What's the Big Idea?

The Social Security debate boils down to one key question: Can the current system handle the retirement of the baby boomers—the nearly 77 million Americans born from 1946 through 1964—and still be in good shape for the generations that follow?

Today the system is taking in more than it spends. If nothing is done in the meantime, that situation will be reversed around 2018—some 10 years after the oldest boomers turn 62 (the age of first eligibility for benefits).

Although estimates vary, Social Security should have sufficient funds to pay full benefits until sometime between 2042 and 2052. But rather than cash in the bonds held by the system’s trust funds—which would require the government to raise taxes, borrow money or cut budgets because lawmakers have been tapping the funds to cover other expenses—many experts agree that it would be better to take steps soon to keep the system solvent.

The debate about creating private savings accounts is actually a distraction because, as President Bush has acknowledged, the accounts would do nothing to shore up Social Security’s balance sheet. Money siphoned off to fund the accounts would have to be replaced in order to continue paying the benefits promised to those already retired or approaching retirement. There’s little disagreement that carving private accounts out of Social Security would make balancing its books much harder.

So what would help? Social Security actuaries and Congressional Budget Office analysts agree that the system could be kept solvent for the next 75 years—longer-range forecasting is meaningless—if two changes were made immediately: raise the combined employer-employee payroll tax rate from the present 12.4 percent to about 14.3 percent—that’s a 15 percent hike. Or cut benefits by about 13 percent.

No one, of course, is suggesting such changes. But the numbers are useful in showing that Social Security doesn’t face an unbridgeable financial gap, let alone bankruptcy. Revenues and expenses over the next 75 years are projected to be quite close: Social Security’s trustees anticipate a shortfall equal to less than 2 percent of payroll (total taxable earnings).

Experts and politicians have floated many ideas about how to close that gap. Here are nine ways to increase revenue and trim costs.

Raising Revenue

1. Raise the cap
In 1983 Congress agreed on a goal of taxing 90 percent of all wages in covered employment. Under present law, earnings above a specified cap—which rises as average wages rise and is currently set at $90,000—are not taxed. But incomes of the nation’s highest earners have risen much faster than those of lower-income workers, with the result that about 15 percent of total earnings now goes untaxed. Many experts advocate taxing more of those high-end earnings, and Bush hasn’t explicitly ruled it out.

Former Social Security Commissioner Robert M. Ball proposes lifting the cap gradually so that by 2045 it will once again capture 90 percent of all covered earnings. "This isn’t a new tax,"he notes. "It simply restores a policy already set by Congress—so it should attract bipartisan support."

The change would affect only about 6 percent of all taxpayers, but the increased net revenues would cut the projected shortfall by about 32 percent—or up to 40 percent if phased in faster.

A variation on this theme has been suggested by Sen. Lindsey Graham, R-S.C., who favors a "doughnut hole" approach: taxing earnings up to the present cap, exempting earnings up to a specified level above that, then taxing the highest earners of all. That way, he says, upper-middle-class earners wouldn’t be saddled with increased taxes. Graham would use the increased income to help meet the multi-trillion-dollar costs of transitioning to a system that includes private accounts.

2. Increase the payroll tax rate
Economists Peter Diamond and Peter Orszag would very gradually increase workers’ contributions and matching employer taxes from 12.4 percent of payroll to about 15 percent over 70 years.

Here’s one way to think about the idea: Would you be willing to pay a 21 percent increase in premiums over several decades to maintain an insurance policy that protects you against lost earnings from disability, pays benefits upon your retirement as long as you live, and pays benefits to your survivors when you die? If the answer is yes, then this is an idea worth keeping on the table. It’s estimated that such a payroll tax increase could eliminate 100 percent of the long-term revenue shortfall.

On the other hand, the payroll tax is already high. Pushing it higher could be too hard on lower-wage workers. And Bush has said he would consider just about any idea "except running up the payroll tax rate."

3. Raise taxation of benefits
It’s often said that Social Security wastes billions paying benefits to affluent retirees who don’t need any help. As one Washington reporter put it, "My mom says her Social Security checks just cover the payments on her Jaguar."

The fairest way to fix this problem, some believe, is not to deny benefits to people who do well in life—that would penalize success—but to increase the taxation of benefits so that higher-income beneficiaries would make a greater contribution to keeping the system solvent. This change would reduce the shortfall by about 10 percent.

4. Preserve some of the estate tax—and dedicate it to Social Security
The estate tax is being reduced in stages. Instead of being phased out entirely, as Bush proposes, it could be kept at the level set for 2009, when only estates valued at $3.5 million or more ($7 million for a couple) will still be taxed. Rep. David Obey, D-Wis., among others, proposes such a plan. At that level, he notes, only one-half of 1 percent of all estates will be taxed. Doing away with the tax completely, he argues, would mean "a huge bonanza for those who are already the most fortunate in our society—at the expense of other taxpayers." This change would reduce the shortfall by about 27 percent.

5. Make Social Security universal
About 30 percent of all state and local government employees are not covered by Social Security. Many experts suggest that newly hired employees be brought into the system and share the obligations and the benefits. But some public employees would object, worrying that they might end up with less protection; and some state and local governments would be reluctant to pay their share of the payroll tax. So it’s unclear whether this idea could gain political traction. Ball would give state and local governments five years to modify their employment benefit plans. Making the system universal would reduce the shortfall by about 10 percent.

