A Social Security Reform that Benefits All

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from NCPA,

Congress is once again considering changes to Social Security in an attempt to “save” the program. Social Security benefit payments have exceeded tax revenues since 2010; the funding deficit is growing and, barring reform, will continue to grow indefinitely. Higher tax revenues are necessary to fund benefits as they are currently calculated, say Liqun Liu, a research scientist, Andrew J. Rettenmaier, executive associate director, and Thomas R. Saving, director, at the Private Enterprise Research Center at Texas A&M University.

The system is financed on a pay-as-you-go basis where current tax payments are transferred to current retirees. Changing demographics have resulted in a reduction in the number of workers supporting each retiree and a corresponding need for higher tax rates. Retaining the current benefit structure will require an immediate and permanent increase in the Social Security payroll tax of 3.3 percentage points.

In contrast, a long-run balanced budget for Social Security could also be achieved by retaining the current tax rate, but making the following two benefit reforms.

• Gradually raising the retirement age for workers who become eligible for benefits in 2023 and after.

• Making the benefit formula less generous for higher earning workers through progressive price indexing.

Both the current program with the taxes necessary to close its financing gap (the baseline) and the reformed program produce comparable net results for workers across birth years and across income classes.

• With the baseline program, average-earning men born in 1985 will have to pay 13.5 percent of their lifetime income in taxes and receive benefits equal to 9.6 percent of their income.

• However, the same workers in the reformed program would pay a lower tax rate of 10.2 percent to receive reformed benefits of 8.2 percent.

If the baseline and reformed program are comparable in terms of net lifetime tax rates within income classes and birth years, is there a reason to prefer one to the other? Liu, Rettenmaier and Saving suggest that the smaller reformed program is preferable, primarily for the following reasons:

• Given current debt levels along with ongoing and forecast budget challenges, reducing the size of federal spending is critical in the long run.

• Collecting the higher tax revenues necessary to retain the current benefit formula inevitably produces welfare losses.

• Reducing the scope of a pay-as-you-go financed retirement program will result in the real prepayment of retirement benefits, leading to greater investment and higher national income.

• The reformed program can be complemented with voluntary, individually directed personal retirement accounts.

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