The current federal budget deficit stands at $1.6 trillion. As disturbing as that is, the real cause for concern lies in the alarmingly unsustainable long-term growth of entitlement spending. The Congressional Budget Office projects that Medicare, Medicaid, and Social Security—by far the largest federal entitlements—will grow from about 10 percent of GDP today to about 16 percent by 2035. Social Security, in particular, is expected to remain solvent—able to pay all legal benefits—only until 2039. The good news is that improving Social Security solvency is a relatively simple problem, and one solution, increasing the progressivity of benefits, could be acceptable to both political parties.
Social Security is an unfunded entitlement: Current workers and employers each pay a 6.2 percent payroll tax on earned income, up to an inflation-adjusted cap—$106,800 in 2010—that is deposited in the Social Security Trust Fund. The Trust Fund, in turn, makes payments to eligible citizens, those who are not working because they are either disabled or retired, the latter of whom must have reached the minimum retirement age (between 65 and 67 years depending on date of birth). Long-term spending is unsustainable because of the aging population resulting from a declining fertility rate and the retirement of the baby boomers; whereas there were 8.6 workers paying taxes for each retiree receiving benefits in 1955, there are now only 3.2, and the Social Security Administration estimates the ratio could drop as low as 2.1 by 2031.
Whereas the solution to out-of-control healthcare spending is extraordinarily complex, the answer to this problem is simple: Congress must either raise taxes or cut benefits, or some combination of the two, and must do so in a way that does not affect current retirees or people soon to retire. All that is needed is for the government to muster the political will. It’s been done before. As Jeremy A. Patashnik ’12 explains in the Harvard Political Review’s “Annual Report of the United States,” Congress passed both a payroll tax increase and a gradual increase in the retirement age in 1983 that put the Trust Fund on its current trajectory.
Whether such compromise is possible in today’s political environment is a different story. Among the proposals President Barack H. Obama’s debt-reduction commission has offered for extending solvency are indexing the retirement age to life expectancy, reducing the rate at which benefits increase to adjust for inflation, and increasing the payroll tax cap. Democratic leaders have already balked at the proposal’s effects on benefits for the middle and lower classes, and Republicans, if the current debate in Congress is any indication, are not about to accept a tax increase.
But there is one aspect of the plan, reducing benefits for the wealthy, that might draw support from both sides. The size of a monthly payment to a beneficiary is called the “primary insurance amount” and is based on what is called the “average indexed monthly earnings,” the beneficiary’s average monthly wage during the highest 35 years of earnings on which he paid payroll taxes.The PIA is 90 percent of the first $761 of the AIME, plus 32 percent of the AIME between $761 and $4,586, plus 15 percent of the AIME above $4,586. Benefits, in other words, are progressive: Low-income people receive a greater fraction of their AIME than high-income people.
The debt commission proposes reducing benefits by increasing the progressivity of the benefit formula. Gradually reducing the PIAs for the wealthier half of Social Security beneficiaries along the lines of the Commission’s recommendations would eliminate 45 percent of the Trust Fund shortfall over 75 years. The CBO released an analysis of a similar proposal that would reduce the top two PIA factors by one-third for new beneficiaries beginning in 2017, which would extend the Trust Fund exhaustion date beyond 75 years from now. Scheduled benefits would fall by 24 percent for high-income earners and just three percent for low-income earners.
The beauty of improving solvency by cutting benefits for people with high incomes is that it satisfies the ideological requirements of both political parties. For one thing, it complies with both parties’ moral philosophies: Democrats believe the wealthy should sacrifice to balance the budget, and Republicans oppose government redistribution to people who are capable of providing for themselves. It would also minimize economic impact from the perspective of both the liberal and conservative schools of thought: Keynesians would be pleased that it reduces payments to those least likely to spend the money, and supply-siders could note that it downsizes the government and would not impact incentives as severely as the proposed tax increase.
One should hasten to add that while the plan the CBO analyzed would dramatically extend solvency, it is not “sustainably solvent” since outlays would increase more rapidly than revenues after implementation. Permanent sustainability might require more extreme cuts in benefits to the wealthy, or the combination of this strategy with one or more others. That said, the longer we wait to make needed reforms, the more we will eventually have to either raise taxes or cut benefits. Whatever approach it takes, Congress needs to act sooner rather than later. Cutting benefits for those who don’t need them might be a good place to start.
Peyton R. Miller ’12 is a government concentrator in Winthrop House. His column appears on alternate Wednesdays.