Saving Social Security before it's broke

 

Saving Social Security through simple tax reform

Planning for the coming crisis

 

Gordon L. Weil

Tax reform.  Everybody talks about it but nothing happens.

President Trump might disagree.  After all, taxes were cut for the wealthiest sliver of the population and partially removed on tips.  Unlike traditional Republicans, he does not promote tax cuts to trickle down to create jobs; it’s simply a reward to the rich.

Trump’s critics say that everybody ought to “pay their fair share.”  Billionaire Warren Buffet says he pays at a lower rate than his secretary.  Paying his “fair share” would increase his taxes.  If the people like him are not taxed appropriately, the cost of government boosts the public debt, ultimately raising the tax tab through inflation.

Government spending could be reduced.  Social Security benefits will automatically be less without reform.  In 2032, its retirement reserve fund will be gone and payroll taxes will only cover 78 percent of benefits, which would have to be cut.  There’s a surplus of talk about the problem and a deficit of action.  The clock ticks on.

The 1986 tax act produced real reform.  Taxes were simplified, loopholes were eliminated, and rates were reduced.  Then, with the help of Congress, the big players went to work gaming the new rates and cutting their taxes.  Simplification was lost, together with real reform.  Renewed tax reform could recover some of the 1986 progress.

Taxes could be simple, with fewer loopholes – deductions, exemptions and special rates.  Revenues could increase with lower rates.  Administering the tax system would cost less.  The wealthiest would pay their fair share, supporting government services from which they benefit.  But the wealthiest would get around a new round of tax reform. 

What worries some people about the talk of tax reform is the language of the most aggressive would-be reformers.  Advocates make the system sound so deeply unfair today, that confiscating wealth would be justified.  These extreme reformers attack “oligopoly.”  In turn, they are attacked as “socialists.”  The result?  Talking about tax reform makes a lot of people feel uneasy.

The temperature of the debate could be lowered by learning a couple of lessons from the current tax system.

Trump falsely claims that he eliminated taxes on Social Security.   Instead, he successfully added a limited, three-year tax cut for many seniors, which he claimed cancelled the tax on their benefit payments.  Though it did not fully cover the tax, Trump successfully sold the temporary measure as a major Social Security reform.   Marketing matters.

Social Security contributions are paid at the source.  The party that pays a person’s income also pays the Social Security contribution for itself and the recipient directly to the government.  It’s a flat rate, with no loopholes.  The contribution base is capped at a specific income ($184,500 in 2026); any higher payroll income is free from any contribution.

Social Security can be saved and taxes reformed with no increase for more than 90 percent of taxpayers by a simple reform.  It would not touch the Internal Revenue Code and could readily be adopted by Congress.

The cap on income subject to a Social Security contribution should be eliminated and the definition of income should be changed.  Income to any taxpayer from any source could be subject to the contribution.

The Social Security contribution is now based only on wages paid to individuals.  The base could include all income paid for wages, government payments and investments.  That way, tax evasion by failing to accept a wage could be avoided.

The annual amount of U.S. personal income above $200,000 is estimated at $7.5 to $8 trillion.  The Social Security self-employed tax rate of 12.4 percent would produce about $1 trillion a year from individuals. That would cover the Social Security shortfall, with the surplus going into general federal revenues to fund debt payments, tax cuts or increased benefits.

(Medicare contributions are not subject to an earnings cap.) 

This reform would increase taxes on the wealthiest without allowing loopholes.  With payments to the government coming directly from the source, the taxpayer would not take any action.  Benefits need not be changed.

Companies could also be made subject to making Social Security and Medicare contributions on their retained profits. No loopholes would be available. If corporations have the rights of individuals, they should be treated like them and be contributors.   These contributions would have to be meshed with existing corporate taxes. 

Major individual and corporate contributors might argue that higher taxes thwart their investment in growth.  Economic studies question that argument.

