In the grand scheme of things Social Security isn't one of the most important issues at the moment in terms of budgetary concern. The program is relatively secure, well funded, and well liked, however the way in which people talk about Social Security is an extremely important indicator of their overall approach to dealing with America's fiscal issues, their understanding of America's budget problems, and the ways in which they are likely to address other budgetary and fiscal issues.
How people address Social Security is such a important indicator of their overall knowledge and approach to budgetary and fiscal issues because the finances of Social Security are so simple and straight forward. It is an easy system to understand, with well defined inflows and outflows, and no complex budgeting.
Before we go any further we have to keep in mind that Social Security is funded by the FICA tax (which also includes the 2.9% tax for Medicare as well), and the Social Security portion of the FICA tax has always only been applied to payroll income up to a certain limit. That limit changes over time and is currently $106,800, which means that the 12.4% FICA tax rate is only applied to income from wages and salaries, not capital gains, etc., and it only applies to income below $106,800. Thus, the FICA tax is the most regressive tax in the country, and right now the total revenue raised from the FICA tax is roughly equal to the total revenue raised from the income tax. This means that the taxes raised from payrolls under $106,800 is virtually the same as the taxes raised on all other income. Over the past 30 years this has not generally been due to increasing levels of Social Security taxation, but falling levels of taxation on individual income and corporations. During this time, excess revenue from Social Security has served as a major source of revenue for the federal government, essentially offsetting tax cuts on higher incomes and corporations. It has essentially been a highly regressive stealth income tax.
We often hear people claim that addressing America's long-term deficits will require "reforming entitlement programs", including Social Security and Medicare. While future Medicare spending is projected to grow significantly, which will likely lead to future budget problems, Social Security does not currently, and never will, contribute to America's deficit. In fact, Social Security is forbidden by law from ever running a deficit. Social Security cannot legally ever go into debt or add to the deficit, and so, regardless of anything else, Social Security is not now, and will never be, a contributor to the federal deficit. If Social Security revenues are insufficient to pay promised benefits, the system is required by law to pay lower benefits, not to borrow to pay promised benefits.
There are in fact two completely different issues that have to be considered when talking about Social Security finances, paying back the "Trust Fund" and long-term budget shortfall forecasts. First lets address the Social Security "Trust Fund" issue.
When many people talk about Social Security adding to the deficit, what they are talking about is the "repaying" of the Trust Fund. What "repaying" the Trust Fund actually involves is "selling" the securities held by the Trust Fund. How this is exactly done can make a big difference. Over the past 30 years $2.5 trillion in excess Social Security taxes have been collected and "put into the Trust Fund", which essentially means that they have been buy long-term government bonds, thus that $2.5 trillion served to finance the national debt. It is a debt owed to American workers and retirees who paid excess taxes for the past 30 years in order to establish a "savings" for payment of Social Security benefits to the baby boomer generation.
What is important to keep in mind is that the Social Security system is not the cause of the debt, the Social Security system was used to finance debt that was already being incurred. If either the Social Security Trust Fund didn't exist or the money for the Trust Fund was put into something else, like for example invested in the stock market, either that debt would still have been incurred or income taxes would had to have been raised in order to avoid the debt, which means that total tax rates would had to have been higher for the past 30 years had the Trust Fund not existed in its current form.
To say that any strains placed on the budget due to the redeeming of securities in the Trust Fund are "caused" by Social Security would be like saying that the Chinese are a cause of our deficits due to the fact that we have to pay them back for the money we borrowed from them. Or, as a more individual example, it would be like borrowing money from your 401K (which you are legally required to pay back), and then when you have to pay the money back, stating that your 401K is the cause of you not having enough money.
The fact is that Social Security taxes have been financing the deficit for the past 30 years. Over the next 30 years there won't be a Social Security surplus to continue financing the deficit, and on top of that, either money will have to be raised from general revenue to pay for the securities that are redeemed from the Trust Fund each year to pay for Social Security benefits, which would reduce the national debt, or those securities will have to be sold to other debt holders, thus doing nothing to reduce the debt, just transferring it from the Trust Fund to private debt holders.
Any attempt to "reduce the deficit" by making changes to Social Security necessarily means defaulting on the debt, or at the very least extending the terms of the loan agreement in such as way as to defraud those who paid in the extra taxes in the first place. Social Security itself will never ever add to the deficit, it legally can't. The only thing that can happen is that it can have insufficient funds to pay the scheduled benefits, but it can't run a deficit.
Any talk of raising the retirement age or reducing benefits in order to "reduce the deficit" really equates to defaulting on the securities held by the Trust Fund, not paying back money that is owed the Social Security system, ultimately the American retirees who paid into it. But those who claim that reductions in benefits are needed to "reduce the deficit" don't put it that way. What they are really saying, however is, "our plan to reduce the deficit is to not pay back our creditors," and in this case, "our creditors" are us. Framing the issue as deficit reduction is just a way of tricking the public into agreeing to being defaulted on by the federal government.
