Social Security Under the Gun: What Every Citizen Needs to Know
176
Social Security Under the Gun: What Every Citizen Needs to Know
176Paperback(First Edition)
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Overview
Product Details
| ISBN-13: | 9781403971753 |
|---|---|
| Publisher: | St. Martin's Publishing Group |
| Publication date: | 02/07/2006 |
| Edition description: | First Edition |
| Pages: | 176 |
| Product dimensions: | 5.50(w) x 8.50(h) x 0.39(d) |
About the Author
Read an Excerpt
Social Security Under the Gun
What Every Informed Citizen Needs to Know About Pension Reform
By Arthur Benavie
St. Martin's Press
Copyright © 2003 Arthur BenavieAll rights reserved.
ISBN: 978-1-4039-7175-3
CHAPTER 1
Fixing Social Security
Social Security faces two major problems: a shortage of revenue over the long run and the public's perception that the rate of return on payroll taxes is too low. Many politicians, columnists, and scholars assume that the only way to solve these problems is to fundamentally restructure the program by diverting a portion of the payroll tax into personal retirement accounts and giving workers the option of investing these funds in the stock market. This reasoning has become widely accepted during the last several years. As Representative E. Clay Shaw Jr. (RFL), chair of the House Ways and Means Social Security Subcommittee, put it: "The question is, should you have individual accounts in addition to the existing system. You have to. There is no other way to save Social Security for our children and grandchildren."
President George W. Bush also wants privatization: "We must save Social Security. ... In my address to Congress, I described the principles that must guide any reform. ... Social Security reform must offer personal savings accounts to younger workers who want them."
To me this logic seems flawed — almost as irrational as saying that because your house needs a new roof you have to buy another house. The problems facing Social Security do not require that it be fundamentally reformed by diverting payroll taxes into the stock market. Perhaps we can do better by tuning Social Security up rather than trading it in.
In this chapter, I discuss ways of solving Social Security's problems without altering its basic structure.
REMEDIES FOR THE LONG-RUN DEFICIT
According to official projections, Social Security needs additional revenue over the next several decades in order to pay benefits that have been promised. How serious is this problem? The Social Security trustees don't seem alarmed. They said in their 1999 report that the problem "can be solved by small gradual changes." The Advisory Council agreed, saying that the long run deficit can be taken care of "without much difficulty by making several relatively minor changes." Moreover, the projections for Social Security have improved each year since 1997. In that year, the Social Security Trustees estimated that the trust fund would be depleted in 2029, while in 2004 their projected depletion date was 2042.
How can we eliminate this shortfall without fundamentally restructuring Social Security? A variety of proposals to raise revenue or cut benefits have been offered by analysts and politicians. The ideas currently being debated include
•? making Social Security universal
•? altering the benefit formula
•? raising the payroll tax cap
•? raising the tax on benefits
•? cutting the COLA (the cost-of-living adjustment)
•? lengthening the period for averaging wages
•? increasing the normal retirement age
•? means-testing
In addition, we could simply raise the payroll tax rate. This tax does, however, weigh disproportionately on low income families, and polls indicate that the American people are against boosting it by almost two to one. Finally, we could tap the income tax to help eliminate the revenue shortfall. I discuss this possibility in Chapter 3, under the subheading Eisner's Magic Bullet.
Making Social Security Universal
Social Security currently covers 96 percent of all wage earners, but about a quarter of all state and local government workers (around 4 million) are left out. Bringing in all newly hired state and local workers would help solve the long-term deficit because these wage earners would pay payroll taxes for many years before receiving benefits. To include all state and local government workers hired after 2005 would reduce the long-term deficit by an estimated 10 percent.
This idea, unanimously supported by the Advisory Council, has generated little controversy and is a part of most reform plans. It is widely agreed that all wage earners should be a part of the nation's social insurance program. Though the tax burden on presently excluded state and local government workers would rise, they would benefit as well, since they would have greater freedom to change jobs without losing benefits, better protection against inflation, better survivor and disability coverage, and more reliable protection for spouses who are not automatically protected under state plans.
Altering The Benefit Formula
Given the current Social Security system, your children's benefits will almost surely be greater than yours, even adjusting for inflation. Why is this? Because of the way Social Security benefits are calculated. They're computed using a formula by which the monthly benefit equals some percentage of lifetime average monthly wage. The higher the average wage, the higher the benefit. Specifically, according to the formula used in 2005, a worker's monthly Social Security benefit equaled 90 percent of that worker's first $627 of average monthly earnings, plus 32 percent of the next $3152, plus 15 percent of the earnings between $3,779 and $7,500. These earnings numbers are scheduled to rise each year to keep pace with prices. (Earnings exceeding $6,700 were neither taxed nor included in the benefits formula.) Note that the benefit formula is constructed so that benefits of higher income workers constitute a smaller percentage of their lifetime average monthly income than benefits of lower income workers. This formula is largely responsible for the anti-poverty effects of Social Security.