This reform could be marketed, à la Trump, as “Save Social Security,” reassuring lower-income recipients and getting an indecisive Congress off the hook.  Social Security already has elements of income redistribution, so the reform would be doing nothing new.

This could be one way to deal with deficit spending and Social Security.  It’s worth a look.

 

Social Security war looms

 

Gordon L. Weil

The war over Social Security is on the verge of breaking out.  It will run short of funds to pay for promised benefits in less than 10 years.

Many American leaders intentionally ignore the issue, which may be the most important economic and political challenge before them. They dodge the problem because there are only two solutions – raising taxes or cutting benefits, and both are politically dangerous.  Facing only downsides, politicians push the problem off, making it worse.

Either payroll taxes will have to be raised or retirement and disability payments will have to be cut – or both – to keep the program solvent.  The aging population does not include enough people paying payroll taxes to cover the costs of benefits for current beneficiaries.  Expenses rise, but income either does not rise as fast or might decline.

The Republican textbook answer is that revenues could be increased if Social Security reserves could be invested in the stock market instead of lower interest Treasury debt.  Over time, the financial markets have grown, though during recessions and other economic setbacks, they have faltered.  This proposal has not been endorsed by Congress, but it lives on.

Treasury Secretary Scott Bessent said a provision of the One Big Beautiful Bill, known as Trump accounts, “is a backdoor for privatizing Social Security.”  Trump accounts give newborns an account of $1,000 with gains used to supplement their education spending when they are 18. 

After he set off immediate alarms, Bessent retreated, claiming that privatization would supplement Social Security, not replace it. Two funds, the original and the add-on, would co-exist.

Trump accounts will come at a cost to taxpayers, and so would a parallel investment fund.  Does Bessent propose taking part of the payroll tax revenues for private investment, thus reducing the reserve for paying benefits that would otherwise flow from the original Social Security?  Would for-profit investment firms handle the add-on funds?

Though not an exact parallel, this proposal sounds like a variation on Medicare Advantage, run by insurers, instead of using original Medicare, operated by the government.  Recent reports suggest that the insurers put profits over health care, and retirees may suffer both physically and financially.

Two senators have proposed creating a separate fund from the Social Security Trust.  Revenues from that new fund would be used to close the gap between traditional benefits and the money available from the Trust.  The new fund could invest in the stock market rather than only in U.S. Treasury debt, as does Social Security.  After 75 years, it would repay its balance to the Trust.

This proposal would require an initial investment to get the new fund into operation so that it could produce enough income to cover the benefit shortfall and to maintain its assets, enabling it to survive for 75 years.  The senators estimate that it would take $1.5 trillion to create the fund, right from the start.  What would be the source of that seed money?

Social Security was originally intended as a retirement supplement to other income and, based on the life expectancy at the time, it was not planned for payments stretching over decades, as they now do.  For many people, it has become their main or entire source of retirement income. In effect, it may have come to be widely, if not openly, considered a national retirement plan.

In the U.S, there is a belief, virtually the Eleventh Commandment, stating: “Thou shall not raise taxes.”  If Social Security must abide by that rule, the only realistic option is to reduce benefits.  That’s what many pre-retirement people accept as inevitable, though they themselves may have failed to save for their later years.

Bessent and others seem to believe that investing in the market will increase returns enough to ensure Social Security will never have a shortfall.  Retirement payments would be hostage to the performance of those making the investments – amounting to an act of blind faith.

Congress has been approving changes that reduce the shortfall by boosting the age to receive full benefits, raising the cap on how much income is subject to the payroll tax and making most of the benefits for higher income people subject to income taxes.  These are all helpful, but not enough to close the gap.

A wide array of other options is available, and it is possible to estimate the effect of each of them on reducing the Social Security shortfall.  You can be the policy maker by using this questionnaire.  Go to the Revenues (or the other tabs) tab and make your choices, and you will see their relative effect. 

Note that diversifying Social Security investments, the Bessent idea, only solves 6% of the problem.  It’s not the solution.

Have fun with the questionnaire.   Members of Congress ought to give it a try.