By William A. Galston
Jettisoning the cap on taxable earnings wouldn’t get us even halfway to a solution.
Utah Republican Orrin Hatch is a veteran senator who knows how to get things done, often on a bipartisan basis. As ranking member of the powerful Senate Finance Committee, he would be the odds-on favorite to become chairman if the Republicans take control of the Senate in November. So it is worth paying attention to what he does.
Some time ago, Sen. Hatch posed a series of questions to the Congressional Budget Office about the effects of possible policy changes on the long-term solvency of Social Security. All of the options would mean more revenues for the system, and none involved structural changes or cuts in benefits. On a quiet July Friday last week, the CBO unveiled its response, and the results are instructive.
Because Social Security makes multigenerational promises, the CBO calculates its financial condition in a 75-year window. That time-horizon might appear to be meaningless. So much can change, so fast. But unlike many other programs, Social Security’s financial outlook is shaped by key variables that change slowly, if at all. (Predictions made decades ago about the rate of increase in longevity turned out to be remarkably accurate.)
The CBO puts the 75-year imbalance in Social Security at 1.2% of GDP—about $200 billion in 2014, and rising steadily as GDP increases. If we do nothing, the Social Security actuaries estimated last year, all Social Security reserves will be exhausted by 2033, after which revenues could cover only three-quarters of currently scheduled benefits.
To close that gap while maintaining scheduled benefits, we would need to enact an immediate increase in the payroll tax rate from 12.4% to 15.9%. For workers earning $50,000 a year, that would mean a tax increase of $900, nearly 2% of gross income. And employers would have to match it. For workers making the maximum now subject to payroll taxes (a bit under $120,000), taxes would rise by $2,100.
Because earnings covered by Social Security are capped, the payroll tax is steeply regressive: Higher-income earners pay a much lower rate than do those at lower levels. For a worker making $250,000, payroll taxes amount to only 5.9% of total earnings, less than half the rate of someone making $50,000.
Many people have proposed making the tax less regressive by bringing more of total income under the cap, and there is a historical basis for doing so. In 1983, when Congress averted insolvency in the system by enacting the recommendations of the Greenspan Commission, about 90% of total earnings fell under the taxable cap. Although that cap has risen in tandem with average wages ever since, increasing inequality in the distribution of earnings means that today only 83% of total wages are subject to the payroll tax. Restoring the ratio of three decades ago would mean doubling the maximum earnings subject to the tax to $241,600. For someone making the maximum, that would mean a tax increase of $7,600, with employers liable for the same increment. Numbers this large affect calculations about hiring and raises.
One might imagine that such a sizable increase in covered earnings would be enough to stabilize the system for the long term. In fact, the CBO calculates, it would reduce the imbalance by only 30%. Indeed, eliminating the cap and taxing all earnings would solve just 45% of the problem. If we stick with the current payroll-based funding system, any solution would have to involve an increase in the payroll tax rate as well.
These eye-popping numbers show what will have to be done if we don’t change scheduled benefits, now or in the future. Yet no change is exactly what the American people want. In a study released last month, the Pew Research Center asked 10,000 adults to choose between two statements: Social Security benefits should not be reduced in any way, or some future reductions need to be considered. Sixty-seven percent endorsed the first, 31% the second.
Even 64% of “steadfast conservatives” in the Pew poll, who might be expected to desire reining in an entitlement, opposed any reduction. And forget about generational warfare: Another Pew report, released in December, found that 61% of young adults ages 18 to 29 are against Social Security cuts.
Given this backdrop, most members of Congress would prefer to do nothing. But that is not possible. By the end of fiscal 2017, Social Security’s disability-insurance trust fund will run out of money. Many Democrats want to put a patch on the problem by transferring funds to the disability program from the Social Security retirement trust fund, postponing the disability crisis at the cost of bringing forward the date at which the retirement fund would be exhausted. According to a Senate staff member, Sen. Hatch hopes to focus on the disability issue to catalyze a broader discussion. The hard numbers in the CBO’s response to his inquiry reveals how difficult that conversation will be.