As a member of the President's Commission on Fiscal Responsibility and Reform, which is charged with producing a bipartisan plan to rein in future budget deficits, I get to hear the favorite deficit reduction schemes of friends, acquaintances and strangers. A surprising number lead with Social Security. Some begin, “The first thing is to raise the retirement age in Social Security, which would fix a big part of the problem, right?” (Wrong). Others are afraid the Commission will recommend cutting the benefits of elderly widows living on the edge of subsistence (absurdly unlikely). Many insist that Social Security, because of its separate funding, plays no part in projected federal deficits (also wrong), and therefore should be exempt from the deficit-cutting exercise. As usual, the real story is more complex.
The right reason for saving Social Security is to reassure all Americans that this hugely successful program is solidly funded and will be there for the millions who depend on it when they need it. That such action will make a modest contribution to reducing long run deficits is a serendipitous by-product, not the central motivation. The reason for acting now rather than later is simply that the sooner we act the less drastic adjustments we have to make. These adjustments can involve revenue increases, future benefit reductions (including retirement age changes), or some of each. They need not be large if they are done soon and they need not have a significant effect on those currently retired or close to retirement.
Here is a quick refresher on how Social Security works. Workers and their employers pay Social Security taxes on their wages (up to a limit of $106,800 increased annually for inflation) during their working lives and are entitled to benefits when they retire, become disabled or die leaving survivors. These payments are credited to a fund from which the benefits are paid.
Since the last reforms in 1983 Social Security has run a cash surplus. More money was coming into the fund in payroll tax collections than was needed to pay current beneficiaries. The excess was invested in special Treasury bonds that pay interest. However, with the retirement of the baby boomers and increasing longevity driving up benefit payments, as well as high unemployment reducing payroll tax collections and swelling disability rolls, that cash surplus is fast disappearing. Looking forward, current tax collections will not be enough to fund all benefits; so part of the benefits will have to be paid from the accumulated interest or from cashing in the Treasury bonds. By about 2037, on current calculations, the accumulated interest will be used up and the bonds will all be cashed. Payroll tax collections will still be coming in, of course, but will only be sufficient to pay about three quarters of the benefits due. If nothing is done before 2037, benefits will have to be cut immediately by a quarter (and more thereafter) or the government will have to find the money elsewhere to make up the difference. The system won’t “go belly-up,” as some scare-mongers allege, but it will require dramatic adjustment either in benefits, revenues or both.
If no crisis is projected in the Social Security fund itself for 27 years, why should Social Security be part of the current deficit discussion? I see at least three reasons. First, this is the best time to put Social Security on a sound sustainable track. The only better time would be last year or any year before that. Workers need to know that Social Security will be there when they need it so that they can make other retirement plans on top of a secure base. People who will reach retirement age in 2037 aren’t faceless “future generations.” They are our younger colleagues in the workforce whose payroll taxes are deducted from every pay check – and most of them have been paying those taxes for at least a decade already. They deserve to know that they are contributing to a robust system, one with benefits that they can count on in their retirement planning. Polls indicate that many of them do not believe they will ever collect any benefits.
Moreover, the sooner we act, the smaller the adjustments need be, whether they are benefit reductions, tax increases or some of each, because small changes cumulate over time. We have already waited too long. We should fix Social Security now to avoid more painful changes later.
Second, fixing Social Security now would not only reassure future retirees. It would build confidence both at home and abroad that our political system can still function to solve important problems. It is true, as we keep telling ourselves, that the United States is not Greece. But our public debt is on a dangerous trajectory with no end in sight. World markets have a tendency to plunge rapidly when confidence erodes. Unless we demonstrate an ability to get our house in order we risk a Greek-type debacle at some point. Legislating future Social Security adjustments now is particularly attractive as a signal to the markets because there are essentially no adverse implications for our current recession-ridden economy. We have to fix it sometime, so show we can do it now?
