Social Security’s future: The problem and the proposals part II

Social Security Benefits ReformRecent studies have rekindled fears about the Social Security program’s approaching insolvency without congressional action. Social Security reform has long been considered a “third rail” of American politics. The alternatives for preventing insolvency will undoubtedly result in suffering for sizable populations. Several members of Congress have come out with ideas to solve the issue. Not many tools are available to Congress to resolve the Old-Age and Survivors Insurance (OASI) fund deficit. However, it can generally lower benefits or raise trust fund revenues by doing things like:

Raising the retirement age

Depending on the birth year, retirees typically start receiving benefits at age 66 or 67 (reduced early benefits are possible from age 62). Several lawmakers and others advocate for the rise of the full retirement age. For those who were born in 1978 or after, some have suggested raising the eligibility age to 70.

However, the American Academy of Actuaries (AAA) highlights several potential issues with this strategy. For instance, extending the retirement age reduces benefits. Suppose those between the ages of 67 and 69 were required to continue working. In that case, jobs might not be available, particularly for those who engage in manual labor. A higher retirement age would disproportionately impact low-wage workers and those with higher death rates. It would also probably raise the price of employer-provided insurance and the cost of disability insurance.

Increasing payroll tax

On the first $160,200 in wages paid in 2023, employees and employers each pay 6.2% in payroll taxes for 12.4%. The tax rate could be raised, and the wage cap could be changed or eliminated to increase payroll taxes.

The AAA claims that, among all the numerous ideas and laws for resolving the impending deficit, “raising the tax rate best preserves the current system structure.” According to the Congressional Budget Office, if the overall payroll tax rate rose immediately and permanently to 17.6% (before considering the consequences of such changes on the economy), trust fund reserves would be sufficient to pay planned payments through 2097.

Others have proposed applying the tax to more significant amounts of wages. Some would use the tax for earnings greater than a specific threshold (for example, $400,000), creating a “doughnut hole” of income not subject to the tax.

The AAA notes that the fund could increase revenue without increasing benefits if only the contribution base increases, not the benefit base. Although the outcome would be comparable to raising the tax rate, only employees with incomes over the benefit base would be subject to the higher tax burden. In other words, wealthier earnings would suffer because of this.

However, the AAA claims that even factoring in the additional taxable profits would help. This is because the benefit formula’s other earnings would be towards the low end of the earnings spectrum, where the benefit formula percentage is the highest. Furthermore, while the extra tax income would start immediately, the additional benefits would gradually kick in over time.

Changing benefits formulas

The Consumer Price Index for Urban Wage Earners and Clerical Workers is the basis for COLA adjustments. The annual rises could slow using a different inflation index. Because early retirement years’ smaller benefit gains compound over time, this would result in net benefit reductions.

Other suggestions include altering the basic formula for retiree benefits or benefits for eligible spouses and dependents. The primary insurance amount, for instance, is what Social Security refers to as the base benefit and is based on average indexed monthly earnings (AIME), typically the average of a beneficiary’s most considerable earning years over 35 years.

The AIME for most workers could decrease by increasing the average years included when calculating the AIME. However, the AAA warns that this might have “particularly negative consequences” for workers without a regular income. An example is parents who quit their jobs to care for their children.

Implementing means testing

For affluent or high-income retirees whose current income or assets surpass a specific threshold, means testing often refers to decreasing or terminating Social Security benefits. Means testing proponents contend that individuals who don’t need financial assistance shouldn’t benefit from the program.

According to detractors, reducing or eliminating benefits for the wealthy would be unfair because they have made contributions and been promised perks just like everyone else. They also caution that this reform would weaken public support for Social Security, deter people from working in their older years, and promote spending rather than saving.

For more information on Social Security reform, visit the first post in this two-part blog series, “Social Security’s future: The problem and the proposals.” Contact our RRBB accountants and advisors if you have questions.

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