How to Fix Social Security -- and What It Will Mean for Your Taxes

Last week I explained why I thought it would be a bad idea to close Social Security’s long-term funding gap by simply making all wages -- not just those up to the annual ceiling, which this year is $117,000 -- subject to payroll taxes, thereby socking it to wealthier workers. That wasn't a popular opinion among those who feel it only right to raise the levies on the top 1%, or even top 5%.

“When all other sources have been depleted soak the portfolio holders even more disproportionately,” one critic responded via social-media .

Tweets, unfortunately, don't make great policy arguments. And as Social Security’s doomsday clock keeps ticking, it's all the more urgent to come up with a balanced reform strategy and act on it. Last week the Congressional Budget Office projected Social Security’s trust funds would be depleted during calendar year 2030—a year earlier than its previous estimate. If this happens, the program could then pay only about three-fourths of its scheduled benefits.

How, then, to close the funding gap? Although I do not want to see the wealthy as the primary bill-payer for Social Security reform, I do think the payroll tax ceiling is set too low. Today that ceiling, which is $117,000 this year, captures about 83% of all wage income, but it used to apply to 90%. The reason for the decline is widening income inequality, as the upper end of the wage scale has soared disproportionately higher.

Raising the ceiling until it once again covers 90% of the nation’s wage income would help, somewhat, to improve Social Security's finances, the CBO found. The big headline here is that hiking the ceiling to cover 90% of wages would require a huge jump—from a projected $119,400 in 2015 to $241,600. The steep hike is necessary because high-end earners are a relatively small slice of the U.S. population. Even so, raising the payroll tax ceiling, which more than doubles the amount of Social Security payroll taxes paid by wealthier earners, would close only 30% of the system’s projected 75-year actuarial deficit.

You might wonder why we don't eliminate the ceiling altogether so all wages are subject to payroll taxes. Glad you asked. Eliminating the ceiling would still close only 45% percent of the deficit, according to CBO. Both these projections assume that wealthier people would also see their Social Security benefits increase.

To make a more significant reduction in the deficit, you could limit Social Security benefit increases for the wealthy to only an additional 5% of pre-retirement earnings. In that scenario, along with eliminating the earnings ceiling, we could close nearly two-thirds of the funding gap. Still, as I wrote last week, I think soaking the rich this way is nearly as bad as soaking poorer people. Soaking people is not what Social Security was or should be about. It’s about requiring people to set aside enough money through a mandatory payroll tax to provide them a modest level of retirement security.

For most people the payouts are, indeed, modest. In 2013 a 66-year old who had earned average wages during his or her working life would qualify for lifetime Social Security payments beginning at $19,500 a year. This amounts to 45% of average pre-retirement income. What’s more, most workers file for benefits early, which sharply reduces the level of income replacement.

Yet that's pretty much how the program was designed, and even these low levels of replacement income have been enough for Social Security to be a spectacular success. Before the program began in the ‘30s, retirees had the highest poverty rate of any age group. Today they have the lowest. (Medicare gets major credit as well.)

Problem is, even as Social Security has worked well, the other parts of the retirement system have fallen apart. The move from defined benefit pensions to 401(k)s and other defined contribution plans has shifted enormous retirement risk from employers to employees, and the numbers show that many aren't saving enough to meet their goals.

Given the looming retirement shortfall, there has been growing support to expand Social Security benefits, not contract them. That will be tough to do. As the CBO reported last week, under current rules Social Security’s long-term deficits will continue to balloon. Over the next 25 years, program income will amount to 5.2% of the nation’s gross domestic product, while program benefits will account for 6%.

The fundamental problem is the aging of America. As the wave of Baby Boomers moves into retirement, the number of people collecting Social Security is projected to rise by roughly a third from 58 million today to 77 million in 2024—and by nearly 80% to more than 103 million by 2039. By contrast, the work force, defined as people aged 20 to 64, is expected to increase by only 5% by 2024 and just 11% by 2039.

Something’s got to give. Higher taxes, in one form or another, are inevitable.

Philip Moeller is an expert on retirement, aging, and health. He is an award-winning business journalist and a research fellow at the Sloan Center on Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.