How to save Social Security from Heritage Foundation

“Saving the American Dream: The Heritage Plan to Fix the Debt, Cut Spending, and Restore Prosperity,” Heritage Foundation, May 10, 2011 by  Stuart Butler, Ph.D. , Alison Acosta Fraser and William Beach is one of the finest papers I have ever read. Over the next few days I will post portions of this paper, but I will start off with the section on Social Security. Here is the first portion:

Saving the American Dream is The Heritage Foundation’s plan to fix the debt, cut spending and, above all, restore prosperity. It balances the nation’s budget within a decade—and keeps it balanced. It reduces the debt and cuts government in half. It eliminates government-mandated health care and fully funds our national defense. It squarely confronts Social Security, Medicare, and Medicaid, the three so-called entitlement programs, which together account for 43 percent of federal spending today.

To encourage Americans to become more fiscally responsible, the Heritage plan redesigns our entire tax system into an expenditure tax that will have a single, flat rate. This is a structure that will promote savings, therefore benefiting individual Americans, our body politic, and the economy.

At the end of the day our plan, while economic in nature, has a higher moral purpose. If entitlements are not reformed, the next generation and future ones will have to pay punitive tax rates that will end liberty as we have known it. Our proposal, which was funded by a grant initiative set up by the Peter G. Peterson Foundation, aims to preserve America’s promise bequeathed to us by past generations.

Social Security

Summary

Social Security is the largest single federal program, paying out about $700 billion per year to some 60 million Americans. It is a major source of retirement income for millions of Americans. Yet Social Security went into the red in 2010, paying out more in benefits than people paid in as payroll taxes. The Congressional Budget Office says that these deficits will continue for at least the next 75 years and probably indefinitely.

What Is Social Security?

Social Security, today’s largest single federal program, provides (1) retirement income to workers and their spouses, (2) survivors benefits to the family members of deceased workers, and (3) disability benefits for workers who have been injured and are unable to work and to the families of those workers. The program is funded by a 12.4 percent payroll tax that is paid equally by both the worker (6.2 percent) and his or her employer (6.2 percent). Employers correctly see their contribution as a part of the employee’s total compensation.

In 2009, the most recent year for which data are available, Social Security spent a total of $685.8 billion providing these benefits. That was also the last year that Social Security collected more in payroll taxes than it paid out in benefits. Starting in 2010, the program started to run cash-flow deficits that the Congressional Budget Office says are unlikely ever to end. The annual Social Security deficit will increase every year until about 2030, when it will reach about $350 billion annually in 2010 dollars (without including any inflation), and stay at approximately that level permanently.

Social Security does have a $2.5 trillion trust fund from the surpluses that it collected between 1983 and 2009—but that money isn’t there. Rather than build up real assets in a real trust fund, Congress actually spent that money on everything from roads to corporate welfare. That trust fund is filled with special-issue Treasury bonds that the U.S. Treasury is required to finance when they are needed to fund Social Security’s deficits. As they are bonds not backed by any real assets, the government will have to either borrow or raise taxes to pay for them.

In essence, then, these bonds are really a demand on future tax collections—a lien. In 2010, the Treasury started to redeem these bonds, or tax liens, by tapping into other tax sources in order to cover Social Security’s deficits. Around 2037, even those special-issue bonds will run out. From that time on, under the provisions of current law, every retiree—no matter how wealthy or how poor—will have his or her Social Security benefits cut by about 22 percent.

Over the next 75 years, the program has promised to pay $7.8 trillion more in benefits than it will receive in payroll taxes. The only way that future retirees can collect all of the benefits promised to them is to make their children and grandchildren pay massive amounts of additional taxes.

Without Reforms, Entitlements will consume all Tax Revenues

Heritage proposes to solve these problems and strengthen the Social Security system by tightening its benefits and returning it to its original purpose: a guarantee that older Americans won’t fall into poverty. Heritage proposes to make Social Security “real insurance” for Americans as they reach retirement.

