The Blatant Flaw of Bernie Sanders' Social Security Fix

Image source: Flickr user Craig Sunter.

The remaining presidential candidates may not see eye-to-eye on much, but no candidate would argue against the fact that the Social Security program, as it exists now, is unsustainable and needs help.

Social Security's problem in a nutshell In case you haven't been paying close attention, let's run through a brief synopsis of the latest report from the Social Security Trustees.

The program, which is currently paying benefits to nearly 60 million people, most of whom are retirees, is on pace to burn through its cash surplus by 2035. The reason this is happening is because baby boomers are retiring in greater numbers, and there simply isn't enough new payroll tax revenue being funneled into the Social Security program to cover this exodus from the workforce. At some point in the future the amount of money leaving the Social Security Trust will outweigh the money being brought in, and the cash reserves will be depleted.

The other "problem" (although this is great news) is that people are living longer than ever according to the latest data from the Centers for Disease Control and Prevention. Over the last five decades the average life expectancy in the United States has jumped by nine years to nearly 79 years. A lengthy lifespan allows beneficiaries to draw on benefits for a longer period of time, further draining the Trust.

Per the Trustees' report, in order to sustain the program through 2087 a cut in benefits of 21% would be needed. Since this isn't a particularly popular solution among the public, lawmakers continue to put forward ideas on how this cash shortfall can be resolved.

Image source: Bernie Sanders.

Bernie Sanders' three-point Social Security fixOne Social Security reform proposal that's really garnered a lot of attention comes from Democratic presidential hopeful and former Vermont governor Bernie Sanders. At a time when retirees and pre-retirees are concerned about a potential cut in benefits, Sanders has pledged to expand Social Security benefits for all income classes.

Here's a rundown of the three-point plan Sanders presented to fix Social Security's reserve shortfall.

First, as noted above, he'd give a benefits boost to everyone. According to Sanders this would work out to an average payment increase of $65 per month, which, based on what the average Social Security recipient brings in, annually works out to about a 5% increase in average benefits. Sanders argues that since workers have paid into the Trust during the course of their lifetimes, the government is obligated to ensure that these workers can meet their basic expenses during retirement.

Secondly, Sanders wants to lift the payroll tax cap to generate more payroll tax revenue from the wealthy. As it stands in 2016, all income up to $118,500 is taxable at a rate of 12.4%, with the proceeds of this tax going into the Social Security Trust (typically this 12.4% is split evenly between you and your employer, or 6.2% each). However, any income earned above and beyond $118,500 is free and clear of the payroll tax. Sanders' proposal would create an exemption zone between $118,500 and $249,999, and then reinstate the 12.4% payroll tax on income above $250,000.

Image source: Flickr user Nicolas Alejandro.

Third, Sanders wants to change the way benefits are adjusted for inflation. Currently, cost-of-living adjustments, or COLAs, are calculated using the Consumer Price Index for Urban Wage Earners and Clerical Worker, or CPI-W (thank goodness for acronyms!). The problem is that retirees' spending habits tend to differ from that of urban and clerical workers. The elderly spend far more on medical care and housing, and less on education, food, and transportation. This means any increases in benefits may not accurately reflect their needs. Sanders wants to begin using the CPI for the elderly, or CPI-E, to account for the 40 million-plus seniors who rely on their benefits growing in-step with their expense needs.

The Sanders campaign projects that the Social Security Trust would remain solvent through 2065 (an extra 30 years) if this plan is implemented in full.

The blatant flaw in Sanders' Social Security fixOn one hand, Sanders' plan would indeed raise additional revenue from taxing well-to-do individuals at a higher rate, and the across-the-board benefits boost, as well as tie-in with the CPI-E, should put lower-income seniors on a more solid footing than they were on in previous years.

But we've also looked at concerns with Sanders' Social Security fix before. Wealthier individuals paying more into the program without getting a commensurate boost in retirement benefits could be viewed as an issue. Additionally, removing money out of the pockets of well-to-do individuals could sap hiring and consumption, which are both economic growth drivers.

Image source: Flickr user Thomas.

However, there's one blatant flaw in Sanders' Social Security fix that we haven't covered yet: Sanders' plan, while boosting benefits, will probably increase seniors' reliance on Social Security income while penalizing investment income at a higher rate. In theory we'd like to see seniors decrease their reliance on Social Security and become more self-reliant heading into retirement. The Social Security Administration suggests that your benefits are only designed to replace about 40% of your working income, yet an AARP poll from September showed that 51% of those surveyed expect to rely on Social Security income for 41% to 100% of their income during retirement.

Now here's the thing: if Sanders' plan concretely solved the cash shortfall that would be one thing. But that's not what Sanders' plan would do. It would add enough tax revenue to extend the life of the program to 2065, but today's millennials and Generation Z would be facing a benefits shortfall during their golden years in much the same way boomers may be facing a shortfall during their retirement.

According to a Fidelity Investment survey of self-made millionaires released in 2012, most respondents cited stock or asset appreciation, compensation/wages, and stock options/profit-sharing from a 401(k) as the primary reasons why they were able to grow their wealth. With Sanders' tax plan and Social Security proposal, capital gains and dividend income for the wealthy ($250,000+) are taxed a rate commensurate with ordinary income tax rates (39.2% to 54.2% under Sanders' proposed tax brackets), and a 2.2% tax is added on top of the current long-term capital gains and dividend income tax rates for all other income classes. This plan could discourage investment and increase reliance on the Social Security program -- and that's probably not a good thing if the program is not on solid footing over the long run.

Please keep in mind that the numbers used by Sanders, and even my prognostications, could be way off. Sanders' proposals do have merit considering that a Social Security fix will likely lean on higher tax revenue as one component. However, pushing benefits higher at the detriment of investors doesn't seem like a strategy that will fix the Social Security program, or ease the retirement burden of millennials and generation Z.

The article The Blatant Flaw of Bernie Sanders' Social Security Fix originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.