Social Security: Safety Net in Need of Repair

By Marvin L. Stone

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AUGUST 2005 - When Social Security was established in 1935, wages up to $3,000 were taxed at 2%, with the employee and employer each paying half. Over the years, both the rate of tax and the wage base have increased; currently, wages up to $90,000 are taxed at 12.4%. Social Security has also been expanded to include self-employed individuals, who pay a tax equal to that paid by the employee plus that paid by the employer.

President George W. Bush has described Social Security as a safety net that has a hole in it. The “hole” can be defined as the impending inability of Social Security to fulfill its obligations because benefits paid will exceed both current tax receipts and the sizable reserves ($1.7 trillion at the end of 2004) that have been accumulated to date. President Bush proposes mending the hole by allowing workers to invest a portion of the payroll taxes that would otherwise be paid into the Social Security Trust Fund into private accounts that would be invested in stocks and bonds. Unfortunately, diverting funds that would otherwise be paid into the Social Security Trust Fund into private investments would increase, not decrease, the size of the hole in the safety net.

Fostering a system of such private accounts to augment Social Security is the first step to doing away with Social Security entirely. While Social Security is not without its flaws, it has managed to provide a safety net for millions of Americans for 70 years and can continue to do so with modest adjustments. Starting down the road to complete privatization of Social Security is tantamount to throwing out the baby with the bathwater.

Keeping Social Security solvent requires that the Trust Fund receive funds at least equal to the benefits it disburses. While President Bush has repeatedly refused to consider an increase in the payroll tax rate, there have been indications that raising the $90,000 income cap on which the tax is levied might be politically palatable. Increasing that base, which has been increased every year since 1973, would affect only those wage earners and self-employed individuals in upper income brackets. For example, increasing the income cap from $90,000 to $100,000 would cost a wage earner who earns $100,000 or more $765 and a self-employed individual $1,530.

The age at which wage earners can begin receiving Social Security retirement benefits has been fixed at 65 since 1935. That age is now scheduled to rise to 67. Life expectancy has increased from 61.7 years in 1935 to 77.3 years in 2004. As a result, many more Americans are eligible to draw Social Security benefits. Greater life expectancy has increased work-life expectancy as well, because Americans tend to retire much later than was the case in 1935. It is time to raise the retirement age further, to reduce the outflow of benefits.

To further improve the solvency of the Trust Fund, Congress should consider initiating a means test for those receiving Social Security benefits. To multimillionaires, Social Security benefits are hardly a safety net. Therefore, limiting the payment of Social Security benefits to individuals with incomes of less than, for example, $250,000 per year should substantially reduce the outflow of benefits from the Trust Fund. Such a means test should be adjusted annually in step with changes in the cost of living. A kind of means test is already applied via the income taxation of Social Security benefits: Individuals with little income pay no tax on their Social Security benefits; those with higher income pay tax on as much as 85% of the benefits received.

Other than payroll taxes, the Social Security Trust Fund’s only other source of income is interest on its invested surplus. As of December 31, 2004, that surplus totaled $1.7 trillion. By law, the trustees must lend surplus funds to the U.S. Treasury. President Bill Clinton suggested in 1999 that the trustees should be permitted to invest the fund’s surplus in marketable securities as well as in U.S. Treasury obligations.

President Bush has stated that market investments could produce a greater rate of return than do the U.S. bonds currently held by the Trust Fund. Those greater yields should be earned within the Social Security Trust Fund rather than within private accounts. It is doubtful that the average American possesses sufficient knowledge and discipline to successfully manage the private account suggested by President Bush. Relying on the established Social Security Trust Fund management is more likely to provide the desired safety net over time.

Even if no changes are made in the law governing Social Security, the Trust Fund will be able to pay promised benefits until 2042, according to Social Security Administration actuaries—more than 100 years since Social Security was originally enacted. While no changes will guarantee the fund’s solvency forever, by enacting the changes described above, Social Security may well be able to fulfill its obligations to the American public for another 100 years.

Marvin L. Stone is a CPA in Denver, Colo.




















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