Bernie Sanders' Social Security Reform Will Fail -- Here's Why

Each month, 63 million beneficiaries receive a Social Security benefit check, with more than one out of three recipients reliant on this payout to help pull them out of poverty. There simply isn't a program out there that does more for the financial well-being of retired Americans than Social Security.

But despite its importance, a number of demographic changes are weighing on the program. The ongoing retirement of baby boomers and lower birth rates are both threatening to lower the worker-to-beneficiary ratio over the long run. Meanwhile, income inequality and longevity have been on the rise over the course of many decades. Altogether, these problems are weakening America's most important social program.

According to the June 2018-released Social Security Board of Trustees report, these demographic shifts are expected to push the program from a net cash surplus to a net cash outflow very soon. In fact, yours truly contends that this shift may already be happening. With the program's net cash outflow expected to grow substantially with each passing year, the latest Trustees report forecasts that all $2.89 trillion in Social Security's asset reserves will be depleted by 2034. That's assuming Congress does nothing to add new revenue, cut long-term expenditures, or enact some combination of the two, before then. If nothing is done, then-current and future retirees can expect an across-the-board benefit cut of up to 21%.

Clearly, something needs to be done to shore up Social Security for current and future generations of retirees. The big question has always been, what?

Presidential hopeful Bernie Sanders proposes a major Social Security overhaul

Progressive presidential candidate Bernie Sanders, an Independent Senator from Vermont, believes he has the solution.

On three separate occasions since March 2015, Sanders has introduced or reintroduced the Social Security Expansion Act as a means to shore up the program and lift benefits for lower-income beneficiaries. Although you can read about the plan specifics in greater detail, here's a quick rundown of the most important changes Sanders' proposal would make to the program.

  • Implements a doughnut-hole tax on income above $250,000: The biggest change is that Sanders' plan would aim to raise revenue by taxing the wealthy. Currently, Social Security's 12.4% payroll tax applies to earned income (i.e., wages and salary) between $0.01 and $132,900, with anything above this top-end amount exempted. With the Social Security Expansion Act, a moratorium on the payroll tax would exist between $132,900 and $250,000, with earned income above this amount again subjected to the payroll tax.
  • Changes the inflationary tether to the CPI-E: Next, Sanders' proposal would abandon the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) as the program's cost-of-living adjustment (COLA) measure and replace it with the Consumer Price Index for the Elderly (CPI-E). By focusing on the spending habits of senior households, it's presumed that annual COLAs would be higher.
  • Increases minimum monthly benefits: A champion of the blue-collar worker, Sanders' plan would increase minimum monthly benefits for low-income retired workers to ensure they are paid more than the federal poverty limit.
  • Increases the net investment income tax: The Social Security Expansion Act would also hit investment earnings for people with modified adjusted gross income above $200,000, and couples over $250,000, with an additional 6.2% surtax. The net investment income tax already amounts to a 3.8% on investment income above these thresholds, but would hit 10% under Sanders' proposal.

As with most Social Security benefit expansion plans, it sounds great on paper. But dig into the weeds and you'll see that Sanders' proposal simply won't work.

Here's why Bernie Sanders' Social Security reform would fail

While Sanders' reform bill does offer a number of positives, including an immediate uptick in revenue from the wealthy with which to tackle Social Security's estimated 75-year cash shortfall of $13.2 trillion, it overlooks some key points.

First, taxing the wealthy probably won't go over as smoothly as expected from a variety of aspects. If we look back at the period of time between 1932 and 1981 when the peak marginal tax rate on the rich ranged between 63% and 94%, we rarely find instances when the effective tax rate for the rich approached these lofty tax figures. Rather, the wealthy often find innovative (but legal) tax loopholes with which to avoid taxation. It would not be surprising if Sanders' doughnut-hole tax brought in less revenue than expected as the rich shift their income recognition. As a reminder, investment income is exempt from the payroll tax.

To build on this first point, it's also common for higher tax rates to weigh on long-term growth prospects for the U.S. economy. Since the payroll tax accounted for close to 88% of Social Security's revenue collected in 2017, a slower-growing economy would very likely also correlate to subdued increases in year-over-year payroll tax collection.

Although a bit conjecture on my part, it's also worth mentioning that the wealthy tend to be among the biggest political campaign donors. Placing a higher tax burden on these individuals may not sit well, and it could mean lost votes (and donations) in future elections. This is a big reason why President Trump has shied away from proposing direct changes to Social Security.

The second major problem revolves around the use of the CPI-E as the program's inflationary tether. Even though measuring the spending habits of senior households should result in more accurate inflation readings (and therefore a more accurate COLA for retired workers), it still has deficiencies. For instance, the CPI-E overlooks a number of Medicare expenditures, meaning even with an inflationary tether designed for seniors, it would still probably underreport the inflation they're contending with.

In addition, a somewhat recent report from the Government Accountability Office reminds us that the CPI-E is considered by the Bureau of Labor Statistics to be an experimental inflationary measure. It would be quite costly and time-consuming to refine the CPI-E's methodology for actual use as Social Security's inflationary tether.

Then there are the actual votes needed to pass such a measure. When it comes Social Security solutions on Capitol Hill, there are fixes aplenty with basically no middle ground. In order to pass the Social Security Expansion Act, 60 votes would be needed in the Senate. Unfortunately, neither political party has had a supermajority (60 votes) in the Senate in 40 years. This makes bipartisan cooperation mandatory for the passage of any Social Security reform, which simply isn't going to happen with Sanders' bill.

Finally, Sanders' plan may be understating the impact of longevity and lower birth rates on the program. It's no secret that the Trustees adjust their outlook all the time based on numerous geographic and fiscal changes. But it's pretty clear that life expectancies have increased over time, and birth rates have fallen to a 40-year low for U.S. women, as of 2017. If nothing is done to curb being able to receive benefits for 20-plus years, or accounts for lower worker replacement as the result of a four-decade low in birth rates, Social Security will likely still be facing a cash shortfall over the long run, even if Sanders' bill is implemented.

Mind you, Sanders' bill does offer good ideas. Raising revenue will be important to quickly combatting Social Security's cash shortfall since the Republicans' plan to reduce expenditures over time works far too slowly. But, as you can see, it also has a number of shortcomings that I believe would lead to it failing to get the job done.

The $16,728 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.