The federal government currently has a debt of over $14 trillion, of which $2.5 trillion is held by the Social Security system. Of that $14 trillion in debt, the $2.5 trillion held by Social Security is the money we should be most obligated to pay back in a timely way. The other $11.5 trillion is owed disproportionately to wealthy individuals, institutions, and foreign governments, those who least need it. The $2.5 trillion owed to Social Security is owed disproportionately to America's least advantaged, the disabled and elderly, and mostly to those in the poor and middle class. Make no mistake, what those advocating "reducing the deficit through adjustments to Social Security" are talking about is writing off a portion of that $2.5 trillion which is owed to America's poor and middle class retirees, in order to make it easier to pay back the $11.5 trillion owed to wealthy bond holders and foreign governments.
The simplest way to think about it is that the Social Security Trust Fund, for the past 30 years has forced America's poor and middle-class to become one of the largest financiers of the national debt. Of all of the national debt, the debt financed by the Social Security Trust Fund is the portion of the national debt most heavily paid for by poor and middle-class Americans.
Claiming that paying back the money owed to Social Security will "add to the deficit" is no different than saying that paying back any of the debt we owe will "add to the deficit". The lenders aren't the cause of the deficits, the borrowing is the cause. The Social Security system (financed by taxes levied entirely on low and middle incomes) has been one of the major lenders to the federal government for 30 years, now the bill is due.
Now let's move on to issue number two, the long term funding of Social Security.
The Social Security system is currently on track to exhaust the money allocated to the Trust Fund and be unable to meet the currently projected benefit obligations in about 30 to 50 years. That's a pretty long way off. At that time the Social Security system, according to current projections, would not have enough money coming in to pay out the promised benefits. At that time it is estimated that if nothing at all is done, Social Security would be able to pay out approximately 75% of the currently scheduled benefits indefinitely, meaning that if no changes are made, in about 40 years the benefits would be about 75% lower than what the currently promised benefits for those retirees are. However, also keep in mind that the way that benefits are calculated also means that in about 40 years the currently promised benefits would be higher, even after adjusting for inflation, than what current recipients receive. This is because benefits grow faster than the rate of inflation (which is a potential problem with the benefit calculation), so the fact that we wouldn't be able to pay the fully promised benefits in 40 years doesn't even mean that people in 40 years would be getting less than people now, it means they would probably be getting the same amount as people now, because the promised benefits for people retiring in 40 years are higher, even after adjusting for inflation, than what people get today (according to projections, which are so far off they could be largely meaningless).
So even doing nothing at all is no tragedy. But the real question is, why do we have this projected shortfall in the first place, since back in 1983 the National Commission on Social Security Reform, appointed by Ronald Reagan and headed by Alan Greenspan supposedly "fixed" Social Security for good by significantly raising the FICA tax (from 6% to 12.4%) and eliminating various exemptions, etc.?
The biggest factor in the projected shortfall of Social Security has been increasing income inequality. When the calculations were made for funding Social Security they were made based on the assumption that both the ratio of payroll income to capital gains would stay the same and the distribution of payroll income would stay the same. After all, these ratios were relatively stable for the 30 years that preceded the action of the Social Security Commission (which began meeting in 1982). The data that they had to look at showed stable income distributions for 30 to 40 years. However, beginning in the 1980s income distributions began shifting dramatically, both the portion of Gross National Income going to payrolls and the distribution of income within payrolls.
What has happened over the last 30 years is that the portion of national income subject to the FICA tax has steadily decreased. It is sometimes noted that back in 1983, then the revisions to Social Security were made, that 90% of payrolls were subject to the FICA tax, and today that has dropped to around 84%, but what most people fail to also point out is that payrolls themselves, as a percentage of national income, have been falling as well.
In 1983 close to 60% of Gross National Income was subject to the FICA tax, whereas today that has dropped to around 53%.
Comparing the percentage of national income subject to Social Security taxation prior to 1983 is largely meaningless since the rates were much different, the caps were different, and there were many different exemptions from the program, etc., so it's simply not comparable.
This is the the fundamental root cause of the long-term funding issues with Social Security. Anyone who attributes the long-term funding issues with Social Security to any other cause, such as declining number of workers to retiree, people living longer, etc., etc., is either lying or doesn't know what they are talking about, period, it really is that simple.
The number of workers per retiree has been stable at around 3 workers per retiree for 40 years, and is projected to fall to 2 workers per retiree by 2030. While this is a decrease in the number of workers per retiree, productivity per worker has also increased dramatically over this time as well and can be expected to continue in the future. The problem is simply that over the past 30 years 98% of that economic increase has been captured by the highest 10% of income recipients, and thus virtually all of the increased productivity over the past 30 years has been untaxed by FICA, and without any changes will continue to be untaxed by FICA in the future. We could easily support an increasing number of workers per retiree if all, or at least more, economic growth were taxed by the Social Security system. The way the system currently works it is as if we are trying to support an increasing number of workers per retiree in an economy with zero economic growth. That, of course, wont work. The taxes being paid into the Social Security system over the past 30 years have been capped in such a way as to not capture any economic growth, only population growth, it is as if Social Security in 2011 is still being funded by the economy of 1970.
