In May 2015, researchers from Harvard and Dartmouth published a report suggesting that actuaries for the Social Security Administration have been underestimating the demographic challenges facing the program since 2000.1 The fact that Social Security is in trouble was not a surprise, but the possibility that the day of reckoning might come sooner than previously projected generated considerable media attention and may spur renewed political debate.
Social Security is the centerpiece of America’s retirement safety net. Nine out of 10 retirees and eight out of 10 workers are counting on the program as an important source of retirement income.2
Regardless of your age and working status, this might be a good time to look at the challenges facing the program and the potential solutions for addressing its fiscal problems.
There is no mystery to the fundamental problem. Because of Americans’ longer life spans and lower birth rates, there are not enough workers to support the growing number of beneficiaries. In 1955, there were 8.6 workers for each beneficiary. The number of workers per beneficiary fell to 4.0 by 1965 and 3.2 by 1975. Currently, there are only 2.8 workers contributing to Social Security for each beneficiary. By 2035, this is expected to drop to 2.1, at which point it will level off.3
Since 2010, the Social Security system has been supplementing its revenues from trust funds built up during the period when revenues exceeded expenses. Based on current actuarial projections, these funds will run out in 2033, at which point the program might be able to pay only 77% of scheduled benefits; the percentage falls to 72% by 2088.4
Although the Harvard-Dartmouth researchers did not offer a specific date when the funds might run out, they found that the program’s expenses have been consistently underestimated since 2000, primarily because they were not fully adjusted for increasing life spans.5
A 2014 study by the National Academy of Social Insurance (NASI) looked at potential solutions addressing Social Security’s funding shortfall in terms of their impact (based on current actuarial data) and public opinion.
The most popular revenue-enhancing changes — “strongly” or “somewhat” favored by more than four out of five survey respondents — were to gradually raise the FICA payroll tax rate (paid by both workers and employers) from 6.2% to 7.2% over 20 years, and to gradually eliminate the taxable earnings cap over 10 years so that all earnings would be taxed.6
In 2015, workers’ earnings up to a maximum of $118,500 are subject to the payroll tax; the earnings cap is indexed annually for inflation. Raising the taxable earnings cap to $230,000 (which would cover 90% of all earnings by U.S. workers, a target set by Social Security legislation) would reduce the funding gap by 29%. Eliminating the earnings cap altogether would reduce the gap by 74%. Gradually raising the payroll tax would address about 52% of the shortfall.7
A majority of survey respondents oppose benefit reductions, such as reducing or eliminating benefits for high-income beneficiaries, raising the retirement age, and reducing the cost-of-living adjustment (COLA). In fact, 70% to 80% of respondents favored potential benefit increases, including raising the COLA, raising benefits for those who are 85 and older, reinstating survivor benefits for college students, and raising the minimum benefit. Of course, any benefit enhancements would only increase the deficit and would have to be offset by revenue increases.8
These reforms could work with the current Social Security system, but some legislators have suggested a more fundamental shift toward privatization — allowing younger workers to divert some or all of their payroll taxes from Social Security to private accounts. However, this approach would increase the current Social Security deficit, and it raises questions about the long-term security of a private savings program.
Using a trade-off analysis technique, the National Academy of Social Insurance found that 71% of survey respondents favored a reform package that included (1) gradually eliminating the taxable earnings cap, (2) gradually increasing the payroll tax rate, (3) raising the COLA to reflect inflation experienced by seniors, and (4) increasing the minimum benefit. This proposal would eliminate an estimated 113% of the shortfall currently projected by the Social Security actuaries.9 However, if the Harvard-Dartmouth researchers are correct, additional changes would be required, perhaps excluding the benefit increases.
The NASI study suggests that Americans may be ready to support steps to rescue Social Security. The larger question is whether policymakers are willing to make the difficult choices required.
With heightened public attention, the future of Social Security may become an issue in the 2016 political elections. If so, renewed focus on an old problem may help ensure the future of America’s retirement safety net.
1, 5) Journal of Economic Perspectives, Spring 2015
2) Employee Benefit Research Institute, 2015
3–4) Social Security Administration, 2014
6–9) National Academy of Social Insurance, 2014
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.