In the economy as a whole, the average wage has always tended to move upward over time, even adjusting for inflation. As a result the purchasing power of Social Security benefits has increased from one generation to the next. One controversial proposal put forward by President Bush's 2001 Commission to Strengthen Social Security (see Chapter 3) would solve the long- term deficit by eliminating this feature. Benefits would be indexed to the price level rather than the average wage. The result would make the purchasing power of benefits equal between generations, but benefits would fall relative to average wages from one generation to the next. According to the chief actuary of the Social Security Administration, the purchasing power of the currently-promised benefits of a median-earning 65 year old retiree in 2042 would be cut by 25 percent. By 2075 the benefit reduction would be 46 percent.
The Social Security deficit could also be reduced by altering the benefit formula so that benefits would continue to rise over time but at a slower pace. This idea is embodied in a proposal by Edward Gramlich, chair of the 1994–1996 Advisory Council, and also in the plan presented by the National Commission on Retirement Policy, a commission consisting of Senators John Breaux (D-LA) and Judd Gregg (R-NH) and Representatives Jim Kolbe (R-AZ) and Charles Stenholm (D-TX).
The idea has stirred little controversy, perhaps because the formula can be adjusted so that most of the benefit cuts are focused on the wealthy. Although 90 percent of Americans oppose an across the board cut in benefits, almost three out of five support a reduction for those with incomes of more than $40,000 a year.
Raising The Payroll Tax Cap
It doesn't matter whether your annual salary is $80,000 or $800,000 or $8 million, you pay the same Social Security tax (currently $4,724 per year) because wages above a certain level are ignored by the Social Security system: they are neither subject to the payroll tax (currently 6.2 percent of wage income) nor included in the benefits formula. In 2005, that maximum wage level — called the payroll tax cap — was $90,000. This maximum wage is scheduled to go up every year to keep pace with increases in the nation's average wage.
Raising the cap would increase both revenues and benefits, but it would increase revenues more. For example, raising the cap by 2 percent a year above the already scheduled increases would reduce the long-term deficit by around 12 percent. A 2005 study by the office of the Actuary estimated the cap would virtually solve the 75 year revenue short fall.
Why not eliminate the cap altogether and require people to pay Social Security taxes on their entire wage income? Shouldn't a corporation president earning a salary of $8 million a year pay a higher payroll tax than I do? This sounds like a good idea when we look at only the revenue side. The rub comes on the benefit side. Do we want to give multimillionaires Social Security benefits that run to six figures?
The reason the cap has been retained is political. As economist Wallace Peterson put it, eliminating the cap "would be strongly resisted by higher-income wage and salary workers, for their taxes would rise more than their benefits." Researchers Dean Baker and Mark Weisbrot agreed, predicting a "backlash among upper income taxpayers" if the cap were lifted. A 2005 study by the Office of the Actuary for the Social Security Administration estimated that eliminating the cap would virtually solve the 75 year revenue shortfall.
Most reform plans supported by Democrats would raise the cap faster than is presently scheduled. Plans advanced by Republicans don't even mention the cap.
Raising The Tax On Benefits
Income taxes on Social Security benefits — unlike income taxes on other types of income — are credited to the Social Security trust fund. Thus, raising the tax on benefits would help solve Social Security's revenue shortfall.
Currently, we tax Social Security benefits less heavily than we do private pensions. This disparity violates the widely accepted principle that equal incomes should be taxed equally. There is general agreement that this disparity should be eliminated. As the Advisory Council put it, "The fairest way to ask present retirees to share in the cost of bringing Social Security into balance is by revising the taxation of Social Security benefits."
Payments from private pension plans are subject to the income tax only to the extent that they exceed the amount workers have paid in. This portion of the income tax is computed on an individual basis. By contrast, Social Security benefits are taxed at a rate of 85 percent across the board except for low-income taxpayers. (Congress set the 85 percent figure to serve as an estimate of benefits that exceed payroll taxes a worker has paid into the system.)
Economists are critical of the 85 percent formula. They argue that the procedure used to compute income taxes on Social Security benefits should be the same as that used to compute taxes on private pensions, individual by individual. Such a procedure would not only be fair, it would boost Social Security revenue; and the Advisory Council has concluded that "the administrative difficulty of individual calculation is manageable."
There is another difference between the taxation of private pension payments and that of Social Security benefits: benefits received by low-income workers are exempt from the income tax, whereas private pension payments are not. Currently, beneficiaries with annual incomes less than $34,000 for single persons and $44,000 for couples are exempt from income tax on Social Security benefits. Most experts agree that this special exemption should be eliminated, that low-income beneficiaries should be given only the protection provided to all low-income taxpayers.
