Time is running out to avoid cuts to Social Security benefits

Social Security has long been considered the “third rail” of U.S. politics — the implication being that if you touch the program, you’ll suffer a nasty shock. But time is running out to implement changes that would avoid benefit cuts for Americans already struggling to save for retirement.

The most recent annual report from the program’s Board of Trustees moved up to 2033 the projected year when Social Security's finances would require a 23% cut in benefits. Politicians are well aware of the potential fixes: House conservatives recently recommended raising the retirement age to receive full benefits to 69.

While it's unlikely to become law, the proposal put the spotlight back on a thorny problem that has bedeviled lawmakers for decades: If changes to the popular program aren’t made, benefits will get cut.

Social Security is basically a pay-as-you-go program. Payroll taxes from workers and employers flow in to fund current benefits for retirees. The mismatch between the money coming in and the money being paid out is becoming increasingly untenable. And the Social Security system can't plug a shortfall by borrowing. 

Raising the retirement age would keep people working longer and in theory, increase the tax revenue available to pay benefits. To explore what other options there are to address the system’s finances, Bloomberg reached out to retirement experts across the political spectrum. Ideas range from diverting general revenue to make up the projected shortfall to refocusing the program on lower-income workers and establishing a minimum benefit.

While the experts have major areas of disagreement, they come together in warning that the US is running out of time to phase in gradual changes to avoid drastic cuts.

A RATIONALE FOR GENERAL REVENUE
Alicia Munnell, director, Center for Retirement Research at Boston College 

Social Security’s “pay-as-you-go” structure dates back to the late 1930s, when policymakers decided to pay out benefits that were much higher than contributions for the early generations of Social Security recipients rather than build up a trust fund that would have grown and paid interest. Most of the current shortfall can be attributed to this "Missing Trust Fund."

Thinking of ways to eliminate the shortfall is not hard — many options are available to reduce benefits or increase revenues. I strongly oppose benefit reductions, given that current benefits are modest and most people don't save enough on their own. That leaves revenues. The conventional options are raising payroll tax rates or expanding the payroll tax base.

Alternatively, given the source of the shortfall, it makes sense to consider an infusion of general revenues — out of income tax receipts — to cover the cost of scheduled Social Security benefits. At the same time, the program would retain a well-defined payroll tax contribution from workers — equal to what they would have paid if the trust fund had been maintained — so that benefits remain an earned right.

PULLING LEVERS
Marc Goldwein, senior policy director, Committee for a Responsible Federal Budget 

Restoring solvency requires the equivalent of either reducing scheduled benefits by about a quarter, raising revenues by about a third, or a combination of the two. You wouldn’t want to do that across the board, but there are a few major levers to use that could get you most of the savings.

On the benefits side, the main levers are how you calculate initial benefits, the retirement age and the inflation adjustment. With the retirement age, you get the most impact if you change the full retirement age — the age when you get full benefits. The FRA is 67, but it’s not indexed to life expectancy, meaning the programs will cover more and more years of retirement as we live longer. Increasing or indexing the age could limit costs.

On the revenue side, one option is to increase the amount of wages subject to the payroll tax beyond the current $160,200 maximum. Historically, that wage cap has covered up to 90% of wages; today it covers more like 83%. 

The payroll tax rate provides another lever — and you could increase the 12.4% payroll tax gradually so that after-tax wages continue to grow. 

Finally, you could broaden the payroll tax base and close loopholes. A lot of compensation — from health care benefits to stock options to flex savings account contributions — is not subject to the payroll tax. 

A reasonable plan would probably adopt some combination of these proposals, and phase them in swiftly but gradually.

RAISE RETIREMENT AGE — AND MINIMUM BENEFITS
Shai Akabas, director of economic policy, Bipartisan Policy Center 

Restoring Social Security’s financial health and enhancing benefits for vulnerable beneficiaries aren't mutually exclusive goals. Tackling them together is the best way to garner the necessary bipartisan support for Social Security reform and ensure the program can adequately sustain future generations. 

Rather than simply raising taxes and cutting benefits until the funding gap is closed, our proposal includes policy provisions that complement each other and address areas in which the program needs to evolve. For example, experts predict that average U.S. life expectancy will continue to increase, but Social Security’s retirement age is now static. As Americans live longer — and spend more years in retirement — Social Security outlays will continue to grow at an unsustainable pace.

Gradually increasing the age at which Americans can claim full Social Security benefits would be a huge boon to the program’s finances. A recent analysis by the Urban Institute showed that increasing the retirement age by just two years over a 23-year phase-in period would close nearly a quarter of Social Security’s long-range shortfall.

At the same time, as we emerge from Covid-19, it has never been clearer that average life expectancy obscures huge racial, economic and geographic disparities. In isolation, raising the retirement age would perpetuate those disparities. That is why we also recommend enacting a new minimum benefit to keep American retirees out of poverty. A modest, targeted supplement to standard Social Security payments for low-income beneficiaries could dramatically improve financial security for the lowest earners. What’s more, it could easily be structured to preserve the incentive to work for those able. 

Any effective reform package will also require revenue raisers, such as increasing the taxable maximum. But more than any individual proposal, the holistic approach is critical.

SCALE BACK MAXIMUM BENEFITS
Andrew Biggs, senior fellow, American Enterprise Institute

When Social Security started in 1935, the world of retirement was very different from today. Many Americans didn't survive to retirement age, and those who did reach age 65 didn’t live long afterward. Retirees as a group were disproportionately poor. There were few avenues for saving for retirement on your own, with no mutual funds or computers to manage them. Social Security was designed around that world, and it still is. But the world has changed.

Over the last four decades, seniors’ incomes have grown 1.6 times faster than incomes of working-age households. Median retiree incomes are at record highs and poverty rates are at record lows. Eighty percent of seniors tell Gallup they have enough money, not merely to survive, but to “live comfortably.” Seniors, once a disproportionately poor group, are today a disproportionately rich one.

Countries similar to the U.S., such as Australia, the UK, Canada and New Zealand, reduce elderly poverty by focusing their resources by providing minimum benefits to the retirees who need the help the most. But they reduce costs by paying far lower benefits to middle- and upper-income seniors.

And today, more Americans are saving more for retirement in 401(k)s than ever before. Employment at older ages is at record highs and Americans are claiming Social Security benefits 1.5 years later than they did in 1985. An average American retiring today receives a Social Security benefit that is approximately 40% higher than in 2000, after adjusting for inflation.

In the short term, the minimum benefit could be increased to guarantee against poverty. At the same time, the federal government should provide a retirement savings account for every employee who isn't offered a retirement plan at work, and every employee should be automatically enrolled in their plan. Finally, over decades, the maximum Social Security benefit should be scaled down so that, as in the UK, Australia and New Zealand, every retiree eventually receives the same base benefit.

There is no magic to this plan. It restores Social Security to solvency by scaling back promised benefits for middle- and upper-income retirees. But by doing so it avoids raising taxes, which will be needed to address Medicare, the national debt and other pressing needs. With retiree incomes at record highs, it makes sense to adjust Social Security for the 21st century. Social Security reform can be effective and affordable, if we follow the facts.