Proposals for Reforming Social Security

Many of the proposals for reforming Social Security can be understood simply by examining the equation for the surplus. Remember that the number of workers × the tax rate × income is the tax revenue collected from workers, whereas the number of retirees × the Social Security payment is the total transfer payments to retirees. If the system is running a deficit, then to restore balance, either revenues must increase or payouts must be reduced. The tax rate and the amount of the payment are directly under the control of the government. In addition, there is a ceiling on income that is subject to the Social Security tax ($106,800 in 2011). At any time, Congress can pass laws changing these variables. It could increase the tax rate, increase the income ceiling, or decrease the payment. If we simply think of the problem as a mathematical equation, then the solution is easy: either increase tax revenues or decrease benefits. Politics, though, is not mathematics. Politically, such changes are very difficult. Indeed, politicians often refer to increases in taxes and/or reductions in benefits as a political “third rail” (a metaphor that derives from the high-voltage electrified rail that provides power to subway trains—in other words, something not to be touched). Another way to increase revenue is through increases in GDP. If the economy is expanding and output is increasing, then the government will collect more tax revenues for Social Security. There are no simple policies that guarantee faster growth, however, so we cannot plan on solving the problem this way. Delaying Retirement We have discussed the tax rate, the payment, and the level of income. This leaves the number of workers and the number of retirees. We can change these variables as well. Specifically, we can make the number of workers bigger and the number of retirees smaller by changing the retirement age. This option is frequently discussed. After all, one of the causes of the Social Security imbalance is the fact that people are living longer. So, some ask, if people live longer, should they work longer as well? Moving to a Fully Funded Social Security System The financing problems of Social Security stem from a combination of two things: demographic change and the pay-as-you-go approach to financing. Suppose that, instead of paying current retirees by taxing current workers, the government were instead simply to tax workers, invest those funds on their behalf, and then pay workers back when they are retired. Economists call this a fully funded Social Security system. In this setup, demographic changes such as the baby boom would not be such a big problem. When the baby boom generation was working, the government would collect a large amount of funds so that it would later have the resources to pay the baby boomers their benefits. As an example, Singapore has a system known as the Central Provident Fund, which is in effect a fully funded Social Security system. Singaporeans make payments into this fund and are guaranteed a minimum return on their payments. In fact, Singapore sets up three separate accounts for each individual: one specifically for retirement, one that can be used to pay for medical expenses, and one that can be used for specific investments such as a home or education.