Third, the interaction of an aging population with rising health care spending is the reason federal spending is projected to rise faster than the economy can grow over the foreseeable future. Spending for Social Security alone is projected to rise from about 4.8 percent of Gross Domestic Product (GDP) in 2010 to about 6.2 percent by 2035, when most of the boomers will have retired. That is not a trivial increase in spending, even though spending for Medicare is projected to rise considerably faster—from 3.6 percent of GDP in 2010 to 5.9 percent in 2035 even if we are very successful in cutting the growth of medical costs. Tax increases can be part of the solution, but we cannot raise taxes continuously to offset the growth in spending without eventually damaging the economy, and we can’t afford to keep borrowing increasing amounts, so we have to find ways to keep total federal spending from growing significantly faster than the GDP.
The fact that programs for seniors are driving projected spending increases doesn’t mean they should bear the brunt of the cuts (surely an aging democracy will spend relatively more on older people than a younger one). But neither should programs for the aging be immune. In particular, do we want to allow rapid growth in programs supporting seniors (including Social Security) to drive out spending for education or scientific research or improving infrastructure that might contribute more to future economic growth? Strong growth will ease the economic burden of an aging population, and weak growth will compound it. Fixing Social Security in the context of broader deficit reduction allows us to debate those competing priorities. Those who believe that slowing federal spending growth is necessary to curb future deficits, but want to exempt programs for the aged, need to say why, for example, it is more important to continue increasing benefits for upper-income retirees than to nourish low-income children.
If a higher retirement age will be part of a package of Social Security Reforms, it needs to be phased in slowly and carefully. The age at which retirees can draw full benefits has been rising gradually under a law passed after the 1983 reforms. It now stands at 66 and is already scheduled to rise to 67 in the future. However, workers can choose to retire as early as 62, on reduced benefits—benefits calculated to give them the same total amount as they would have gotten if they had retired at the normal age. At least 40 percent of workers retire as early as they can (age 62) and only a few continue working to the full retirement age (66) or later. In other words, most workers choose to take lower benefits than they could obtain by working longer—some because they want to retire and can afford to forego the larger benefits and some because they cannot work any longer and need the money right away.
Raising the retirement age is a way of reducing benefits across the board. Those who favor increasing the normal retirement age beyond 67 emphasize the fact that people live considerably longer than they did when Social Security was created and seniors are more active than they used to be. This fortunate development means that many people can continue working productively longer than their parents did. The problem is that increases in longevity and health have been concentrated among people with higher earnings and more education. Many jobs take a heavy toll on the human body, or require being on one’s feet for long hours at a stretch. The fact that so many people opt for early retirement at lower benefits suggests that many have lost their jobs or simply can’t work longer.
Increasing the age of full retirement in the future (to, say, 68, or 69) without changing the early retirement rules would mean even lower monthly checks for those retiring at 62 or even 65. Some would stay in the labor force longer, but those unable to do so would just have less money to live on. Those whose checks were reduced most would likely be those who had low earnings over their working lives and accumulated few assets. Raising the early retirement age (i.e., saying no one could collect even reduced benefits before, say, age 64), would mitigate these reductions in monthly checks—and would likely keep more workers at their jobs longer--but it would be even harder on people in their early 60s with physically demanding jobs and no other options.
A package of Social Security reforms that includes raising the age of full retirement or the early retirement age or both should include measures to assist those who physically can’t do their current jobs and create new kinds of jobs for older workers. The cost of these measures would reduce the savings from increasing the retirement age. Hence, the benefits of increasing the retirement age could be more difficult to achieve and even further in the future than proponents suggest. Alternative benefit reductions, especially those reducing future increases at the top end of the income distribution, should also be considered, along with measures to augment revenues, such as accelerating the increases in the limit on earnings subject to the payroll tax.
Opponents of including Social Security in a deficit reduction plan, sometimes point out that Social Security has been running surpluses for decades. Investing those surpluses in Treasury bonds meant the government was borrowing from Social Security to fund other spending. Now that the time has come to redeem those bonds, they say, Social Security should not be “punished” by having to share in the reduction of future deficits. But putting Social Security on a sound fiscal footing is not “punishing” the system or its beneficiaries. The bonds held by Social Security are obligations of the United States and will be paid. But current and future workers need to know that Social Security will be there for them, and the way to reassure them is to act now to adjust the future benefits, revenues or both. Immediate action is best for Social Security. That such action will also modestly reduce long run deficits and show the world that our political system is not totally gridlocked is just icing on the cake.