Social Security---The High Cost of Demagoguery

The Trustees of the Social Security program recently released its annual report on its financial status.

It is not a pretty picture.

The Social Security retirement fund is projected to become insolvent in the first quarter, 2033--- a mere seven years from now.

It can survive until 2034 if they raid the companion Social Security Disability fund to pay retiree benefits.

At that point all of the trust fund assets will be exhausted and benefit payments can only be paid to the extent of current Social Security tax revenues. Current Social Security tax revenues only cover about  75% of current outlays.

This means that every current Social Security beneficiary could be faced with a cut amounting to about 25% of their current benefit.

Social Security could be restored to firm financial solvency (75 year timeline) with the equivalent of a 29 % (3.65 percentage point) payroll tax increase, a 22% reduction in total benefits, or a 27% reduction in benefits for new beneficiaries if Congress acted to solve the problem this year.

If Congress waits to 2034 to solve the problem it just gets more expensive.

Delaying action until 2034 would increase the size of necessary adjustments by 15 percent. In that year, taxes would need to be raised by 34% (4.27 percentage points), benefits cut for all beneficiaries by 26%, or some combination thereof. Changes to benefits for new beneficiaries alone would be insufficient to restore solvency to the program, even if benefits were eliminated entirely.

Source: https://www.crfb.org/papers/analysis-2025-social-security-trustees-report?_sc=OTQzMjQwNSMxNzc3MDg%3D

Liberals would like people to believe that all of Social Security's problems could be solved by simply removing the earnings tax cap  (currently $184,500) and making all earnings subject to the FICA tax.

There are three problems with this.

First, it needs to be remembered that under current Social Security law high earners get proportionately less in benefits than low wage earners.

Uncapping the the cap would entitle high earners to higher benefits under the current formula.

As it is, hIgh earners only replace about 26% of the earnings they paid Social Security taxes on while low earners replace about 74%.

Uncapping the payroll tax without adjusting the benefits would make it far, far worse 

Social Security would look less like the social insurance program it was designed to be and more like a conventional welfare program. Such a change would alter the foundational elements of the program that have existed for almost 80 years.

Second, putting another 12.4% tax on high earners (6.2% on the employee and 6.2% on the employer) above the current cap could have massive negative effects on the economy.

It would be as if a massive flat tax was layered on to the current tax system.

One economic model suggested that such a tax burden could reduce long-term GDP by 1.5 percent.

It would represent the largest tax increase as a share of GDP in the last 40 years.

You begin to understand the impact when you consider what it would look like for a high earner in California.

Someone with over a $1 million of earnings would see a top marginal rate of 58.5%. A self-employed individual would be looking at a top marginal rate of 66.5% as Jared Dillian in an article at Reason.com explains.

Under current law, employees and employers each contribute 6.2 percent in Social Security payroll taxes on the first $184,500 in income. By eliminating the cap, that 6.2 percent tax would become a new top marginal tax rate. For example, a taxpayer in California would pay a 37 percent federal income tax rate, a 13.3 percent state income tax rate, a 1.45 percent Medicare tax, a 0.9 percent additional Medicare tax, and a 6.2 percent Social Security tax, for a top marginal rate of 58.85 percent. For self-employed people, who pay both sides of payroll taxes and Medicare taxes, the top marginal rate would rise to 66.5 percent—among the highest marginal rates in the world.

Third, most projections suggest that doing this by itself is not enough. Other measures such as raising the retirement age or raising the overall tax rate for everyone would still be required. 

The Committee for a Responsible Budget has developed a handy interactive tool that allows users to develop their own plan to restore solvency to Social Security.

For example, here is a plan that would involve all of the major issues that I believe will have to be considered to some degree in any Congressional compromise to insure Social Security's solvency.

1) Increase in the overall tax rate

2) Increase in the maximum tax cap

3) Increase in the future retirement age

4) Reduction in benefits for high earners

5) Reduction in COLA adjustments.

For example, the plan I proposed in the tool gets Social Security to 98% of what it needs for long-term solvency.

It is about as balanced as it can be between tax increases and benefit adjustments.

At the same time, it is unlikely to make anyone happy.

This is where we find ourselves due to not addressing this issue earlier.

What is sad about all of this is that President George W. Bush made an effort to reform Social Security in 2005---21 years ago. It made a lot of sense since the reserves in the trust fund had grown to substantial amounts and were still growing as the Baby Boom generation reached their peak earnings years.

