Candidates Tackle an Unlikely Target—Remaking Social Security

With an energy crisis, a credit crisis, a housing crisis and a war grabbing headlines, there’s little wonder that the future of Social Security isn’t high on policymakers’ agendas right now. Indeed, since President Bush’s 2005 plan to privatize Social Security flopped, there’s been a notable silence in the discussion over how, or even whether, to make changes in the New Deal-era program.

Then the presidential campaign began. And the two contenders for the Oval Office, Republican John McCain and Democrat Barack Obama, have danced, ever so gingerly, on the infamous “third rail” of American politics—Social Security. Though neither candidate claims to have a comprehensive solution to Social Security’s long-term financing problems, both have been willing to stake out positions aimed at rescuing what they say is a program in trouble.

Each candidate has offered ideas that would fundamentally remake key aspects of Social Security—altering its shape in ways that would make it unrecognizable to millions of current and future beneficiaries.

McCain, in his Senate career and his previous run for president, has supported privatization of the program, a goal that would upset the current structure of guaranteed benefits that are roughly based on a worker’s lifetime earnings and payroll taxes. His recent statement that Social Security’s traditional financing mechanism, in which younger workers pay taxes to support those who have retired, is a “disgrace” touched off a furor. This inter-generational financing of Social Security has been part of the program since its inception, and is the reason many politicians call Social Security a pact between generations. The “disgrace” comment, coupled with McCain’s past expressions of support for privatization, have led many independent experts to conclude that if he were to be elected president, McCain would put some form of privatization back on the political table.

McCain, though, has left it unclear whether the private accounts—which he says would be limited to younger workers—would replace all or part of a traditional benefit, or supplement them. “John McCain supports supplementing the current Social Security system with personal accounts—but not as a substitute for addressing benefit promises that cannot be kept,” the candidate’s official website says. Allowing young workers to divert a portion of their payroll tax money into personal accounts would mean the funds would not go into the Social Security trust fund, hastening the date on which the fund would contain insufficient money to pay promised benefits. Creating a separate, “add-on” system of personal accounts, like universal 401(k) savings plans, would not adversely affect the system’s finances.

Though his position on private accounts has at times been murky, McCain is consistent in saying he would be open to all suggestions, and would approach Social Security revision through a bipartisan panel similar to the 1983 Greenspan Commission. “That’s the way Ronald Reagan and Tip O’Neill did it,” McCain said on ABC’s This Week in late July. “And that’s what we have to do again.”

Obama criticized his former rival Hillary Clinton when she took a similar position during the Democratic primary debates, saying that creating a commission dodges the issue. The Democratic nominee has, in fact, come up with a novel approach to some of Social Security’s future financing needs: He would create a “doughnut hole” in the payroll tax structure that has historically supported the Social Security trust fund.

Currently, payroll taxes are capped when an individual earns $102,000 annually, an amount that rises with national wage growth. The cap has long been a source of controversy, since a worker making less pays tax on all of his or her income—while someone making, say $150,000, isn’t taxed on full earnings. Benefits, though, also are capped in relation to the tax cap.

Historically, the tax cap was set at a level that would capture about 90 percent of wage and salary income. But in recent years, as wage growth among higher-income workers has been faster than it has been for those below—that is, as inequality has increased—the traditional 90 percent marker has fallen away. Currently, the cap lies at about 83 percent of national wages, according to Jason Furman, an economic adviser to the Obama campaign.

To raise the cap straightforwardly to where it has historically been set would require payroll taxes to be levied up to about $160,000 in wage income. But Obama has said repeatedly that he won’t raise taxes on those who earn less than about $250,000. And so he would bore a “doughnut hole” into the program.

Those earning between $102,000 and $250,000 would see their tax remain the same. But those with earnings of $250,000 and above would see a tax hike. Obama campaign aides said they haven’t decided whether this would require both employers and employees to pay the full 6.2 percent payroll tax rate now in effect, or whether a lower rate would apply. His aides also have suggested that income taxes, rather than payroll taxes, might be levied. Without more specifics, it is impossible to calculate how much of Social Security’s future funding gap would be closed.

Irrespective of which approach Obama takes, the doughnut hole itself could crack Social Security’s political foundation: Since the program’s inception, workers have received benefits that are roughly linked to the amount of taxes they’ve paid into the system. That, experts on Social Security say, is what has sustained it politically for so many decades—workers believe they are paying for their own benefit. Breaking the link between taxes paid and benefits received would make Social Security seem more like welfare, a program in which income is transferred from those most able to pay to those who need more support.

“If we’re going to go this route where we no longer have a link between what you pay in and what you get back, then what is this program?” says economist Dean Baker, coauthor of the 1999 book Social Security: The Phony Crisis. “It’s enjoyed a lot of political support precisely because there was this link.”

And so, absent an immediate crisis—the Social Security trustees say the program can pay full benefits until 2041—the question for the candidates may not be how they would fix Social Security, but whether it should be fixed right now.