Social Security Reform

The Current System

Social Security began in 1935 to provide benefits to workers and their family members due to retirement, disability or death. It is attributed to be a major factor why the poverty rate in the US steeply declined during the last half century. Social Security is funded by the Federal Insurance Contributions Act (FICA) tax which is independent of federal income taxes. Workers and employees match equal amounts of the flat rate tax, currently 12.4% of each worker's wages. The funds are used immediately to provide for the obligations of current beneficiaries. The amount of benefits to workers depends upon their earnings during the course of their career as well as adjustments for inflation. Any surplus amount in excess of current obligations is invested in US Treasury securities.

In 1983, largely as a concern of the impending retirement of baby boomers, Social Security laws were altered to accommodate the influx of beneficiaries. The changes made were increases in payroll taxes, retirement age, and the tax cap for wealthy individuals and state government employees were added to pool of recipients.

The increase in payroll tax increased the percentage of income paid per worker, boosting revenues of the Social Security Trust Fund. The full benefit retirement age was gradually increased from 65 to 67 effectively reducing the length of payout per beneficiary. Many state & local governments provided pension plans for employees and were given the option to not participate in Social Security. To a large degree this was discouraged and new employees were no longer given the option of participation. This increased the pool of workers and subsequent revenue to payroll taxes. These changes led to the first ever surplus in the Social Security Trust Fund, which was invested in US government securities.

The 1983 reform provided the Social Security Trust Fund with a surplus, the first in its history, and is still producing a surplus today. But projections of costs to future beneficiaries indicate that further reforms are needed to accommodate the influx of retirees. Americans born between 1946 and 1964, nicknamed Baby Boomers, will begin retiring at the end of this decade and receive Social Security benefits for many years to come. Social Security will cost more than it has ever in the past. Baby Boomers are the major factor; other factors include increased average life span, immigrant populations, economic growth rates, and reproduction rates. Analysts attempt to predict future payouts based on these factors. All factors are subject to error, but predicting an influx in immigrant populations is the most difficult to estimate.

A popular ratio is used to depict the increase in beneficiaries projected over the next 50 years. The Beneficiary to Covered Worker Ratio measures the number of people drawing Social Security Benefits to the number of workers paying into the system. Currently, there are 30 beneficiaries for every 100 workers. Projections indicate that by 2030 that number will increase to 46 and by 2050 to 50 beneficiaries. The implication of this ratio is there are fewer workers paying into Social Security. Since the majority of payroll taxes are used immediately to fund current obligations, this presents a potential problem in the years to come.

In recent years, particularly in President Bush's second term, concerns about the future of Social Security began to enter the forefront of political banter. The concern was the present system would collapse under the weight of increased obligations to the Baby Boomer cohort. This will be discussed in further detail, but it is important to note that this is not a problem yet. Baby Boomers were the cause of a similar and unexpected problem as they reached school age; the educational infrastructure at the time was not prepared for the influx of children into the system.

Analysts forecast under current law that by 2017 tax revenues flowing into the trust fund will be less than total obligations that year. By 2040, interest and assets will be depleted and tax revenues will only be able to cover 74% of scheduled benefits and payroll costs. By 2080, revenues projected to only cover 70% of obligations to beneficiaries.

Proposed Reformation Efforts

According to Social Security's Board of Trustee's, the actuarial deficit is 1.89% of taxable wages. The Congressional Budget Office estimates the deficit to be about half that size. Either way, the deficit is used to measure the difference between current and required payroll taxes necessary to fulfill beneficiary obligations for the next 75 years. Proposed options to fill the actuarial deficit include raising the tax cap, extending coverage to more workers, raising the retirement age, decrease benefits, reduce inflation adjustment, raise payroll taxes, use other taxes, invest surplus funds in alternative securities and privatize the Social Security system. Each will be discussed in further detail.

Raising the Tax Cap

The Tax Cap refers to the law that limits payroll taxes to a certain amount of earned income. The 2006 cap is $94,200, meaning that any wages earned above that sum are not subject to FICA tax. The earnings cap increases each year based on the increase in average income. Only 6% of workers earn more than the cap, but earnings above the tax cap account for 15% of the aggregate income of all workers who pay into Social Security.

If the cap was eliminated and all earned income was taxed, but the earnings did not count towards additional benefits, Social Security would be solvent for the next 75 years. It is projected to produce 116% of the revenue required. This violates one of the fundamental elements of Social Security that links contribution to benefits. If the cap was eliminated and the earnings were tied to additional benefits, this would almost eliminate the actuarial deficit. This still violates the historical rationale of 'extending Social Security coverage to a level where forced saving is unnecessary and where the provision of additional retirement income is best left to private saving and pensions' (Advisory Council on Social Security, 1979)

Extending Coverage

Approximately 25% of employees of state and local governments are covered by alternative pension plans and choose not pay into Social Security. If it was required that all new civil servants must pay into Social Security, this would reduce the deficit by approximately 10%. Extending coverage was one of the methods used in the 1983 reform. Many employees prefer alternative pension plans. Additionally, this would take time for municipalities to modify the pension systems to incorporate Social