Economics isn't called "the dismal science" for no reason. Economists tend to spend most of their time researching ways to try and fix self-inflicted wounds to the economy, then delivering the bad news that the fix is usually a tax or reduction in funding.
Unfortunately, most aspects of our public finances, like health care, education spending, or defense spending, require relatively difficult and painful fixes. But fortunately, there is one area of our government finances -- Social Security -- which can be fixed with relatively simple solutions.
Whichever end of the political spectrum they're on, politicians have a tendency to cloud the issues in order to promote their political interests. Like all other social programs, Social Security has fallen prey to this conundrum. The purpose of this article is to try and dispel some of the myths and confusions perpetuated about this program.
Make no bones about it -- something needs to be done to either change the inputs into Social Security (i.e. taxes), the way the program earns its returns, or the benefits paid out from the program. Otherwise, according to the federal government's General Accounting Office, in 2008 the Social Security trust fund's surplus cash will start to be drained, and by 2042 the fund will completely run out of money.
Having the Social Security trust fund completely bereft of cash doesn't mean an end to benefits being paid after 2042. After all, there still will be payroll taxes coming into the fund. The important thing to know is that the sooner politicians act to ensure that Social Security remains fully funded and able to pay out benefits without draining the trust fund, the easier the burden will be on all workers. If politicians wait until 2042 to try and fix the program, either a 30% reduction in benefits paid out or a 42% increase in payroll taxes will be required to keep Social Security solvent.
Without going into any normative arguments and debating the merits of Social Security, I want to dispel the myths revolving around this program and provide an overview of some solutions to ensure that Social Security remains solvent and funded.
Allow Social Security to invest in riskier assets
One the easiest and least contentious ways that we can help this program remain solvent is to allow its trust fund to put the money that it receives from payroll taxes in investments that earn a higher rate of return. Currently the fund is only allowed by law to invest in low-yielding government treasuries, and not things like stocks or riskier but higher-yielding corporate bonds. The more that the trust fund can earn on the investments it makes, the less other measures will be needed to fill Social Security's funding gap.
It's important to note that personal retirement accounts are not a solution to the program's financial problems, because allowing individuals to choose their investments does nothing to reduce the underfunding of the program. I'll save further discussion of this issue for another article, though.
Change the rate of payroll taxes
Another way to fix Social Security is to simply raise the payroll taxes that fund the program. Politically, this may be the most difficult thing to do, but the trustees of the Social Security fund estimate that raising payroll taxes by 2% (holding everything else equal) today will be sufficient to fund the program for the next 75 years. The longer that raise is delayed, the more this rise in taxes will have to be to fully fund Social Security.
As unappealing as a rise in payroll taxes is, this is traditionally how our government has handled the program's lack of funding in the past. When Social Security first debuted in 1935, the total payroll tax was only 2%, a far cry from the 12.4% payroll tax paid into the program by employers and employees today.
There's currently a ceiling of about $90,000 on the level of income subject to the payroll taxes that fund Social Security. By increasing or eliminating the ceiling of income subject to this tax, some of the program's lack of funding could be ameliorated.
Change the benefits received from Social Security
Maybe the easiest way to fix the program is to simply increase the retirement age at which workers can start to receive benefits; currently, it's 62. Doing so makes sense, since workers are living much longer than when Social Security was first enacted.
A more contentious way to bring the program back to solvency is to decrease the size of benefits that retirees receive while on Social Security. According to the Social Security trust fund, if benefits are immediately reduced by 13%, this would make the fund solvent for the next 75 years. Personally, I think this solution makes the least sense, though, since reducing benefits really eliminates the whole idea of Social Security and may jeopardize the planning of many people currently nearing retirement.
There are other longer-term, more indirect, and sometimes less practical ways to fix Social Security, including enacting laws that raise the rate of economic growth (which the government should be trying to do anyway) or increasing the size of the labor force. These types of fixes are hard to estimate and predict, and are thus beyond the scope of this article.
Most people are aware that any Social Security funds they receive from the government will not be nearly enough to rely on to fully fund all retirement expenses. But even if you've been stocking money away in shares of blue-chip companies like Microsoft
For further Foolishness: