What I Know and Think I Know About Social Security

Rarely if ever has a subject of public importance been so obscured by demagoguery, endlessly recycled rhetoric and misplaced emphasis as Social Security and its problems. But after some modest research and a great deal of thought I may have broken through the smoke and mirrors.
To begin, we must understand that the Social Security system performs two functions. It is a social insurance program, and it is a redistributive program.
The social insurance part is pretty much self-explanatory. All workers who are covered by the program pay premiums in the form of social security taxes. These payments go into the Social Security trust fund, which by law is invested in government securities. Out of this trust fund they receive monthly benefit checks upon retirement (or in case of disability or a few other situations which are not the center of debate).
To say that Social Security is redistributive means that those at the lower end of the income scale get proportionately more than those at the middle or upper end. This is accomplished by means of a progressive benefit formula, through which those who have earned the least get a greater percentage of their earnings in benefits. (Specifically, benefits are calculated in this way: When a worker retires, the system goes through a complex process to compute his "Averaged Indexed Monthly Earnings," or AIME. The AIME reflects, roughly, the amount earned over a lifetime and therefore the amount contributed to the system. From this AIME amount, the worker's initial benefit is calculated according to a formula that yields a greater percentage for smaller earnings. Currently the formula is: 90% of the first $627 of AIME, plus 32% of the next $3152, plus 15% of everything over that.) But the progressivity holds only up to a point, namely the earnings cap, which is currently $90,000 per year. Beyond that figure, earnings are not taxed for Social Security.
These two aspects of the system - social insurance and redistribution - fit together to make the system stronger and better suited for its purpose of insuring every retiree a decent living. The largest benefits, relative to income, go to those with the largest need, but every worker has a stake in the system, thus insuring strong support.
The term "indexed" means that the benefit amount is adjusted to economic conditions. This takes two forms. First, the worker's earnings through the years are indexed to the average wage increase, with her initial benefit based on that. For example, suppose the worker retired in 2000 and her first earning-year was 1965, and suppose that the average wage in 2000 was three times that in 1965. Then her 1965 earnings would be multiplied by three.
Second, monthly benefits after retirement are indexed to the cost of living, expressed in the Consumer Price Index (CPI), which has risen less slowly than average wages.
This double type of indexing makes sense, for when a person is working she is an earner, and credit for her earning should not be degraded by wage inflation. But when the worker has become a retiree and is receiving benefits, she is a consumer, and the value of the benefits she received should not be degraded by price inflation.
The Problem
As we all know, the Social Security system has a problem (a solvency gap, as I will call it). Somewhere down the road it will run out of money, because there will be more and more retirees taking money out while fewer and fewer workers put money in, and because retirees are living longer. All this has been belabored long and hard, and I'm not going to belabor it any more, except to note the two crucial dates: In 2018, it is predicted, the outgo in benefits will begin to exceed the inflow from taxes, and the trust fund will have to be drawn down. In 2041 the trust fund will be empty. (But these are only approximations, based on a number of imponderables such as the exact demographics and the state of the economy.)
Thus the question that has brought Social Security to public attention: How to close the solvency gap. This is the one need on which everyone agrees, but I suggest that we should also meet the following requirements:
-- preserve the social-insurance aspect so that the system continues to receive widespread support from the public.
-- continue to provide an adequate safety net for those at the bottom.
-- be realistic, that is, responsive to the factual situation and the purpose(s) of the system.

Before going on to consider how these requirements might be met, I want to look at a widespread but totally erroneous opinion, namely:
"The Social Security trust fund is nothing but worthless IOUs because the government has already spent the money for other things." The Social Security trust fund, by law, is invested in U.S. government bonds. In this the trust fund is no different from individual, corporate or foreign-government investors. Money received for these bonds is used by the government for other needs - after all, why would it want to sell securities if it didn't need the money? Will the government default on these securities, i.e. renege on its "full faith and credit?" Of course not. Where will it get the money to redeem these bonds? From the same place it gets the money to redeem any other government securities. Whatever difficulty arises from the Social Securities trust fund is merely part of the overall problem of the government's debt.
Bush has been the poster boy for the claim of worthlessness. In a speech at the Bureau of Public Debt in Parkersburg West Virginia on April 5, he stood in front of a filing cabinet containing Social Security bonds and said, "There is no trust fund - just IOUs that I saw firsthand." At a press conference on April 28, he talked about the pay-as-you-go feature of the Social Security system and said, "And all that's left behind is the cabinets full of IOS'." (Apparently he did not use the word "worthless," but in saying "There is no trust fund" he clearly implied that the bonds were worthless, and some of his partisans must have used the term because it appears constantly in news articles on the subject.)
Bush's claim is astounding -- he is impugning the integrity of the government of which he is chief executive - and shows the ultra-extremes to which he will go in hyping the "crisis" of Social Security. More on this later.
The Solutions
To resolve the Social Security problem, there are a number of possible solutions (other than Bush's proposals). Here are my top five:
1) Raise the earnings ceiling. As mentioned above, earnings subject to the Social Security tax are capped at $90,000, currently. A change upward would bring in more revenue and make the benefit schedule more progressive.
2) Raise the retirement age (i.e. the age at which workers can claim full benefits). This change is already in progress - the retirement age will gradually rise until it reaches 67 in 2027. But it could be raised faster. This would be a realistic policy change, responding to the overall increase in life expectancy as well as advances in health care that allow those in their 60s and after to lead a more active life.
3) Reduce benefits slightly at the top of the schedule. The benefits could be reduced slightly and high-income recipients would hardly notice.
4) Raise the income tax on Social Security benefits. At present, benefits are subject to the federal income tax according to a breathtakingly complex formula. The formula could be changed to bring in more revenue, and the additional revenue could be funneled into the Social Security system.
5) Revise the Consumer Price Index downward. The CPI governs increases in benefits. Some economists complain that, as now formulated, it is an overestimation of the true cost of living. Revising the CPI downward would mean a decrease in benefits, but it would be a bow to realism.
These changes are superficial: They don't touch the basic nature of the system, but only adjust its present features. Furthermore, they are flexible: The adjustments can be expanded or contracted in the future, as experience corrects initial estimates. No one change would eliminate the solvency gap, but by all accounts some combination would do so. (And if necessary, other similar changes could be introduced, such as bringing local and state government workers into the system). They would also meet the other requirements I've listed above. As to the exact combination of changes, that is for the Congress to decide. My point is this: The Social Security problem can be solved through modest and superficial changes such as these. We don't need basic, system-wrenching changes such as private accounts.
Bush, as we know, has put forth a proposal for private accounts. This is what I will take up next issue.
Read More on Minding the Issues
Volume 1, Issue 2, Posted 03.57 PM / 19th July 2005.