This reform means that Social Security’s promises in the future will change in several ways:

  • Social Security will gradually be transformed from an “income replacement” system back to its original purpose of guaranteeing seniors freedom from fear of poverty and assuring a decent retirement income. This means that Social Security benefits will evolve over time into a flat payment to those who work more than 35 years—a flat payment that is sufficient to keep them out of poverty throughout their retirement.
  • Because the new Social Security is a real insurance system, designed to protect seniors from poverty, retirees with high incomes from sources other than Social Security will receive a smaller check, and very affluent seniors will receive no check. This transparent way of income-adjusting benefit checks will replace the method used today, whereby the checks of even modest-income seniors are taxed and thus reduced.
  • To help make up the difference between the new Social Security benefit and what workers may desire for a more comfortable retirement, our plan will create greater incentives for workers of all income levels to save more for retirement. These savings will supplement their Social Security and create a more secure retirement.
  • Americans live much longer than they used to. While this is good news, it means that they are spending a much higher proportion of their lives in retirement. Regrettably, these longer retirements play a major role in Social Security’s financial problems. For this reason, the Social Security retirement ages will be raised gradually and then indexed to life expectancy. This will create a more reasonable balance between the number of years a person works and the number of years one receives Social Security benefits.
  • To encourage people to stay in the workforce longer, those who work beyond full retirement age will receive a higher level of after-tax income during the period when they are not claiming benefits.

This new Social Security system is reasonable, predictable, and affordable. It focuses resources on those who need the most help while providing complete protection against poverty for all seniors who qualify for full benefits.

The Details

A Predictable Benefit That Provides Economic Security. The centerpiece of the new Social Security system involves a gradual transition to a flat benefit that pays retirees who qualify for a full Social Security check. This amount is well above the income level that the Census Bureau says an American over the age of 65 needs to avoid poverty.

Thus, the new system will guarantee that no retiree falls into poverty because of insufficient income. Under today’s system, retirees can pay Social Security taxes for 35 years and still receive a benefit that is below the poverty level. Some of these seniors are forced to go on welfare. The new system corrects this serious flaw.

The flat benefit will be the equivalent of about $1,200 per month in 2010 dollars when the reform is complete. This is both higher than today’s average Social Security retirement benefit payment ($1,164 per month) and well above the 2009 poverty level for a single adult over age 65 ($857 per month). To ensure that future retirees do not slip back into poverty, the flat benefit level will be indexed for wage growth.

Slow Transition to the New Flat Benefit. The new flat benefit will be phased in slowly. Current retirees and those who are close to retirement will see only a minimal change in the basic design of their benefits. Those with a significantly longer time before retirement, who have more flexibility in planning their future, will see larger changes in their benefits. Workers born after 1985 will come under the new flat Social Security benefit system when they retire.

Limiting Social Security to Those Who Actually Need It. In addition to moving to a flat benefit over time, the plan makes Social Security a properly financed, true insurance program. It starts to do that immediately. This means that the program will concentrate on protecting the economic security of retirees rather than following the current approach of promising unaffordable benefits to all without regard to need.

This new approach means that retirees with substantial non–Social Security retirement income will start receiving a lower benefit on a sliding scale that gradually reduces Social Security checks to zero for those with the highest non–Social Security incomes. This transparent mechanism will apply to benefits received by affluent Americans under both the current system and the flat-rate system. This transparent, sliding-scale approach is a major improvement on today’s taxation of Social Security benefits.

Under the plan, income-adjusted benefits start in 2012 as individual retirees with non–Social Security incomes above $55,000 start to see a slight reduction in benefit payments. Those with higher non–Social Security income will see larger reductions in their checks. Individuals with more than $110,000 in non–Social Security income will receive no Social Security payments. Married couples who file taxes jointly would be subject to higher thresholds, with benefits beginning to phase out at a joint non–Social Security income of $110,000 and ending when income reaches $165,000. Married couples can decide whether they want to qualify for benefits as individuals or jointly as a couple. The income thresholds will be indexed for inflation.

