An Unhappy Birthday for Social Security

A sobering thought for Saturday, when Social Security reaches age 75: Most young Americans don’t expect it to be around when they need it. The sobering truth is that they’ll be right if policymakers don’t make changes soon.

The good news is that this is one case where Washington seems to have gotten the message. Odds for a package of changes after President Obama’s debt commission makes its report Dec. 1 are good. But a preemptive challenge to any change by those who claim they want to preserve Social Security poses a threat that will have to be overcome.

Social Security remains on solid footing today, but the demographics are not in its favor. Neither is the economy. This year, for the first time ever, the government will pay out more in benefits than it takes in through payroll taxes. The estimated deficit of $41 billion is due mostly to the high unemployment that has forced more people to tap benefits early -- at age 62 instead of full retirement age. In their annual report, the Social Security trustees projected a return to surplus next year, but within 10 years the deficits will be close to $100 billion annually, as the ratio of people paying into the system vs. people collecting benefits keeps falling, to about 2-1 by 2035, from 16-1 in 1950. While technically there is enough in the trust fund to last until 2037, the trust fund is really just an IOU, and the government will have to borrow -- adding to the overall deficit -- to meet its obligations to retirees. But as everyone knows, federal borrowing is already too high.

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That’s why it’s certain that the debt commission will propose several changes to keep Social Security solvent for the long term -- at least another 75 years. And chances are, opponents won’t be able to prevent Congress from acting. Once seen as the third rail of American politics, Social Security is now regarded as the low hanging fruit when it comes to reining in the debt, as Bill Bixby, head of the Concord Coalition, recently put it.

Fixing Social Security will certainly be easier than seriously slowing the growth in health care costs to save Medicare and Medicaid, deciding on tax reforms or cutting defense programs. But the fix won’t come without considerable pain. According to the Committee for a Responsible Federal Budget, the demographics produce a Social Security gap of 1.92% of taxable payroll over the next 75 years. So if the payroll tax were increased by that amount, the gap would close. But that’s an untenable step.

More likely is a smaller tax hike combined with a higher retirement age and smaller benefits, with means testing applied to both the tax hike and the benefit cut.

An almost sure bet is upping the normal retirement age to 68, which would close 25% of the 75-year projected gap. Some lifting of the cap on income subject to the payroll tax (say from $106,800 today to $200,000) is also likely.

More complicated -- and more controversial -- will be a lowering of anticipated benefit levels.Proposals for accomplishing that include increasing the number of years used to calculate benefits, from the 35 highest earning years to the 40 highest, and/or by changing the formula used to determine benefits and annual inflation adjustments so they track prices instead of wages, a slower rising approach.

Also possible: A program for private accounts as a supplement or carve out to Social Security, means testing of benefits based on wealth (not retirement income), incentives for working longer, changes in survivor and dependent benefits, expansion of the system to include exempt workers and many others.

It’s worth stressing that none of these changes will affect the benefits being received by current retirees, although their future inflation increases could be. Those very close to retirement are also likely to be exempt from most of the changes.

Expect Congress to take up the debt commission’s ideas next year, with Social Security reform more than likely by the end of 2012.