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Fixing Social Security
SOURCE: San Fransisco Chronical
David Lazarus
January 28 2005

Social Security is fixable. But there isn't much agreement about which fix will work best.

In 1983, the last time anyone took a serious whack at addressing Social Security's problems, much of the heavy lifting was done by representatives of former Republican President Ronald Reagan and former Democratic House Speaker Tip O'Neill.

Peter Diamond, a professor of economics at the Massachusetts Institute of Technology who specializes in Social Security, said the two sides hammered out a compromise that included higher payroll taxes and reduced benefits in the form of a higher retirement age.

That compromise, in turn, is expected to keep the system solvent for the next 40 years or so.

"Right now, we've got more ideology than before," Diamond observed. "It's going to be very hard to come up with a new compromise arrangement."

Be that as it may, let's look at a few possible remedies. First, a recap of the problem.

President Bush says a looming shortfall in funds will leave Social Security "flat bust, bankrupt." That's just not true. But there won't be enough money to meet all of the system's obligations.

By 2018, as millions of Baby Boomers become pensioners, Social Security is expected to begin paying out more in annual benefits than it takes in from payroll taxes.

Around 2042, the system's current surplus of more than $1.5 trillion (assuming it's repaid by the government, which has already spent the money elsewhere) will be exhausted.

From this point on, Social Security will be forced to rely exclusively on revenue from workers and their employers. Yet even then, it will still be able to meet almost three-quarters of its yearly financial obligations.

Restoring the system

The problem to be solved, then, is how to restore the system to full solvency and how to keep it that way for decades to come.

For his part, Diamond favors tinkering with bits and pieces of the Social Security apparatus, rather than sweeping changes. This would protect the neediest recipients, he argues, and would have the virtue of political feasibility.

"It's a complicated system," he said. "Nips and tucks are exactly the right way to move toward a political compromise."

For example, Diamond wouldn't raise the minimum retirement age of 62 or push payroll taxes through the roof. But he would create mechanisms so that taxes and benefits are changed to accommodate longer life spans and the strain this can place on retirement resources.

On the other hand, Michael Tanner, who oversees Social Security studies at the libertarian Cato Institute, said he would focus primarily on changing the way annual benefits are tabulated.

He'd switch from using wages as a benchmark to using the cost of living, which rises more slowly. Some experts say this would cut current benefits almost in half by 2065.

But Tanner first and foremost supports Bush's proposal for allowing workers to steer some of their payroll taxes into private accounts.

"Doing anything without private accounts is a bad idea," he said.

My feeling is that both Diamond's and Tanner's approaches miss the mark. Bold, easily understood measures are required here, with pain shared relatively equally across the economic spectrum.

The private accounts envisioned by Bush are effectively useless. If people want to set money aside, they can already do so in 401(k) plans and individual retirement accounts.

If the government wants to be more proactive in encouraging people to save, it can include a box to be checked on income tax returns that would channel a portion of annual refunds into an IRA.

It could also authorize the Social Security Administration to set up and maintain IRAs on taxpayers' behalf, aside from contributions to the Social Security system.

But when it comes to Social Security's future solvency, the simple fact is that revenue will need to be increased and benefits almost certainly will have to be reduced. There's no other way.

Raising the minimum retirement age probably won't do much. It's a simple fact that Americans want to retire early, and the government shouldn't be in the business of telling seniors that they have to keep working when they don't want to.

Instead, we should raise the age at which retirees qualify for full payments, from 67 to perhaps 69. This is a benefit cut, pure and simple, but it would address Social Security's solvency without undermining the system's integrity (as would be the case with private accounts).

Raising payroll taxes

We should also incrementally raise payroll taxes to reflect the happy fact that we live longer than ever and that medical advances will probably ensure longer retirements than our grandparents could have possibly imagined.

Meanwhile, it's time to do away with the current $90,000 cap on taxable earnings.

This would represent an enormous tax increase for the wealthy (who have grown accustomed in recent years to paying fewer taxes). But it would also create parity with other wage earners.

Why should someone making $50,000 a year have to pay 6.2 percent of his or her paycheck into Social Security, while, because of the cap, someone making $5 million a year pays only about 0.1 percent?

Yet I'm prepared to completely contradict myself and argue that parity has no place when it comes to benefits. Bill Gates, for example, will not need a Social Security check.

The world's richest man received $901,667 in compensation last year from Microsoft. But because of his stock holdings, Gates' net worth was placed by Forbes magazine at $46.6 billion.

With the cap in place, Gates paid about $5,600 into Social Security last year, or the same amount as someone making a tenth of his earnings. Without the cap, he would have paid in almost $56,000.

Should Gates in turn receive his duly earned benefits? No, sorry. He doesn't need them.

Instead, Gates gains from the more stable and prosperous society he's helped create by preventing lower-income retirees from struggling to get by.

And maybe, just maybe, those pensioners will have enough set aside to buy Microsoft's latest operating system and an MSN account so they can manage their finances online.

I'm not sure where the cutoff should be for Social Security eligibility. But I think there's a real question whether any retiree with a net worth of more than $5 million or an annual income of more than $150,000 needs an extra $2,000 or so per month.

Experts don't agree

The experts vary in terms of their own prescriptions. For example, MIT's Diamond would slowly raise the cap and impose a 3 percent surcharge on all additional earnings. Cato's Tanner is open to means testing as long as private accounts are part of the picture.

The proposals I outlined above are undoubtedly simplistic, but they illustrate that solutions to Social Security's fiscal woes are within reach.

What needs to be remembered above all is that when the system was created in 1935, it had a very specific goal: "To alleviate the hazards of old age, unemployment, illness and dependency."

As he signed the Social Security Act into law, President Franklin D. Roosevelt had this to say:

"We can never insure 100 percent of the population against 100 percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age."

Protecting the average citizen. It seems that we've lost sight of that aspiration amid the intensely partisan debate that's come to characterize this issue.

Social Security is not about fostering a sense of personal responsibility. It's not about teaching people to save more. It's not about creating an "ownership society."

As Roosevelt said, Social Security is about providing "at least some protection" to ordinary citizens "through old-age pensions and through increased services for the protection of children and the prevention of ill health."

That's the system we're trying to save. It's a system worth saving.

David Lazarus' column appears Wednesdays, Fridays and Sundays. He also can be seen regularly on KTVU's "Mornings on 2." Send tips or feedback to dlazarus@sfchronicle.com.

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