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Solving for Solvency: A Menu for Closing Social Security’s Long-Term Budget Gap

Photo by Spencer Platt via Getty Images.

Jared Bernstein served as chief economist and adviser to Vice President Biden from 2009 to 2011. He’s now a senior fellow at the Center on Budget and Policy Priorities. His last appearance on Making Sense was in August 2012, in the post, “Better Off than Four Years Ago? Compared to What?” and in our broadcast story “Previewing Democrats Economic Platform: Supporting Small Business, Education.”

Jared Bernstein: When budget wonks talk about the long-term fiscal challenges facing the country, we invariably emphasize the challenge of paying for Medicare (and other public health care obligations) over that of paying for Social Security.

The reason for that emphasis is easily seen in the figure below, from the Congressional Budget Office’s long-term projections. One of those lines is clearly unsustainable, the other — the one for Social Security — looks relatively manageable.

So, at this point, you’re probably thinking I’m going to hold forth on ways to “bend the cost curve” on health care. After all, there is no path to fiscal sustainability that doesn’t find its way out of this thicket.

Well, it’s a great and vital topic, but, honoring Paul Solman’s request when he asked me to write this for Making Sense, I’m going to focus on the other line.

As Larry Kotlikoff so continually emphasizes on this page, Social Security faces solvency challenges too, and while graphs like this one above often lead some to declare that problem relatively minor — which it is, compared to health care — it’s not trivial, and there are portentous debates afoot as to how to close the Social Security solvency gap.

First, what’s the hole we need to fill here?

Though some economists like to scare you by throwing around the trillions in unfunded obligations, those numbers need a context. Don’t listen, for example, to bean counters with hair on fire screaming about the Social Security’s $20 trillion in unfunded obligations over its “infinite horizon.”

Listen to those who point out that A. that amounts to 1.3 percent of GDP over that time frame (see Table IV.B6 on page 65 here), and B. with measures like those on the menu below, we can meet this challenge.

The conventional way that economists think about Social Security solvency is through closing the 75-gap between the program’s inflows and outflows. As most recently estimated, that gap amounts to 1 percent of GDP or 2.7 percent of taxable payroll. The latter is a good benchmark because the program is supported through payroll taxes.

So let’s look at a menu of choices to close that gap:

Switch to the Chained Consumer Price Index (CPI)

Social Security benefits are adjusted for price growth using the CPI. Because it does not fully account for consumers switching to relatively cheaper products when prices of the items in their market basket change, that measure of price growth is biased up a slight bit, and the index-making-nerds have come up with a fix which grows about 0.3 percent slower per year.

This is, however, a benefit cut relative to current benefits as promised, and that’s especially problematic to the low-income, “old” elderly, since the loss compounds over time and, as the New York Times put it in a convincing editorial the other day, “The chained index is in many ways a better method of tracking price changes for the broad working population, but there is no compelling evidence that it is better for computing the Social Security COLA [Cost of Living Adjustments].”

Paul Solman interjects: In fact, NewsHour produced a story on elderly shoppers in Colorado confronted with these problems many years ago.

Jared Bernstein: Many have thus argued, correctly, that there should be a “bump-up” in benefits for this group to offset the loss, or better yet, a price index designed to properly reflect the price growth faced by the elderly, with their notably different consumption basket.

But even with allowance made for the poor elderly, a partial switch to a chained CPI would close somewhere in the vicinity of 15 percent of the solvency gap.

Raise the Cap on Taxable Benefits

Historically, about 90 percent of earnings have been subject to the payroll tax. But since earnings inequality has pushed a larger share of earnings over the cap, that share is now in the mid-80s.

Phasing in a new, higher cap that would get us back to a 90th percentile “tax-max” would close from 30-40 percent of the gap, depending on whether those paying higher payroll taxes later got higher benefits.

Lowering Benefits for High-Income Retirees

Often discussed under the rubric of “means-testing” — conditioning benefits on current income levels — the idea here is that while Social Security is a universal public pension program, one way to promote its solvency is to reduce benefits for those who arguably need them less.

There’s a smarter way to do this than means-testing, however, which would involve a whole new layer of administration to track senior’s incomes. Instead, we could adjust the formulas that calculate a retiree’s initial benefit. But you have to proceed cautiously here, because most of the program’s beneficiaries depend on this income. For two-thirds of elderly households, Social Security provides at least half of their income.

So, I’d recommend a formula adjustment that only affected folks at the top of the income scale. Of course, the higher you go, the less gap you close. The Rivlin/Dominici budget commission, a seriously thought-through alternative to the Simpson-Bowles group, suggested one that reduced the benefit growth of only the top 25 percent of beneficiaries, closing only about 5 percent of the solvency gap.

Gradually Apply the Payroll Tax to Employer-Provided Health Care Benefits

Finally, the Rivlin/Domenici budget commission also came up with this interesting idea worthy of consideration as these benefits are currently tax exempt.

This exemption is the single largest item among the so-called tax “breaks” or “exclusions” in the Federal budget.

In addition, the fact that employer-sponsored fringe benefits are exempt from taxation has fueled cost pressures in the health-care system and eroded the Social Security tax base. Over the years, a rising share of workers’ total compensation has come in the form of untaxed benefits rather than taxed wages. So this idea would both raise revenue for Social Security and phase down a tax break that is itself one factor behind the uniquely inefficient American health care system.

To do so would eventually close about 40 percent of the solvency gap.

Put It all Together and What Have You Got?

Put them all these menu options together, and they fully close the 75-year Social Security solvency gap, and do so in a balanced way, combining benefit cuts and revenue increases, while protecting economically vulnerable seniors.

These measures make the most sense to me, but there are, of course, other choices. Note, for example, that this menu excludes directly raising payroll tax rates or increasing the retirement age.

The point is, while many will object to one fix or another, a functional political system would generate a solvency compromise containing measures like these, especially if folks would stop running around talking about an “entitlement crisis” and start focusing on plausible solutions.

This entry is cross-posted on the Rundown — NewsHour’s blog of news and insight.

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