maximum income,
  • Raising the retirement age,
  • Progressive price indexing and
  • Changing the benefit formula.

The report then shows who will lose on each proposal. Here’s how it works out.

The most popular option with voters is to eliminate the wagebase maximum because 94 percent of all workers earn less than the wage base maximum. Take this step (and raise the overall employment tax by 1.3 percentage points) and the program will immediately be solvent. Indeed, revenues would immediately exceed benefit payments for another decade, just as they did from 1984 until recently. Can we trust Congress with the extra cash? Ho-ho-ho.

Raising the retirement age is a nice idea for its simplicity. It also requires a 1.3 percentage point increase in the employment tax. The researchers note that it would be the least progressive option because workers with high incomes tend to live 20 percent longer than average while workers with low incomes tend to live 7 percent shorter than average.

Progressive Price Indexing, a tool that would affect how retirement benefits are increased, would require only a small 0.6 percent solvency tax. It would also be the most progressive in terms of benefit distributions, giving more to lower income workers and less to higher income workers. It would also increase the lifetime tax rate for younger workers because their benefits would be reduced the most. It is a subtle and slow-acting tax on the young.

Changing the Benefit Formula. Changing the existing benefit formula would also result in workers receiving less in future benefits. This method would reduce future benefits the most, but it would require no additional solvency tax. Like progressive price indexing, it would shift the burden to the young, having them pay the same taxes to receive smaller benefits. A single medium income male worker born in 1945, the report estimates, would lose $39,061 in lifetime benefits relative to current law. But the same worker born in 1985 would lose $179,947 in benefits, nearly $140,000 more in dollars of constant purchasing power.

That’s quite a difference.

What can we do about it? Well, it depends on how old you are. If you are young, you need to protect yourself from the weasels in Washington. They will do their best to shaft you before they increase current taxes. If you are older, this is a good time to start thinking about sharing a burden that will otherwise be carried almost entirely by the young.

Filed Under: Government, Taxes & Other Disasters, Social Security