6 Ways to Fix Social Security

Here's the problem with Social Security: the money coming in is no longer enough to pay full benefits. Workers currently pay into the system through a payroll tax of 6.2% on up to $118,500 of earnings in 2015; employers pay another 6.2%. If more money comes in than goes out (as it has in the past), the surplus goes into a trust fund, which is invested in special Treasury securities. Interest on the securities fattens the fund, as does a tax on benefits for some beneficiaries.

But people are living longer and fewer workers are around to support them. Since 2010, the Social Security Administration has been using the interest on its securities to cover the shortfall. Without a fix, it will have to start redeeming the securities themselves by 2020; the fund will run dry in 2033. At that point, payroll taxes plus the tax on benefits will cover only three-fourths of the full benefit.

Despite dire predictions, partisan disputes and a natural tendency to procrastinate, Congress is not about to let Social Security go south. And when it does decide to fix the social insurance program, the ideas will come from both sides of the aisle. Look for these six proposals to be on the table when Congress finally sits down to talk turkey.

Congress already made this fix once, when it bumped the full retirement age to 66 for people born from 1943 to 1954 and to 67 for people born in 1960 or later.

Given that life expectancies continue to increase and that people are working longer, raising the full retirement age to, say, 68 or 69 (in other words, a benefit cut) makes sense, says Andrew Biggs, of the American Enterprise Institute, which studies policy issues. A variation of the idea indexes the full retirement age to increases in longevity rather than raising it according to a set schedule.

In 1983, when the earnings cap was $35,700, it captured 90% of all wages; the cap, which rises each year as wages rise, is now $118,500, but rapid wage growth among high earners means the tax applies to about 85% of all wages. Raising the cap over the next several decades to cover 90% of all wages (a proposal that would affect about 6% of earners) is an easy fix that most people support, says Bill Hoagland, senior vice-president of the Bipartisan Policy Center.

Eliminating the cap is another matter. With this option, favored by a majority of respondents in a recent survey by the National Academy of Social Insurance (NASI), taxes would go up significantly for people at the high end of the earnings spectrum. (Imagine the ding on Kobe Bryant's full salary and you get the idea.) Benefits for high earners would also go up, but not by as much as they paid in, because of the nature of Social Security's benefit formula. The prospects for removing the cap? Almost nil, says Hoagland.

Social Security benefits are based on workers' highest earnings over 35 years, adjusted for wage growth. But the system uses a progressive formula that replaces a higher portion of income for lower earners than for high earners. Changing the formula to reduce benefits across the board is a nonstarter, says Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget. "It makes much more sense to protect people who depend on the program and ask people who need it less to get less in benefits."

Among the options: Maintain the same replacement rate for low earners--say, the bottom 30%--and reduce benefits for earners above that level on a sliding scale. "We want the program to be strong for low-income people who are too poor to save and don't get pensions at work," says Biggs, of the American Enterprise Institute. "There's no reason upper-income people can't save more for retirement." As for eliminating benefits for high earners, that idea would change the concept of Social Security as an earned benefit and has never generated much support.

Currently, Social Security benefits rise along with annual increases in the consumer price index. Economists have suggested that another price index, known as the chained CPI, more accurately reflects how consumers react to price rises--that is, by subbing hamburger for flank steak or chicken for beef. Switching to the chained CPI would lower the annual increase for inflation by an estimated 0.3 percentage point, according to a report by the American Academy of Actuaries, and reduce about one-fourth of the Social Security deficit.

The idea, endorsed by several bipartisan panels as well as President Obama, will probably be part of any future discussion, says Biggs. It is the only solution likely to be adopted that would affect current as well as future beneficiaries.

One obvious way to fix Social Security is to have workers pony up more. Boosting the tax by a few percentage points (split evenly between workers and employers) would solve the problem immediately, whereas a gradual hike of 0.1 percentage point a year over 20 years would minimize the pain for workers, whose real wages would presumably grow at a faster rate.

Amidst talk of raising revenues and cutting benefits, this proposal stands apart: boosting benefits for vulnerable populations.

Suggestions include creating a minimum benefit that would keep longtime low earners above the poverty level, increasing benefits for the very old and extending the age at which dependents lose survivor benefits. Groups with representatives from both sides of the political debate have shown a willingness to consider such targeted increases. Expect them to be part of an overall deal.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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