The importance of Social Security for America's retirees simply can't be overstated.
As of January, the Social Security Administration's (SSA) monthly snapshot showed that nearly 41.4 million retired workers were receiving monthly payments averaging $1,363. This may not sound like a lot of money, but the SSA's data from 2016 shows that 61% of all retired workers receiving benefits relied on their monthly Social Security checks to account for at least half of their income. Without this money, there would presumably be a considerable poverty problem among seniors.
Both solutions work -- that's the problem
But America's most sacred social program is caught in a tailspin. Two ongoing demographic shifts -- the retirement of baby boomers and the steady lengthening of life expectancies over the past couple of decades -- are expected to push Social Security to the brink, so to speak. While the program is in no danger of going bankrupt (as long as people are working, payroll taxes will be collected, and payments made to beneficiaries), the current payout rate may not be sustainable.
According to the Social Security Board of Trustees report from 2016, the more than $2.8 trillion in spare cash currently held by Social Security should be depleted by 2034, at which point an across-the-board benefits cut of up to 21% may be needed to sustain the program through 2090. While there are numerous proposals on the table to fix Social Security, doing nothing and cutting benefits when the Trust burns through its spare cash is essentially the least favorite "fix" among the public.
Perhaps the greatest irony here is that solutions aren't the issue. Well over a dozen separate fixes for Social Security have been proposed. The crux of the problem is that Democrats and Republicans on Capitol Hill can't agree on a plan.
The way I see it, the real issue with the Democrat and Republican proposals is that they're both right, which makes compromising extremely difficult. While both approaches clearly have downsides, both the Democrat and Republican solutions would extend the life of Social Security for retired workers. In other words, both plans work.
How Democrats would fix Social Security
Let's begin by taking a generalized look at the three ways Democrats often propose to fix Social Security. We won't be looking at any bill in particular; just the general concepts that most lawmakers in the Democratic Party tend to agree on when it comes to Social Security reform.
1. Raise the payroll tax earnings cap
Pretty much every Democratic proposal involves increasing Social Security's payroll tax cap. As it currently stands, 12.4% of your pay between $0.01 and $127,200 is taxed as 12.4%. However, most Americans don't pay the full 12.4%. They're responsible for half (6.2%), with their employer picking up the tab for the other half (6.2%). Any earned income above and beyond $127,200 in 2017 is free and clear of the payroll tax.
As the argument goes, since roughly 90% of Americans are paying into Social Security with every cent they earn, it's not fair that the wealthy are only paying tax on a smaller percentage of their income. Select payroll tax proposals have suggested providing a moratorium between the wage-indexed cap ($127,200) and, say, $250,000, then taxing all earned income above $250,000 at the 12.4% rate, or removing the maximum earnings cap completely. Removing the cap completely would go a very long way to narrowing Social Security's more than $11 trillion budgetary shortfall.
2. Tie COLA to the CPI-E
Second, Democrats would like to stop using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) as the determinant of the annual cost-of-living adjustment (COLA) and replace it with the Consumer Price Index for the Elderly (CPI-E). The CPI-E strictly factors in the spending habits of households with persons aged 62 and up, meaning it would emphasize medical and housing expenditures more, and de-emphasize less important expenditures, such as education, entertainment, apparel, and transportation.
The Senior Citizens League has estimated that if the CPI-E were used in place of the CPI-W, seniors would have been paid an aggregate of $29,600 more over the past 25 years.
3. Give low-income workers a raise
Lastly, Democrats would like to see low-income retirees earn more. While there are minimum monthly benefits in place, this doesn't mean seniors are necessarily earning enough annually to move above the national poverty income threshold. Democratic solutions to fix Social Security often include measures to boost payouts to low-income workers, women, and/or older Americans (i.e., those in their 80s or 90s).
Obviously, this plan isn't perfect. It requires the rich to pay more without compensating them any more when they retire and begin claiming benefits. It also boosts payouts by using the CPI-E and giving low-income workers a raise, which is counterproductive to the current budgetary shortfall for Social Security.
The Republican solution for Social Security
Just like the Democrats, Republicans have a three-pronged approach to solving Social Security's budgetary woes. Once again we're not focusing on any specific bill here; we're just examining the basic tenets of most Republican Social Security proposals.
1. Raise the full retirement age
Hands down the most popular solution for Republicans in Washington involves raising the full retirement age. Your full retirement age, which is determined by your birth year, is the age at which you become eligible to receive 100% of your monthly payout. Claim benefits before reaching this age, and your monthly payout is permanently reduced. Wait until after your full retirement age to claim benefits, and your monthly payout is even higher.
The various Republican proposals have suggested increasing the full retirement age from 67, which will be reached in 2022, to 68, 69, or even age 70. Raising the full retirement age would presumably coerce healthy seniors to remain in the workforce, ultimately adding more payroll tax revenue into the program. It would also account for lengthening life expectancies.
2. Tie COLA to the Chained CPI
Republicans also have a strong tendency to want to abandon the CPI-W. However, their proposal usually involves switching to the Chained CPI, not the CPI-E.
The difference between the Chained CPI and the CPI-W is that the Chained CPI takes into account a buying habit known as "substitution." In other words, if the price of a good or service increases in cost by a lot, the Chained CPI assumes the consumer will trade down to a less expensive good or service. The CPI-W does not factor in consumer substitution. As a result, the Chained CPI would result in lower annual COLAs than the CPI-W, which according to Republicans would more accurately represent the inflation that seniors are facing.
3. Means-test for benefits
Finally, Republicans often suggest means-testing seniors for benefits. In short, means-testing would be an arbitrarily chosen annual income level at which well-to-do retired workers would receive a reduced benefit, or perhaps no benefit at all.
As a completely arbitrary example, if a Social Security-eligible senior were earning $200,000 a year, he or she might be deemed ineligible for benefits based on means-testing since the income provided by Social Security is essentially not needed to live comfortably and pay bills. Republicans believe means-testing will save money by eliminating unnecessary payouts.
The Republican plan isn't perfect, either. Raising the retirement age and relying on the Chained CPI means a benefits cut for future retirees, along with lower annual COLAs. Seniors would either need to wait longer to file their claims, or be willing to accept a steeper reduction in monthly payouts.
While neither party's plan is perfect, they both make fiscal sense and achieve the task of getting Social Security back onto stable ground. The real question at this point is whether Democrats and Republicans can work together on a joint plan when both of their current plans make sense. Only time will tell.
The Motley Fool has a disclosure policy.