Income-adjusting benefits is not new. It occurs in today’s Social Security system. But it is largely hidden today and hits lower-income seniors, not just the affluent. Seniors with as little as $15,000 in non–Social Security income, or even less in some cases, must pay tax on part of their benefits. Seniors with more income than that pay steadily higher rates of tax on more of their Social Security benefits. The Heritage approach, when fully phased in, would income-adjust benefits transparently and not tax the benefits a senior receives. It also would start income-adjusting at a much higher income. Today, about half of seniors have their checks eroded by taxation. Under the Heritage plan, only about 9 percent of seniors would see their checks reduced and only just over 3.5 percent of seniors would receive no check.

Real insurance also protects seniors from poverty if their financial situation changes. Retirees who suffer a sudden and permanent drop in non–Social Security income would find their benefits rapidly restored.

More Accurate Inflation Protection. The annual cost of living adjustment (COLA) for Social Security, which protects retirees against inflation, will be based on the Chained Consumer Price Index (C-CPI-U), a measure of inflation that is more accurate than the index used currently. The Bureau of Labor Statistics specifically designed this inflation measure to better reflect the way that consumers buy different items as the prices of various products fluctuate.

A More Reasonable Retirement Age. The plan adjusts the standard retirement age to reflect increases in life expectancy and those anticipated in the future. Under the plan, these changes are phased in gradually. Those nearing retirement are affected only slightly. Over the next 10 years, the age for full benefits rises to 68 for workers born in or after 1959. Over the next 18 years, the early retirement age rises to 65 for workers born in or after 1964. After that, both early and normal retirement ages will be indexed to longevity, which will add about one month every two years according to current projections.

The plan recognizes that a small proportion of workers will be physically unable to work until these ages. It therefore includes an improved disability system to protect them. The reformed disability system ensures that those who are unable to work longer receive a quick and accurate decision on their benefit application rather than facing today’s long delays, and improves today’s often arbitrary decision-making process.

Incentives to Work Longer. Starting immediately, those who work past their full-benefit age receive a special annual tax deduction of $10,000, regardless of income level. For instance, once the new system is completely phased in, a worker earning $50,000 per year who delays Social Security payments will see a $200 per month increase in spendable income.

An Improved Savings Plan to Supplement Social Security. As Social Security is transformed into a real insurance system that focuses scarce resources on those who need them most, the plan also creates better ways for workers to build savings for retirement.

Beginning in 2014, a new savings plan will be introduced over two years. Under this plan, 6 percent of each worker’s income is placed in a retirement savings plan that the worker owns and controls unless he or she explicitly declines to have such an account. (This approach is known as automatic enrollment.)

This new, additional retirement security system gives Americans another tool with which to secure their retirement standard of living. Savings are invested through an improved version of the IRA/401(k) employment-based retirement savings system already familiar to Americans. The money put into these savings accounts will not be double-taxed, unlike today’s Social Security payments and many other savings mechanisms.

In addition to this new savings plan, workers have two other important ways to save for retirement.

First, under the reformed tax system detailed below, all savings (without limit) will no longer be double-taxed. Savings remain completely free of taxation until they are actually spent.

Second, as benefit reforms drive the costs of Social Security below the level of taxes collected, those savings will go into the workers’ accounts.

The Bottom Line

The Heritage plan reforms Social Security to create a retirement security system that will be available for future generations. It will be one that provides a reasonable, predictable, and affordable benefit that ensures that no retiree who has worked for 35 years or more faces poverty or economic insecurity. At the same time, this new system protects our children and grandchildren from the massive tax increase that would be necessary to pay all of the Social Security benefits that Washington has irresponsibly promised.

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Comments

  • pension plan definition  On January 20, 2013 at 2:29 pm

    Nice post. I learn something totally new and challenging on
    sites I stumbleupon on a daily basis. It’s always helpful to read content from other authors and practice a little something from their websites.

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