Blame Democrats and Republicans for disastrous Social Security fund

Blame Democrats and Republicans for disastrous Social Security fund
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Before 2010, Social Security ran annual surpluses of payroll taxes over benefit checks. But the surplus cash was spent by both Democratic and Republican administrations, which in exchange issued Treasury bonds to the Social Security trust fund. Since 2010, the payroll taxes to Social Security have fallen short of the benefit checks. This shortfall has been met by interest income from the Treasury bonds held by the trust fund.

Last week, however, the Social Security trustees reported that its shortfall will be $1.7 billion this year, including interest income from its Treasury bonds. The trustees will have to start selling Treasury bonds. These sales signal the beginning of the end. The trust fund will be forced to liquidate nearly $3 trillion in Treasury bonds by 2034. Absent legislative reforms before then, Social Security will become “insolvent” and benefit payments will be automatically cut by an estimated 23 percent.

I and other commentators have urged Congress to avoid such drastic benefit cuts by adopting a reform package with a mixture of measures. To avoid all benefit cuts, the package would have to save $13.2 trillion compared to the cost of the existing Social Security program over the next 75 years, according to the actuaries of the program.

Yet, both political parties are advocating proposals with little chance of being enacted soon. Despite the imminent insolvency of Social Security, Democrats are pushing for a 2 percent increase in monthly benefits for all retirees and a new minimum benefit for low earners.

This proposal is financed in part by immediately applying the 12.4 percent payroll tax to specified earnings, perhaps over $200,000 to $400,000, above the current annual maximum of $128,400 now subject to this tax. This proposal would also gradually raise the Social Security payroll tax from 12.4 percent to 14.8 percent for all employers and employees. Such steep tax increases are obviously nonstarters for Republicans.

Instead, Republicans are pushing for a gradual rise in the normal retirement age, which is slated to stay at 67 after 2027. While this proposal is based on the longer life expectancy of Americans, it is strongly opposed by many liberal Democrats. They emphasize that elderly Americans may not be able to get work after 67, and they may not be capable of holding physically demanding jobs like construction.

Republicans also are pushing for a reduction in Social Security benefits as initially set at retirement rather than after retirement. Now, these initial benefits are based on an employee’s average annual earnings, increased over his or her career by an index that typically rises 1 percent a year faster than the consumer price index. However, Democrats point out that the lower third of earners, who rarely have any other retirement plans, can hardly survive on their current level of Social Security benefits.

Of course, both parties could agree to a compromise package of reforms. The following are three potential components of such a package. First, apply a 2 percent surcharge on all earnings above the maximum earnings subject to the payroll tax without raising benefits. This would augment revenues for Social Security, at a much lower rate than 12.4 percent, spread over a much broader group of high earners.

Second, move normal retirement age to 68 around 2040 and index to increases in life expectancy thereafter. Continue to allow early retirement at age 62 for all workers, and keep normal retirement age at 67 for those in physically demanding work. Third, in calculating initial benefits at retirement, phase in a formula based on consumer price index growth over a worker’s career for the top third of earners, who have other retirement plans subsidized by taxes and corporations. Retain the existing more generous formula for other retiring workers.

Unfortunately, given the intense hostility between the parties, they are not likely to agree on a compromise package of reforms before Social Security is on the brink of insolvency. Since these reforms are “hot potatoes,” they will be put off by today’s politicians who do not want to risk their careers by solving problems far into the future.

But gradual and sensible reforms will not be feasible in 2034. To meet the needs of retirees and other Americans close to retirement, Congress will likely pass large enough appropriations to avoid any reduction in Social Security benefits. In turn, the Treasury Department will have to regularly issue more bonds and significantly raise the national debt by more than $300 billion each year in today's dollars.

Although we know how to prevent a Social Security crisis, Congress is not likely to adopt reforms much in advance of 2034. From then on, the United States will need a large amount of debt capacity to address this crisis, so this is yet another reason to try to keep our national debt from exceeding 100 percent of our economy over the next decade.

Robert Pozen is a senior lecturer at the MIT Sloan School of Management and a nonresident senior fellow at the Brookings Institution.