How to Think Through Social Security Reform

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It's all the rage to talk about the affluent West's entitlement crisis now that the Greek economy is melting into the Aegean Sea. One way to prove to investors and critics that we can handle the burden of future promises to seniors is by getting serious about reforming Social Security and Medicare.

But these are very different challenges. Fixing Medicare means fixing medical inflation, and listing the myriad strategies for bending that curve is liking writing a step-by-step manual for solving a Rubik's Cube. Fixing Social Security is simpler because it's essentially an accounting challenge. The government taxes payrolls and pays out benefits. Inflows and outflows. How complicated can that be?

Not complicated at all if your only goal is to list strategies. Very complicated, indeed, if you're trying to turn those strategies into public policy.

Let's start with a simple overview of the strategies (these don't include solutions that would partially privatize the system). On the revenue side, you can either tax more or tax wider. That is, you can raise the tax rate, raise the ceiling of taxable income -- currently, FICA taxes stop at $107,000 -- or tax more people. On the spending side, you can delay the benefits, shrink the benefits, or concentrate the benefits. That is, raise the retirement age where seniors receive full benefits; constrain the benefits by changing the way we peg them to inflation; or preserve benefits for low-income retirees at the expense of richer seniors.

But each of these strategies is fraught with challenges. First consider the revenue-side reforms. Practically nobody is calling for a payroll tax increase because the pain would mostly hit every dollar of middle-income families. Raising the ceiling of taxable income would hurt some middle-income people, too ($120,000 isn't comfortably upper class if you're the single breadwinner in a family of four, especially in a high-tax, high-cost coastal state), but you'd also provoke loud yelling among lower-upper class families. Economic Policy Institute economist Monique Morrissey suggested that raising the earnings cap to 90% of income and eliminating it altogether on the employer side would account for 70% of the projected shortfall. That's an interesting idea, but try telling people making over $250,000 that in addition to the Bush tax cuts expiring, we're also slapping a 6.2% tax on the last $150,000 of their income. Lots of screaming. That's what you will get.*

Now consider the outlay reforms. Raising the retirement age is a bridge between revenue-side and spending-side solutions because you encourage seniors to work longer (and pay more taxes) and retire later (and, at least notionally, receive fewer benefits). On the one hand, it makes sense to run a public pension program that reflects increasing longevity, and Americans spend twice as many years in retirement as we did in the 1970s. On the other hand, it's unlikely that inching up the full retirement age alone with close the hole.

What about slowing the growth of retirement benefits? Arithmetically, this makes a lot of sense. If inflows aren't matching outflows, just slow down the outflows, and voila! Indeed, reducing Social Security's cost-of-living (COLA) adjustment by 1 percentage point could extend Social Security solvency by 25 years. But those outflows aren't just numbers on a spreadsheet, they're necessary cash in seniors' pockets. For the bottom 50 percent of senior income earners, Social Security makes up at least 75% of their income. Social Security is a safety net and COLA adjustments would hurt those who need the most netting.

Finally, we have means-testing, which is the wonky term for scaling back rich folks' benefits to protect poorer folks' benefits. Even though means-testing checks the key boxes of Would Prolong Social Security and Protects Low-Income Folks, it has both liberal and conservative critics. Conservatives don't want SS to transform from a pension program to an outright transfer of wealth where middle- and high-income folks pay to protect the retirement of low-income folks. Liberals are wary of means-testing because they're afraid that this conservative critique could seep into the mainstream and Americans could turn against what has to date been an enormously successful and popular public retirement program.

Social Security is a solvable challenge. But when you look at the solutions and the challenges, you can understand why even solvable challenges can turn into bare-knuckled fights.

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*What about my "tax more people" suggestion? That was my sneaky way of saying that a liberalized immigration policy has a role to play in Social Security. But since this article mostly focuses on actuarial issues with Social Security, I thought it was best to leave the messy politics of immigration reform out of this blog's discussion.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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