On Social Security funding and solvency:
“…
Q. You say Social Security is heading toward insolvency. What does that mean exactly? Is it going to go broke?
Arnold: Before I answer, it is important to understand how Social Security is funded. It is a self-funded pay-as-you-go program. That means it does not receive any money from general taxes, and by law, it cannot. It raises its own revenue through the payroll tax. We all pay a certain percentage of our base salary up to what has called the maximum taxable wage base, and our employers match everything we pay. Although the money is sent to Washington to be put in the trust fund, it’s quickly spent out immediately on beneficiaries.
The last solvency crisis was in 1983. At that time, legislators changed the tax and benefit formulas in ways that gradually built up the trust fund to almost $3 trillion. But right now Social Security is devouring its trust fund. Payroll taxes are no longer sufficient to pay all benefits. So, every month, Social Security withdraws more and more money from the trust fund. And the reason is the retirement of the huge baby boom generation. The next generation is not as large, so Social Security is not getting enough tax revenue.
Projections show that the trust fund will be empty by 2034. At that point, Social Security will have enough revenue to pay only 78% of benefits. And that is what we call the solvency crisis. It happened in 1977, and again in 1983, and each time legislators came together and fixed it. But Congress has been ignoring the problem since 1994, when the actuaries first identified it.
Q. What are some of the options for fixing the solvency problem?
Arnold: Since we have had two solvency crises in the past — 1977 and 1983 — let’s see how legislators fixed the problem then. The first time, they simply raised the payroll tax rate by 25% and the maximum taxable wage base by 68%. Six years later, they switched course. They effectively cut benefits by raising the full retirement age from 65 to 67, phasing it in over four decades. So, those are the two basic options: raise taxes or cut benefits.
You could do similar things today.
For example, to make Social Security solvent for the next 75 years, legislators could raise the tax rate from 6.2% to 8.1%. According to current actuarial projections, this would fix the problem until 2095. So, it is fixable, but painful.
Alternatively,
legislators could close three-quarters of the long-term deficit by immediately abolishing the maximum taxable wage base (currently $147,000), thus subjecting all wages to taxation. Or they could raise the full retirement age to 68. This would close one-seventh of the long-term actuarial deficit.
Legislators could also
change the way benefits are adjusted for inflation. They are currently adjusted with the consumer price index. Some economists think this index overstates inflation. They suggest using an alternative index called the chained price index. If you switch to that index, you would solve one-fifth of the long-term deficit. …”
Social Security remains beloved and holds bipartisan support among American citizens. Yet the program faces an insolvency crisis. Doug Arnold, an emeritus professor at the Princeton University School of Public and International Affairs, outlines workable solutions in his new book.
www.princeton.edu