Bush's plan would have allowed younger Americans to establish voluntary personal accounts in which workers could invest part of their payroll taxes.

The Bush plan would have also curbed the benefit formula for higher income workers but left in place the formula for average and lower incomes.

This would have taken a great deal of pressure off of Social Security's future funding issues as well as providing younger workers the opportunity to get a better return on their lifetime of Social Security contributions.

The proposed legislation went nowhere in the face of sustained demagoguery by Democrats and the AARP  that the Bush plan would involve "gambling" on the stock market.

20 years later we can assess how that would have worked out.

Those voluntary accounts would have performed spectacularly for the benefit of the Social Security system and its beneficiaries under almost any investment scenario.

The S&P 500 is up 767% since January 1, 2006.

The NASDAQ has provided a return of over 1,000%.

Franklin Delano Roosevelt signed the Social Security Act into law on August 14, 1935.

Lost in history is this quote from Franklin Delano Roosevelt in his message to Congress on January 17, 1935 asking Congress to enact the Social Security program.  

It is clear that Roosevelt understood that the program he was asking for was unsustainable in the long term and had to be replaced by a "self supporting system" in 30 years or so.  Unfortunately, that was 91 years ago.

In the important field of security for our old people, it seems necessary to adopt three principles: First, non-contributory old-age pensions for those who are now too old to build up their own insurance. It is, of course, clear that for perhaps thirty years to come funds will have to be provided by the States and the Federal Government to meet these pensions. Second, compulsory contributory annuities which in time will establish a self-supporting system for those now young and for future generations. Third, voluntary contributory annuities by which individual initiative can increase the annual amounts received in old age. It is proposed that the Federal Government assume one-half of the cost of the old-age pension plan, which ought ultimately to be supplanted by self-supporting annuity plans.

FDR openly admitted when the legislation was proposed that Social Security would need to be transitioned to a self-supporting annuity plan system in about 30 years in which the contributions of workers and employers would fund their future Social Security annuity payments. 

FDR also envisioned a system by which individuals could add voluntary contributions to increase the annual amounts received in old age recognizing individual initiative.

Apparently, everyone forgot about FDR's roadmap of how Social Security should work in the future in order to be sustainable.

I asked Google AI where we would be today on Social Security if the Bush plan had been adopted 20 years ago when it was proposed.

Source: Google AI

What is incredible is that the AARP put out an an article last year it which it bragged about stopping the Bush plan claiming that it "saved" Social Security in 2005.

Source: https://www.aarp.org/advocacy/times-aarp-fought-for-social-security/

In early 2005, fresh off reelection, President George W. Bush went all in on his proposal to “fix” Social Security by allowing workers to divert the payroll taxes that fund the program into “personal retirement accounts.”

In his State of the Union address that year, Bush said his plan would save Social Security for future generations by encouraging workers to invest that tax money in the stock market.

AARP disagreed. The nation’s largest advocacy group representing older Americans joined other critics who said the proposal would essentially dismantle the bedrock retirement security program and subject older Americans to the whims of Wall Street in their golden years. 

AARP was ready for the fight — armed with polling data, detailed counterarguments and a blizzard of TV and radio ads. Another potent weapon: its members, estimated to number about 36 million at the time, who flooded the phone lines of their members of Congress to express their opposition.

It just proves that there is a high cost to demagoguery.

A grave error was made in not reforming Social Security 20 years ago when there was a surplus to work with and there was time to implement the reforms.

No such luxury exists today.

Social Security will have to be reformed in the next few years and it will be very painful.

Current beneficiaries will likely not see their benefits cut but that is not assured depending on the nation's overall debt situation.

Retirement ages for younger Americans will undoubtedly increase.

The FICA tax will likely increase for everyone. but it will not mean higher benefits in the future, The returns on Social Security contributions will just get worse.

The payroll tax cap for high earners will be increased significantly if not completely eliminated.

Social Security will become more like a redistributive welfare program than the insurance program that it was originally designed to be. 

Undoubtedly, at that time we will also see the leadership at the AARP claim that they "saved" Social Security.

As we watch all of this unfold over the next few years remember that there is a high cost to demagoguery.

Most all of it was avoidable if demagoguery had been put aside and reason prevailed.

It is a lesson to remember for a number of other issues we are facing today as well.