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Mark Miller: Remaking Retirement

Will the Big Social Security Fix Include Expansion?

Contributor Mark Miller discusses the current thinking in Washington about Social Security reform.

Five years ago, opinion among Washington lawmakers about Social Security reform generally ran along these lines:

"We’re all living longer, so we will need to boost the retirement age. We also should means-test Social Security to avoid paying benefits to rich people. The annual cost-of-living adjustment should be shifted to the 'chained CPI,' which is a more accurate measure of inflation and would reduce inflation increases somewhat."

That was the bipartisan consensus of nearly all Republicans and most Democrats. But it takes two to tango, and the Democratic Party isn’t dancing to that tune any longer.

In 2013, a small number of progressive Democrats began to advance a different idea on Social Security reform. Not only should benefits not be cut--they should be expanded. That viewpoint has since moved into the mainstream of the Democratic party, as signaled by the current support for Representative John Larson’s Social Security 2100 Act.

The Connecticut Democrat’s proposal calls for a small across-the-board bump in benefits, a more generous annual cost-of-living adjustment, a higher minimum benefit for low-income workers, and a tax cut for affluent beneficiaries. More on how this would be paid for in just a minute, but consider: Larson’s proposal had 54 co-sponsors when he first introduced it in 2015; now, it has more than 200 House co-sponsors--more than 85% of the Democratic majority.

Support for Social Security expansion was an important campaign plank for many successful Democratic candidates in the midterm elections. And nearly every declared and potential Democratic presidential candidate has endorsed expansion of some type for Social Security.

Larson’s bill is not likely to become law while Republicans control the Senate and White House. But he is holding hearings on the bill this year in Washington and around the country--the first focused on expansion in 50 years.

One more thing: You don't hear much talk about cutting Social Security benefits in Washington these days. For progressives, playing a good offense has been an excellent defensive strategy (see: Overton Window).

The Action-Forcing Event
One thing everyone agrees on is that Social Security’s finances need to be addressed. The program's combined retirement and disability trust funds (OASDI) are forecast to be exhausted in 2034. At that point, the program would be able to pay about 77% of scheduled benefits from incoming payroll taxes--but that would mean a fearsome across-the-board benefit cut for current and future claimants.

The odds of reaching this financial cliff seem remote--after all, what legislator would want to explain a 25% cut in benefits to constituents? But this Sword of Damocles does undermine public trust in the program, so a fix sooner-than-later would be helpful.

Larson's bill puts Social Security back into balance over the next 75 years--the period of time the program is required by federal law to project its finances. It does this with two tax increases.

First, it would add new payroll taxes to wages over $400,000 (currently, tax collection stops at $132,900 of annual income). The bill also would gradually phase in a higher payroll tax rate, with workers and employers each paying 7.4% by 2042, compared with the current rate of 6.2%.

On the benefit side, Larson provides an increase for all enrollees equivalent to 2% of the average benefit, or about $30 per month. It would shift to a more accurate annual cost-of-living adjustment formula that is more sensitive to medical inflation and other costs disproportionately affecting seniors. (The proposed measure is the CPI-E; see my analysis of this yardstick, and the chained CPI here). The bill would also beef up the special minimum benefit paid to low-income retirees.

For higher-income seniors, the bill also includes, effectively, a benefit boost in the form of a tax cut.

Beneficiaries with higher income pay income taxes on their Social Security benefits. The proportion of benefit that is taxable is determined using a formula called "provisional income"--your adjusted gross income (excluding Social Security benefits), plus nontaxable interest and half of your Social Security benefits. If your provisional income is $25,000 to $34,000 (single return), or $32,000 to $44,000 (joint return), up to 50% of your Social Security benefit must be counted as AGI. If your provisional income is more than $34,000 on a single return or $44,000 on a joint return, 85% of your benefit must be added to AGI.

The Larson bill would replace those thresholds with $50,000 (single filer) and $100,000 (joint filers), and if provisional income is above those levels, up to 85% is counted in AGI.

In the Senate, Senator Bernie Sanders (I-VT) has been a part of the Social Security expansion caucus since its beginning in 2013. He has re-introduced legislation this year that resembles the Larson bill, with a few key differences. The bill does not increase payroll tax rates; instead, it funds the reforms by resuming payroll tax levies at $250,000 (rather than $400,000) and by imposing a 6.2% tax on investment income, mirroring the formula used in the Affordable Care Act, to support the OASDI trust funds.

