How can Social Security be saved?

My wife and I have been receiving monthly Social Security payments for several years.  We also receive monthly payments from other retirement programs, so we are lucky not to depend only on Social Security for financial support. Still, Social Security is an important part of our monthly income.

This means that like the other 68 million people who receive regular Social Security checks, we are worried. Why?  Because on its current path, in ten years everyone’s Social Security check will be cut by almost 20%.  Stated another way, by the mid-2030s Social Security won’t have enough incoming revenues to pay what the system promised to pay recipients.

The reason is demographics.  For decades we have been moving toward a larger-age-heavy population.  The big “baby boomer” generation – of which my wife and I are members – has been increasing the number of Social Security recipients.  Also, older people are living longer.  And to add to the problem, with all-time low birth rates, at some point we could see an actual decline in workers who contribute to Social Security.  This is important because Social Security payments to retirees depend both on what the retirees contributed as well as what current workers are paying.

We’ve been down this path before. Social Security faced shortfalls in the 1980s, also due to the same types of demographic changes.  A commission was appointed to find a solution.  They did, and Social Security has been running on that solution for over forty years.  Among the elements of the solution were an increase in Social Security tax rates and an increase in the age for receiving full Social Security benefits.

I predict we will follow the same process for dealing with today’s Social Security problem.  I expect a broad-based commission will be formed in the early 2030s,  and it will agree on a fix for keeping Social Security financially solvent.

So what might the solution be?   In my viewpoint, there are only four options:  increase Social Security revenues, decrease Social Security benefits, both increase Social Security revenues and decrease benefits, or scrap the current Social Security system and install a totally new system.

Let me give some details on each of these possibilities.  For increasing revenues, there are two major options. One is to increase the Social Security tax rate on earnings, which is currently 6.2% paid both by the employee and employer on the first $168,000 of earnings.   Why is there an income limit for the tax?  It’s because Social Security benefits to recipients stop rising at the limit.  If taxes were paid on earnings above that limit, then the worker would be paying more but without receiving higher benefits.  The framers of Social Security in the 1930s wanted to avoid Social Security being viewed as a welfare program.  Incidentally, the payment limit (now $168,000) is raised each year by the previous year’s inflation rate.

The second option is to scrap the earnings limit and apply the Social Security tax to all earnings, even while continuing to use the limit to stop increases in benefits for people with earnings about the limit.  Of course, this would turn Social Security into a partial welfare program, meaning recipients with earnings above the limit would pay more but with no additional benefits.

Social Security can easily change payments by adjusting the formula used to calculate those payments.  Currently, Social Security breaks a worker’s lifetime income into segments, applies a factor to each of those segments, and then does a calculation to determine the worker’s monthly payment from Social Security. Payments can easily be altered higher or lower by adjusting the segments and the factors for each segment.  Also, Social Security can make different changes for different income groups. So, for example, if it wanted to, the Social Security system could reduce payments to recipients with higher earnings and raise payments to recipients with lower earnings.  Indeed, under the current system, lower income earnings receive a higher percentage of their earnings in Social Security benefits than higher income earners.

Social Security uses past inflation rates in many of its calculations to make earnings in past years comparable to the purchasing power of earnings in more recent years.  But since there are numerous measures of price inflation, Social Security can lower payments by choosing a less generous inflation measure.  This is also a possibility.

Many would consider the changes discussed above as minor adjustments.  These critics argue Social Security should go bold in its next set of changes.  One long-discussed option is the idea of investing some of Social Security’s revenues in the stock market.   Currently Social Security is legally limited to investing funds in US Treasury securities.   While safe, these investments pay a relatively low rate of return. 

While over the long run investors will earn a much better rate of return in the stock market, there’s always the possibility they won’t over a specific time period.  The framers of Social Security also worried about the influence Social Security could have on the stock market with its large investments, and they wanted to avoid this.

My guess is the next commission on Social Security will choose the option of increasing some revenues while reducing some payments, mainly for higher income earners.  This is the approach used by the 1980s commission. 

With a few exceptions, virtually everyone in the country is already receiving Social Security benefits now or will when they retire.  This means dealing with the looming shortfall in Social Security is very, very important. In a few years, there will be a commission to save Social Security.  My advice is to listen to what is proposed, and then decide what is best.

Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.