Saturday, March 12, 2011

Eight Ways to Fix Social Security

In my previous post, I explained why Social Security needs to be fixed. I said that I would offer seven ways to accomplish this in today's post. I've actually done one better than that. Here are eight ways to fix Social Security.

Raise the retirement age.

When Social Security was first implemented, there were not many Americans who lived to age 65 (now 67). Today, due to advances in health care, more of us reach retirement age and live long past retirement age. This means that Social Security will pay benefits to more people for a longer period of time. Raising the retirement age would mean Americans would work longer, thus paying into the system for a longer period, and take benefits for a shorter period.

Index benefits to inflation instead of wages.

Social Security benefits increase each year based upon an index tied to wage increases. As wages rise, so do Social Security benefits. Over time, however, wages rise faster than the cost-of-living. Tying Social Security benefit increases to cost-of-living, rather than wages would, therefore, slow the growth of the program. For an excellent discussion of this proposal, watch this video from Paul Solmon on The Newshour.

Raise the limit on the amount that is taxed.

Social Security is funded through a payroll tax on workers and employers. There is, though, a cap (currently $106,800) on the wages that are taxed. You do not pay any tax on the amount you make above that amount. The cap was put in place to gain support for the program from upper-class voters. If there were no cap, wealthy workers would end up putting a lot more into Social Security than they would take out when they retire. One way to pay for Social Security deficits, therefore, would be to increase, or eliminate, the cap. Wealthier workers would pay more into the system and help pay for its deficits.

Means test benefits.

Social Security is not a welfare program. It is for everyone. This means that wealthy individuals can receive benefits along with our most needy seniors. One way to reduce the cost of the program is to add a means test. It would only be for those who most need it. The wealthy would get nothing, the middle class would get less, and most of the benefits would go to poor seniors.

One important consideration when looking at this solution, and the previous one, is that Social Security would become a welfare type program. Its main purpose would be to transfer wealth from the upper class to the lower class. Social Security already transfers some wealth from the most well off to the least well off. These two proposals would dramatically increase that tendency. While this would help balance its budget shortfalls, it may also reduce support for the program.

Increase immigration.

Due to the Baby Boom generation reaching retirement age, fewer workers are paying into Social Security for an increasing number of retirees. One way to deal with Social Security's budget shortfalls, therefore, would be to increase the number of young workers. Since most immigrants are young, and eager to work, increasing the number immigrants would accomplish this goal.

We have many restrictions on immigration in the US. Many of these restrictions are on high wage jobs, such as doctors and computer programmers, which pay more in FICA taxes than low skilled jobs. So, lifting these restrictions would be particularly beneficial.

Undocumented workers are also particularly good at helping us pay for Social Security because they pay into the system without taking out. But, for reasons I won't go into here, I would advise against policies aimed at increasing the number of undocumented workers.

Make more babies.

Another way to increase the number of young workers is procreation. Government policies aimed at encouraging citizens to make more babies have a poor track record, however. (For more, read this guest post by Brian Hollar.)

Personal accounts.

All of the above solutions deal with Social Security's fiscal problem—revenue increases are not keeping pace with the cost of the program. None of them, however, deal with the structural problem—it is a “pay-as-you-go” system. When Social Security was first passed, in 1935, Congress and President Roosevelt wanted a program that could go into effect right away. To do this, they created a program in which current workers would pay for current retirees.

When you pay into Social Security, that money is not saved for you until your retirement. Instead, you pay for those who are already retired, and when you retire, those that are working will be paying into the system to pay for your retirement benefits. This, however, is the root cause of Social Security's current deficits. We have made promises that we could not keep because we did not plan for a situation where we would have fewer workers paying into the system for an abundance of retirees.

One way to deal with this structural problem would be to wean ourselves off of a pay-as-you-go system for future generations. We could let young workers today put some of their FICA taxes into a personal account. In exchange, they would agree to reduced or no Social Security benefits when they retire.

One of the difficulties of this proposal, however, is that while it helps with the structural problem, it would make the fiscal problem worse in the short term, because, less revenue would be generated for current retirees. This solution, therefore, should not be attempted without first addressing the fiscal problem.


Eric said...

I really like what you've suggested, but unfortunately I think that our politicians do not have the backbone to actually do anything this difficult.

Napp Nazworth said...

Eric: I share your concern. Americans say they want Congress to reduce the deficit, but reject specific proposals to that. Plus, they're fairly ignorant about the composition of the federal budget.

Dan Carroll said...

Hi Napp. Here are comments on some of your points, along with a few of my own suggestions:

Raise the retirement age - good idea, but regressive; the poor are hit more.

Index to inflation - also a good idea, but which inflation rate? The elderly face a different consumption basket than the rest of us.

Means test benefits - don't agree. SS is currently a program that pays people not to work. This would pay people not to save.

Increase immigration - a good idea for more reasons that saving social security.

Make more babies - we may not be able to encourage more babies, but we can stop discouraging baby- making.

Personal accounts - while I generally argue for a forced savings program in lieu of transfer payments (for healthcare too), for reasons too complicated to discuss here, the macro economics of it suggests that PA's don't really solve the funding problem - just transfers it.

Napp Nazworth said...

Dan: Thanks for the feedback. I'm left wondering what your alternative would be, though. You don't like raising the retirement age b/c it's regressive (technically incorrect, but I understand what you're trying to say), yet you don't want to means test b/c it would pay people not to save. The Simpson/Bowles report recommended allowing earlier retirement for jobs that are difficult to do in old age, or contribute to shorter lifespans (such as coal mining). Many European nations do this already. Perhaps this would address your concern?

As I noted in the post, I agree that PAs would not address the fiscal problem, but would address the structural problem. I'm not sure why you say it would "transfer" the funding problem, though? If we eventually moved everyone into a PA system, the funding problem would disappear.

Napp Nazworth said...

Also, regarding changing the automatic benefit increases, it doesn't matter that much to me which you use. As a compromise, we could come up with an index that falls somewhere between inflation and wage growth, and it would still help pay for the increasing cost of the program.

With all these possible solutions, if you go with just one, you have to go extreme with just the one. It would be better to do just a little bit of each.

Dan Carroll said...

In my mind, a reform of social security could dovetail with a more general reform of the tax code. Such a reform would start with a negative income tax that would increase for old age and disability. A negative income tax could replace welfare, social security, and disability. As you start to work, you pay it back with taxes. It's fun to dream.

Studies have shown that individuals in high risk and/or physically intensive occupations are compensated with higher wages relative to their skill level. Thus, they should be able to get better private pensions.

The problem with private accounts is that the funding problem would be transferred to individuals. The expected returns would not be higher in aggregate because returns in aggregate are a function of liquidity, though the dispersion in returns would be much higher among individuals. One benefit, however, is that capital would be transferred from the public sector to the more productive private sector, though its not clear how well the government would react to that.

Dan Carroll said...

I'm not sure what happened to my second comment that answered your questions, but when I have time I'll repost.

Napp Nazworth said...

Dan: Another benefit of private accounts is that you can leave the money to your heirs. So, even though the poor may get less of the benefits because they die earlier, they would at least be able to leave some wealth for future generations which may help them avoid poverty.