What's Next for Social Security?

By Markets Fool.com

While Social Security isn't bankrupt, as many people mistakenly believe, the system is definitely unsustainable in its current form. According to the latest Social Security Trustees' Report, the trust funds will be completely depleted in 18 years, at which point the only money available to pay benefits will be incoming payroll taxes. That is, unless something changes.

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Ways to fix Social Security

There are two main ways to increase Social Security's financial strength: reduce benefits or increase taxes. Within each of these categories, there are several viable options. Or, there could be another option that hasn't been discussed much.

As far as benefit reductions go, across-the-board benefit cuts are so unpopular that they're extremely unlikely to materialize. However, there are other ways of reducing the amount of benefits flowing out of the system.

  • Increase the full retirement age:Currently, the full Social Security retirement age is 66, and it's about to gradually rise to 67 for those born in 1960 or later. However, it could be increased even further, to 68 or even 70.
  • Reduce benefits for higher earners:The Social Security benefit calculation is already weighted in favor of the lowest earners. Adjusting the formula even further could reduce the amount of benefits going out to rich people.
  • Means-test Social Security benefits:This would result in poorer retirees receiving generous benefits, and richer ones receiving less (or none at all).
  • Lower the cost-of-living adjustment (COLA) method:By switching from the CPI to a slower-growing index such as the "chained CPI," it would decrease the growth rate of existing Social Security benefits.

When it comes to tax increases, there are only a couple of ways this could be done. We could increase the Social Security payroll tax, which is currently 6.2% on employers and employees. Or, we could lift or eliminate the earnings cap for Social Security taxes. As of 2016, only the first $118,500 in earned income is taxable for Social Security purposes. By gradually increasing the money flowing into the system, benefit cuts become less necessary. In fact, by increasing the payroll tax rate from 6.2% to 7.7%, Social Security would be solvent for another 75 years with no other changes whatsoever.

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Finally, there is a possibility of creating another revenue stream for Social Security by redirecting existing government spending. This is an option that hasn't been discussed much, but is certainly possible. For example, a certain presidential candidate mentioned the possibility of redirecting billions in foreign aid we're sending to hostile countries into Social Security's coffers.

The other side: Should we strengthen Social Security?

It may seem silly to discuss expanding Social Security's benefits, especially when we're facing the possibility of the system running out of money as-is, but there is actually a lot of support for doing so. In fact, 72% of Americans feel that we should consider increasing Social Security benefits to provide a more secure retirement for working Americans, including a majority among all generations, income groups, and political party affiliations.

Across-the-board increases are indeed a possibility, but there are other, more specific ways many people would like to see Social Security's benefits expanded. For one thing, senior citizens experience a different inflation rate than the rest of us, mainly due to healthcare costs rising rapidly, and we could adjust the COLA to better reflect these costs. Another popular idea involves raising the minimum Social Security benefit so no American with 30 years in the workforce is forced to retire in poverty.

The trade-off is that along with higher benefits comes a need for even higher tax revenue -- not only to provide for the extra benefits but to solve Social Security's pre-existing funding issues. However, most Americans seem to be willing to pay to enhance Social Security's benefits, according to a study(link opens PDF) by the National Academy of Social Insurance.

What's most likely?

In general, any benefit cuts would be extremely unpopular with Americans of all political affiliations, age groups, and income levels. In fact, the same study I referenced earlier found that just 35% of Americans would be in favor of a small increase in the retirement age to 68, and just 24% support reducing the COLA calculation method.

On the other hand, all of the options that preserve or increase benefits are extremely popular, even those having to do with tax increases. For comparison, here's a look at how many Americans are in favor of certain potential Social Security changes:

Proposed Change

Percentage of Americans in Favor

Increase wage cap to include 90% of all earnings

84%

Gradually increase payroll tax rate to 7.2%

83%

Eliminate wage cap altogether

80%

Increase the COLA formula

80%

Increase benefits for the oldest SS recipients

77%

Increase the minimum benefit

72%

Across-the-board increase

61%

Means-test eligibility

40%

Raise retirement age to 68

35%

Raise retirement age to 70

25%

Reduce the COLA formula

24%

Data source: National Academy of Social Insurance.

In addition, tax increases would have a much greater effect on the Social Security funding problem than any realistic benefit reduction. Just to illustrate this, eliminating the wage cap and gradually increasing the payroll tax rate to 7.2% would have a combined effect of eliminating 126% of the funding gap. In other words, not only would this combination make the system solvent, but it would allow for some benefit increases as well.

On the other hand, raising the retirement age to 68 and means-testing Social Security benefits would combine to solve just 36% of the shortfall. So, even if these were to happen, we'd still need tax increases or further cuts to solve the other 64%.

The bottom line is that the exact package of reforms is anyone's guess at this point, but it seems likely that tax and benefit increases will be the likely way to go. Not only do the American people want it that way, but tax increases would do much more to solve the funding dilemma.

The article What's Next for Social Security? originally appeared on Fool.com.

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