If the tax on Social Security benefits were computed on an individual basis and if the special exemption were eliminated, the long run deficit would be cut by around 16 percent.
Cutting The Cost-Of-Living Adjustment (COLA)
Question: How many types of retirement income are automatically adjusted for inflation?
Answer: Only one — Social Security.
Savings accounts are eroded by rising price levels. So are private pensions, since corporations do not insure their retired workers against the ravages of unexpected inflation.
As Henry Aaron and Robert Reischauer put it, "Social Security remains the only source of retirement income that is insulated from the risk of unanticipated inflation and guaranteed to continue as long as the pensioners live." (Henry Aaron was chair of the 1979 Advisory Council, and Robert Reischauer was director of the CBO from 1989 to 1995.)
In 1972, Congress adopted a formula to adjust Social Security benefits automatically, tying them to the consumer price index (CPI); that is, if the CPI rose by, say, 3 percent, benefits would automatically rise by 3 percent. This cost-of-living adjustment (COLA) was intended to guarantee that the purchasing power of benefits would be immune to inflation. Statisticians at the Bureau of Labor Statistics are charged with the task of computing the consumer price index.
When politicians are under pressure to cut spending, one place they look is the COLA. For example, lowering the growth rate in the consumer price index by .2 percent per year would cut Social Security benefits and reduce the long-run deficit by approximately 13 percent. It was for this reason that the Boskin Commission was appointed by the Senate Finance Committee in 1996 to evaluate the accuracy of the consumer price index. It was chaired by Michael Boskin, who had been top economic advisor for the elder President George Bush. At that time the United States was experiencing huge budget deficits that forecasters predicted would continue indefinitely. Politicians were desperate to reduce spending. Trimming the COLA would do the job, at the expense of Social Security beneficiaries. The commission, which consisted of five economists who had already testified they believed the consumer price index overestimated inflation, concluded that it overstated inflation by 1.1 percent a year and recommended cutting the COLA and therefore Social Security benefits by a corresponding amount. (The Bureau of Labor Statistics disagreed.) One percent may not sound like much, but a COLA reduction of this size would reduce benefits by more than 10 percent over an average 20-year retirement.
The Boskin Commission's conclusion, although rejected by many economists, has influenced policy makers. Many reform plans, such as the Moynihan and the Kerrey-Simpson proposals, have incorporated the commission's recommendation.
Economists, however, are in general agreement that the computation of the consumer price index should remain a technical one, left to the Bureau of Labor Statistics, and that it should not become a political football. Even the Advisory Council, which had heated and unbridgeable disagreements over how to reform Social Security, agreed unanimously that the COLA should be determined by the Bureau of Labor Statistics and should not be "motivated by political considerations."
In 1996 the Bureau of Labor Statistics announced that it had improved the consumer price index, making it a more accurate measure of inflation. This change reduces the COLA and will shrink the long run deficit by an estimated 19 percent.
Lengthening The Period For Averaging Wages
Social Security benefits are determined by a worker's average annual salary, an average based on the 35 years of highest earnings. A wage earner must have paid payroll taxes for at least 10 years to be eligible. However, if a person with less than 10 years' work experience is the spouse of a worker who is entitled to Social Security, then the spouse, when 66, receives 50 percent of the worker's benefits. The same option holds for a person with more than 10 years' work experience if the 50 percent benefit exceeds his or her own full benefit. If a person has worked, say, 12 years, the average wage would be calculated using the wage incomes for those 12 years plus 23 zeros.
A majority of the Advisory Council and many reform plans have recommended increasing the number of years used to compute the average wage. Doing so would reduce average benefits, since earnings for years presently excluded are inevitably lower than the 35-year average. If, for example, the averaging period were extended from 35 to 38 years — a widely suggested increase — benefits would be reduced by an estimated 3 percent, cutting the long run revenue shortfall by around 12 percent.
Supporters of this proposal argue that most people work more than 35 years, so incorporating additional years would more accurately link benefits to career earnings. Some analysts believe it's unfair that not all contributions to Social Security are considered in determining benefits. Eugene Steuerle pointed out, for example, that according to the current formula, "fifty years of work at [an average of] $35,000 [per year] will yield lower benefits than 35 years at [an average of] $50,000 [per year]." Steuerle argued that lengthening the averaging period would diminish discrimination against people who have worked more years.
Others have argued that lengthening the averaging period would be a mistake, since decreases in benefits would weigh most heavily on those who worked less than 35 years, particularly on women who stayed home to raise children. Their average wage would be depressed by the inclusion of zeros for years they didn't work. Three out of four women but only one out of four men have worked 35 years or less.
(Continues...)
Excerpted from Social Security Under the Gun by Arthur Benavie. Copyright © 2003 Arthur Benavie. Excerpted by permission of St. Martin's Press.
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