Also, Sanders restores actuarial balance for 50 years, rather than 75 under Larson.

Rationale for Expansion
Some version of these proposals should be adopted, in my view--although I have one concern about funding.

A key virtue of both bills is that they restore long-range solvency of the OASDI trust funds. Increasing taxes to restore solvency is a far better option than increasing the retirement age. The full retirement age already is rising, from 65 to 67, under the reforms of 1983; the idea on the table now would boost it further, from 67 to 69.

A higher retirement age often is couched in those aforementioned reasonable-sounding arguments about rising longevity. But, that argument sidesteps the fact that a higher retirement age is a benefit cut. That’s because it raises the bar on how long workers must wait to receive 100% of their benefits. Moreover, gains in longevity are not being distributed evenly across the population, and higher retirement ages would hit some much harder than others.

Richard Johnson, an economist at The Urban Institute, looked at the question from a different angle in a recent paper, examining the impact of raising the early filing age from 62 to 65. He concludes that 25% of workers aged 62 to 64 would face serious financial problems.

Why expand benefits? First, consider that many elderly Americans are financially vulnerable, despite current Social Security benefits, which averaged $16,104 per year in December 2018. According to the Elder Economic Security Standard Index, half of older adults living alone--and one out of four older adults living in two-elder households--lack the financial resources required to pay for basic needs.

In the years ahead, rapidly rising costs of housing and healthcare, in particular, offer reasons to worry that financial frailty of seniors only will increase over time.

Impact of Raising the Cap
About 6.2% of workers earn income above the current cap and would be affected by various proposals to raise the ceiling, according to analysis of U.S. Census data by the Center for Economic and Policy Research.

One rationale for raising or eliminating the cap is that higher earners effectively pay a lower tax rate. The CEPR argues it this way:

"The cap on the Social Security payroll tax means that those with the highest earnings effectively pay a lower rate. People who earn a million dollars a year pay this tax on about an eighth of their earnings. People who earn a quarter of a million dollars pay the tax on just over half their earnings. It is important to note that this just applies to wage earnings, not other forms of income. If the individual earning $250,000 a year makes another $250,000 from investments, then they end up paying the Social Security tax on about a fourth of their income. The vast majority of workers fall below the $132,900 cap though, and have significantly less stock or other income, if any. As a result, all or most of their income is subject to the payroll tax."

Fair enough, but here’s my concern.

Social Security is not designed to provide benefits to very wealthy households. Payroll tax collection stops at the aforementioned $132,900 this year--but benefits are capped, too. The maximum monthly benefit in 2018 for a worker retiring at full retirement age was $2,788, according to the Social Security Administration, and few actually receive that much.

Raising taxes on high earners without a commensurate increase in benefits would leave the program open to criticism that it is simply redistributing income. That, in turn, undermines a fundamental strength of Social Security--that all Americans are in it together and treated fairly by the program.

True, Social Security already has bend points that return a higher percentage of pre-retirement income to lower- and middle-class households--that has been a feature of the program since its inception. But critics of raising the payroll tax cap think it would push progressively too far.

"The Social Security program is intended to be primarily a required-savings program and not primarily an income-redistribution program," notes William Reichenstein, an emeritus professor at the Baylor University Hankamer School of Business and a co-founder of SocialSecuritySolutions.com, a leading provider of Social Security optimization tools. "In a required-savings program, there is a reasonably close relationship between taxes paid and benefits received, while in an income-redistribution program this relationship is not close."

Reichenstein calculates that under the Larson proposal, someone earning $500,000 would pay $6,200 more annually in taxes, but receive almost no increase in benefits--just $156 lifetime.

Some adjustment in the payroll tax cap is warranted, but this should be done with caution. More attractive options are out there than lifting the cap to stratospheric levels. For example, allowing the OASDI funds to invest even a small share of its reserves in equities could improve solvency dramatically.

All that said, strengthening Social Security’s finances is an imperative, and some targeted benefit increases make sense. Look for these ideas to continue gaining momentum over the next few years.


Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to WealthManagement.com and the AARP magazine. He publishes a weekly newsletter on news and trends in the field at Retirement Revised. The views expressed in this column do not necessarily reflect the views of Morningstar.com.