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Social Security: Absurdly Complex? Not that Hard to Fix?

Joint Deficit Reduction Committee; photo by Mark Wilson/Getty Images
Members of the ‘supercommittee’ participate in a Joint Deficit Reduction Committee hearing October 26, 2011 in Washington, D.C. Although a resolution was never reached, Social Security was on the table. Photo by Mark Wilson/Getty Images.

Larry Kotlikoff’s “34 Social Security Secrets You Need to Know Now” post puzzled enough readers that we’ve been eye-brow deep in follow-up questions ever since, questions which Larry will from now on be answering on Mondays here on Making Sen$e. In one of his early responses, Larry blasted the Social Security system for its complexity and I took issue with his tone, his dismissiveness. He then blasted my response.

Making Sense

Today, Larry goes a step further in his condemnation of our retirement system. But instead of having me respond to his attack on Social Security, I’ve asked Nobel Laureate Peter Diamond to do so. I know of no greater scholar of Social Security than Peter, and he’s been gracious enough to take on Larry for us all.

First, Larry’s latest Social Security salvo.

Laurence Kotlikoff: “We need to run Social Security in a way that doesn’t drive us nuts or our kids broke.”

When a heart patient is laying on the operating table and needs a triple bypass, applying a Band Aid constitutes malpractice. Social Security needs radical surgery before it bleeds our children, who are being left with its enormous bills, to economic death.

Just look at Table IVB6 of the Trustees Report, which shows the system is 31 percent underfunded, i.e., it needs four cents more out of every dollar of earnings covered by Social Security to to keep paying its benefits. That’s one hell of a huge tax hike to ask our kids to pay in exchange for nothing in return. Alternatively, we can decrease all the benefits of all current and future recipients, including my 92 year-old mother, by 23 percent.

Or we can do what one administration after the other has done — wait and do nothing and let this problem get even worse.

As I’ve written elsewhere, my rants about Social Security’s absurd complexity may suggest that I’m a libertarian and would prefer to see SS dismantled with nothing put in its place. That’s not the case. We need to force people to save and obtain survivor, disability, and longevity insurance. Otherwise, some will simply free-ride on everyone else’s altruism by not saving enough and burdening the rest of us with their care. This is why even the Cato Institute — the nation’s leading libertarian think tank — includes compulsion in its Social Security reform plan. The libertarians talk a good game, but when push comes to shove, they also interfere in the behavior of those they care about.

But we need to run Social Security in a way that doesn’t drive us nuts or our kids broke. My proposal at thepurplesocialsecurityplan.org is the way to do this without Wall Street having any involvement whatsoever. I’m a big fan of the basic objective of Social Security, but a big opponent of how it’s been implemented.

President Obama and Mitt Romney would do well to point out that having our primary system of saving be an institution that neither Democrats nor Republicans can figure out and which can’t pay a very large chunk of its bills going forward is doing no one any good and is something they intend to fix yesterday.

Peter Diamond responds.

Peter Diamond: “An outside committee for Social Security with special legislative rules might succeed.”

For years, analysts have been saying that the sooner we address the projected Social Security shortfall, the easier to fix and so the better. This would be a particularly good time to address the Social Security problem since pretty much all proposals involve a slow phase-in, so a good fix could significantly decrease the projected debt trajectory without harming the current sorry state of the economy by excessive austerity. The plan I put forward with Peter Orszag in 2004, with some updating, would do that with a mix of more taxes and some benefit cuts for those not yet retired or close to it. However, continuing to pay full benefits in the near term while creating funded individual accounts financed from existing payroll taxes requires increases in debt held by the public. The debt held by the public is the part that must be repeatedly rolled over (unlike what is held in the Social Security Trust Fund). In addition to their other serious shortcomings, this would be a particularly bad time to consider such plans and the risk they add to our financial future.

Social Security tries to give people a foundation for retirement by basing benefits on need as well as on past earnings that were taxed. As Paul notes, there is enormous variation in the pattern underlying retirement needs and we have added complexities to the benefit structure in response to identification of additional bases of need. As Larry notes, this process of accumulation of fixes, along with changing circumstances, has given us a system that could benefit greatly from redesign, with removal of elements that do not work well while preserving or improving those that do. Generally, the political process does not do well at removing elements that got into the tax code or the Social Security benefit rules or the annual expenditures that we might do better without. Think of how hard it has been to close bases the military no longer wants. (We should not lose sight of the role of voters as well as politicians in making it difficult to address some issues better.) The base-closing commission had no sitting members of Congress and, using the special legislative procedures it was given, succeeded in closing some bases. The supercommittee last fall had only sitting members of Congress and failed to put forth a plan at all. An outside committee for Social Security with special legislative rules might succeed. And electing more members of Congress willing to compromise across diverse legitimate perceptions of how to go forward might help too.

Paul Solman addendum: The Diamond-Orszag plan can be downloaded here. Its key proposals are: a reduction in benefits for younger workers (because they are expected to live longer); raising the payroll tax ceiling on wealthier Social Security recipients because of rising income inequality; raising payroll taxes generally over time. Specifically, as they proposed in their paper:

1) Addressing Improvements in Life Expectancy

To offset the cost from further increases in life expectancy, we propose a balanced combination of benefit reductions and tax increases. Specifically, in each year the Office of the Chief Actuary would calculate the net cost to Social Security from the improvement in life expectancy. Half of this cost would be offset by a reduction in benefits, which would apply to all workers age 59 and younger. The other half would be financed by an increase in the payroll tax rate.

2) Addressing Increasing Earnings Inequality

Our plan gradually raises the taxable maximum, so that the percentage of aggregate earnings above it returns about halfway to its 1983 level — that is, to 13 percent — by 2063. (This raises the payroll tax for roughly six percent of workers each year, those with the highest earnings. [This is known as raising the ceiling or “cap” on taxable earnings, set at $110,100 in 2012. See [our first investigation of this issue](http://www.pbs.org/newshour/bb/government_programs/jan-june05/ss_6-15.html) on the NewsHour and [my latest post about it on Making Sen$e](http://www.pbs.org/newshour/businessdesk/2012/07/what-impact-would-eliminating.html). In addition, write Diamond and Orszag:]

[O]ur plan would gradually reduce the highest tier of the benefit formula, affecting the 15 percent of workers with the highest lifetime earnings.

3) Confronting the Burden of the Legacy Debt

First, mandate Social Security coverage for newly hired state and local government workers, so that eventually all workers will bear their fair share of the cost of the nation’s earlier generosity.

Second, create a legacy tax on earnings above the maximum taxable earnings base, so that very high earners contribute to financing the legacy debt in proportion to their full earnings. This legacy tax would start at 3.0 percent and increase along with the universal charge, described next.

Third, create a universal legacy charge. Roughly half will appear as a benefit reduction for all beneficiaries becoming eligible in or after 2023. The rest will appear as an increase in the payroll tax from 2023 onward. These charges, together, will gradually increase, in order to help stabilize the ratio of the legacy debt to taxable payroll.

As usual, look for a second post early this afternoon. And please don’t blame us if events or technology overtake us. This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions

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