Social Security reform is coming—the only question is when, and what will be done to get the program’s finances in order.
The Old-Age and Survivors Insurance Trust Fund is on course to be exhausted in 2035, and its cousin, the Disability Insurance Trust Fund, will be exhausted around the end of 2016. The Republican-controlled Congress is on course to push for reform during its current session, perhaps in the lame duck period following the 2016 elections.
Exhaustion doesn’t mean the programs would be out of money, because current revenue would be sufficient to continue paying benefits. But retirement benefits would have to be cut nearly 25 percent in 2035, and disability payments would be slashed 20 percent if no fix is implemented before 2017.
It’s hard to imagine any member of Congress eager to explain cuts of that magnitude to voters—so bet on a fix taking place ahead of these deadlines. The disability insurance fund’s woes should be dealt with through a simple reallocation from OASI, although it’s not clear Congress will approve that approach. Still, the real question is what to do about the OASI fund. It can be fixed through benefit cuts, injecting new revenue into the system, or a combination of the two.
Benefit cuts make no sense for middle- and lower-income households, most of which haven’t been able to accumulate significant retirement savings. Progressives are pushing to close the gap through a gradual increase in payroll taxes paid by workers and employers—and by “scrapping the cap.” The latter refers to lifting or eliminating the maximum earnings subject to the payroll tax. The cap is adjusted annually for inflation, and on January 1st it was reset at $118,500 for 2015.
This idea is based on an argument of tax fairness. A wage-earner who takes home double the cap this year—$237,000—will be done paying her taxes on July 1st this year. Someone who earns at the level of the cap or below, will be taxed on every dollar of earnings—effectively paying a much higher tax rate.
Scrap-the-cap proposals vary; most would close the long-term shortfall by as much as 80 percent. The cap could be phased out over a ten-year period; taxes could be applied to earnings above $250,000—but not to wages between the current cap and $250,000. Or the cap could be removed only on workers earning more than $400,000 annually.
Who would be affected by this type of reform? The Center for Economic and Policy Research (CEPR) analyzed Census Bureau data to find out. Their key findings:
The richest 6.1 percent of workers would pay more if the cap were scrapped. Only the top 1.5 percent and 0.7 percent would be affected if the tax were applied to earnings over $250,000 and $400,000, respectively.
Only the highest-income (3.1 percent) of female workers would pay more if the cap were eliminated.
The richest 1 in 43 black or Latino workers would pay more if the cap were lifted entirely.
“This certainly needs to be one of the leading contenders to shore up Social Security in the long run,” says Nicole Woo, CEPR’s director of domestic policy. “It takes care of such a big chunk of the shortfall, and it targets the highest earners—who should be paying the same tax rate as the rest of us.”
Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to Morningstar and the AARP magazine. Mark is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. He edits RetirementRevised.com.