WASHINGTON, December 17, 2016 — Now that president-elect Donald Trump has selected South Carolina Representative Mick Mulvaney as his budget director, it is clear the nation’s attention will soon turn toward reducing the deficit and balancing the budget. Entitlements, mainly Social Security and Medicare, account for about half of the nation’s total spending and both are still growing at an alarming rate. Mulvaney will move to control costs in this area, but exactly how he accomplishes this will be tricky.
Social Security is a pay-as-you-go system. That means those who are currently working pay for those who are currently collecting. In theory, the system works as long as there are at least four or five people working for every person collecting benefits. The other requirement for the system to succeed is that people work for about 45 years and collect benefits for about 10.
Because of rapid advancements in medicine, people are living much longer than these parameters. When Social Security was originally passed in 1935, the system’s original retirement age—the age at which recipients could begin collecting benefits—was set at 65 years of age. At that time, retirees lived, on average, to be about 67. As such, the Social Security tax was only 2 percent of gross earnings, of which half was paid by the employee and half by the employer.
Today, people are living much longer. According to the Social Security Administration, the average person can now expect to live almost 20 years after retirement age, even though that age has been boosted slightly in recent decades standing currently at 66 (for people born in 1943-1954) and gradually rising to 67 for those born in 1960 or later.
That means we have people working about 45 years and collecting for 20 years on average. In addition, there are disproportionately more baby boomers now retiring, meaning there are now only about three people working for each retiree who is collecting. The ratio continues to decline.
The Social Security tax rate now stands at 12.4 percent and can’t go higher without causing an undue burden especially considering that there is also a 2.9 percent Medicare tax, on top of the federal income tax, state income taxes, property taxes, sales taxes and special taxes on products like gasoline. (Both Social Security and Medicare taxes continue to be paid half by employee and half by employer.)
Some futurists tell us that in the not-too-distant future people will be living much longer than they do today, perhaps to the age of 120 or 130. Under the current set-up, that would really bankrupt the Social Security System.
Considering the facts and the projections, the only logical way to fix the this problem is to extend the retirement age and perhaps limit payments only to those who really need them. While raising the retirement age is politically unpopular, it is something that must eventually be done. The key would be to raise it gradually, as occurred at the time of the previous raise. Since we have already experienced a gradual increase to 67, that number would have to be raised to 70 and perhaps higher if the futurists are correct.
Any proposed means testing to determine who really needs these payments poses an interesting problem. One the one hand, workers will argue that they paid into Social Security during their entire lifetime believing they were effectively purchasing an annuity that would begin upon retirement and last until death. There were no special conditions, although the amount varied based on the premiums paid as would be the case with any annuity.
On the other hand, Social Security was designed as insurance. Although the “if needed” part was never included in the Social Security law, it could be implied that, since it is insurance, Social Security payments are only made “if needed.”
Insurance that provides protection against disaster, like with homeowner’s insurance or automobile insurance, is only paid to the policy holder if a disaster occurs. Otherwise, nothing is paid. If a retiree has sufficient resources to comfortably pay for retirement, and thus avoid the disaster of not having any income during retirement, does that person need Social Security?
Another suggestion says that the 12.4 percent rate should be applied to all wages without limit. Originally in 1935, the Social Security tax was applied to only the first $3,000 of wages. Today, it is paid on the first roughly $118,000 in wages. While lifting the wage cap would raise some additional revenue, it could be argued that it is unfair. If there is a maximum benefit that can be paid to a retiree by Social Security, shouldn’t there be a maximum payment made annually into the system?
Spending on Social Security will have to be controlled as will spending on Medicare and Medicaid, both of which will likely be examined when the health care laws are changed. But Social Security could be the biggest problem. Significantly but gradually raising the retirement age and applying a means-testing formula to determine a retiree’s benefits seem like the logical solution.
But when politics are involved, logic is often overlooked.