6. Invest some of the trust fund in indexed funds
By law the Social Security trust funds are invested in government bonds. Putting a portion into broadly indexed stock market funds could yield higher returns. Risks would be lower, because Social Security could ride out market swings far better than individuals, who might have to retire when the value of their account is down.

Several members of Social Security’s 1994-96 advisory council have proposed investing 15 percent of the trust funds in indexed funds. Canada has adopted direct investment for its version of Social Security, and Business Week recently recommended the same thing for the United States, arguing that "it looks increasingly as if the direct-investment approach would be cheaper and entail less risk."

Objections that the government might try to influence the market, either for "political correctness" (buying no tobacco stocks) or to prevent downswings, have lost some force lately because Bush’s private accounts plan, at least for now, also calls for having the government manage the funds. Depending on the amount invested, improved returns could reduce the shortfall by 15 to 45 percent or more.

Other ideas to raise revenue include:

• Provide for a small increase in the payroll tax rate 40 or 50 years from now, if needed to maintain a 75-year balance
• Tap new sources, such as a value-added tax on goods and services
• Partially fund Social Security from general tax revenues (an idea that could work if there were budget surpluses, but not with today’s enormous deficits)

Actuaries agree that Social Security’s shortfall would more than disappear if the relatively modest ideas outlined here were adopted. Some ideas aren’t likely to generate broad political support, but the math shows that even some selections from this menu could keep the system solvent far into the future.

Trimming Costs

Lawmakers have to worry about more than taking care of Social Security. Medicare faces major funding pressures, as does the federal-state Medicaid health insurance program. So there are arguments for slowing the growth of Social Security benefits.

Any proposal that cuts benefits outright should be approached with caution. Benefits were trimmed when the system’s financing was addressed in 1983. As a result, Social Security today provides less retirement income as a percentage of prior earnings than in the past, and the replacement rate, as it’s called, will continue to drop. For a medium earner it was 41.2 percent in 2000; by 2030 it is expected to be 36.5 percent. Moreover, the rising cost of Medicare Part B premiums is expected to have the effect of further reducing benefits by an estimated 9 percent on average by 2030. Here are a few cost-trimming ideas:

7. Adjust the COLA
Social Security’s annual cost-of-living adjustment (COLA) increases benefits to keep up with inflation. It protects 48 million beneficiaries whose buying power would otherwise dwindle over time. The COLA is determined by the Consumer Price Index (CPI), a measure that may overstate inflation by failing to fully reflect the purchasing substitutions that consumers make as prices rise.

The Bureau of Labor Statistics has developed a more accurate CPI, and Federal Reserve Chairman Alan Greenspan, among others, suggests adopting it. Although this would produce only slightly smaller COLAs, it would cut the long-term shortfall by about 18 percent. But many beneficiaries think the present COLA isn’t sufficient and would consider this an unjustified benefit cut.

8. Raise the retirement age
The normal retirement age—the age of eligibility for full benefits—is slowly increasing from 65 to 67. (It will reach 67 in 2027, for workers born in 1960.) Workers can still retire as early as 62, but with benefits reduced a fraction of a percent for each month before full retirement age.

One idea is to continue raising the normal retirement age as life expectancy rises. Edward M. Gramlich, a Federal Reserve governor who chaired the 1994-96 Social Security advisory council, is among those favoring this approach. Gradually increasing the retirement age to 70, he says, would make a "huge impact" but would be "hugely controversial" because people would think they had to work longer. Not so, he insists, because people could still retire earlier, although with lower monthly benefits. A "slight cut in the growth of future benefits," he says, is a fair way to deal with the fact that retirees are likely to live longer—and collect more in benefits—than in 1935, when the retirement age was set at 65. Raising the retirement age to 70 would cut the shortfall by about 36 percent.

9. Index benefits to prices, not wages
Social Security benefits are determined by how long you work, how much you pay in and by other factors, including the general rise in average wages over time. "Wage indexing" has helped lower the proportion of retirees living in poverty from 35 percent in 1960 to 9 percent today.

Bush and others have raised the idea of indexing initial benefits to prices rather than wages. Since prices generally rise more slowly, this would slow the growth of future benefits—as much as 46 percent on average over the next 65 years, according to economists Diamond and Orszag. Cutting benefits that much could have severe consequences. The Congressional Research Service reports that if benefits had been linked to prices rather than wages since 1940, poverty rates among the elderly would be three times as high as they are now, placing a tremendous burden on public assistance programs.

Another idea is to mix both types of indexing, using wage indexing to protect the benefits of lower-earning workers and price indexing to reduce the benefits of higher earners. Greenspan has reportedly explored this idea with Graham. A major drawback, however, could be that if the returns on their contributions to Social Security are reduced too much, higher earners would have a strong motivation to oppose Social Security entirely.

One of the reasons why Social Security has worked well for 70 years is that most people feel the system is fair. Social Security has always paid comparatively higher benefits to lower-earning workers, who might otherwise end up on welfare even after paying into the system throughout their working lives. But few people—except perhaps those opposed to the idea of social insurance—have felt betrayed by its redistributional structure. They may not fully understand how the system’s machinery works (very few people do), but they believe it produces basically fair outcomes.

For that reason alone it’s important not to rush into anything. Most Social Security experts agree that the system isn’t in crisis. There’s ample time, they say, for the country’s leaders to choose wisely from the available options and come up with a broadly acceptable solvency plan.

Thomas N. Bethell is a writer based in Washington, D.C. He edited Insuring the Essentials (Century Foundation Press, 2000), by former Social Security Commissioner Robert M. Ball.