There are three ways to address this problem. The first is to get income distributions back to the way they were in 1980 and keep them there forever. The second is to change the formula for calculating the FICA tax cap so that it is pegged to the percentage of payroll income needed to fund Social Security instead of to a wage index (meaning that if we need to tax 90% of payrolls to fund the program, then set the cap to whatever will capture 90% of payrolls each year). The third would be to fully eliminate the cap on the FICA tax and apply the FICA tax to capital income as well as payroll income.
The first option is obviously the least likely to ever happen. That's pretty much a non-starter, even if you are in favor of lower income inequality. We can't rely on lowering income inequality to fix the system. That option is out.
The second option is workable, and unfortunately is probably along the lines of what would most likely be done. It still isn't perfect and will still have problems dealing with a changing ratio of capital and fringe benefit income to payroll incomes. If the portion of national income going to capital gains continues to increase, even this fix will eventually run into the same problem that we are currently facing. In addition, this would also mean preserving the currently exorbitantly high FICA tax rate of 12.4% on all payrolls below the cap.
The third option is to remove the FICA taxation cap entirely, and apply the tax to capital income in addition to payrolls. This also necessarily implies keeping the benefits the same as what they are now, even though people with high incomes would be contributing much more into the system. However, by doing this it would effectively solve the problem of income distribution leading to shortfalls, and it would allow for a significant reduction of the FICA tax. The current FICA tax of 12.4% could be cut roughly in half to around 6% and still bring in more money than currently, if the cap were removed and it were applied to capital income as well.
This means that someone with an average income of $5 million a year for 30 years would pay $9 million in FICA taxes, but still only receive roughly $2,000 a month in retirement benefits.
The third option, or at least the option of removing the taxation cap, is also by far the most popular option among America. Every poll for the past 5 years that asks about ways to fix Social Security funding and gives the option of "remove the taxation cap" has shown that removing the taxation cap is favored overwhelmingly by roughly 70% of Americans and is always the number one option selected as the best way to fix Social Security finances. See as one example: Poll: Fix Social Security by Taxing Wealthy
When the Social Security Commission met they combined the OASI (Old Age and Survivorship Insurance) and DI (Disability Insurance) programs into OASDI. The 12.4% FICA tax now goes toward OASDI combined. Of that 12.4% tax, however, 1.8% of it goes to the DI program. Even president Obama's conservative deficit commission has listed eliminating the cap on the DI portion. So, if nothing else at least that should be done, and be done quickly. By eliminating the cap on the DI portion the DI tax rate could probably be reduced to 1.4% (cutting the total FICA tax to 12.0%) and still bring in more revenue.
As it stands right now, we have a situation where essentially the entire burden of paying for the disabled falls entirely on the poor and middle class, while those with high income pay virtually nothing toward the care of the disabled. This, of course, is completely ludicrous.
To sum things up here, the fact is that the finances of the Social Security system are not a pressing issue, but nevertheless what people say about the finances of the Social Security system can tell you a lot about both their understanding of the federal budget and their ideological biases.
Anyone who claims that "fixing Social Security" is a component of reducing the deficit is either lying or uninformed, period. The Social Security system never has and never will add one dime to the deficit. The Social Security system, through taxes levied entirely on middle to low wages, has been one of the biggest financiers of the national debt for 30 years. The root cause of all of the fiscal problems with Social Security is income inequality and a system of taxation and benefit adjustment that doesn't take changing levels of income inequality into account. The system was designed under the assumption of static levels of income inequality and a static level of gross national income going to payrolls. As both the portion of national income going to capital income has increased and income inequality has increased both the revenue and expenditure have failed to account for these conditions and thus revenues are falling behind and expenditures are increasing too much.
The way to fix the system then, is not to do something like raise the retirement age, which is just a completely unrelated action that just works around the underlying problem, but rather it is to fix the formulas or take income inequality completely out of the equation by eliminating the taxation caps and applying the tax to all forms of income. The first solution, fixing the formula, would result in a balanced Social Security budget and the ability to keep the benefits essentially unchanged while raising the FICA taxation cap and keeping the tax rate the same, while the second solution would allow us to cut the FICA tax roughly in half while still maintaining benefits. In addition, taking either one of these actions, by bringing in more revenue immediately, would allow for a slower draw down of the Trust Fund, thus reducing the rate at which that debt would have to be paid back, while neither decreasing benefits nor raising taxes on the poor or middle class, who have already been overpaying for the past 30 years.