The Flaw in Democrats' and Republicans' Primary Fixes for Social Security

Few, if any, social programs bear the same importance as Social Security to the American public. Each and every month, some 62 million people receives a benefit from the program, 42.8 million of whom are retired workers. Of these retirees, more than three out of five are dependent on their monthly payout from Social Security to account for at least half of their income. In other words, senior poverty rates would probably skyrocket without the guaranteed monthly benefit that Social Security provides eligible retired workers.

But there's a problem with America's leading social program: The current payout schedule isn't sustainable.

What's wrong with Social Security?

According to the Social Security Board of Trustees' 2017 report, released last summer, the program will undergo a major shift in 2022 that'll see it pay out more in benefits than it's generating in revenue for the first time in 40 years. On the plus side, Social Security will have built up roughly $3 trillion in asset reserves in the four decades leading up to 2022. Unfortunately, this $3 trillion is expected to be completely depleted by 2034.

Why is this happening? There are actually a number of reasons for this shift, but they primarily are a result of:

  • The ongoing retirement of baby boomers from the workforce, pushing the worker-to-beneficiary ratio lower.
  • A steady increase in longevity that's seen the average life expectancy rise by about nine years since 1960. This means seniors are collecting a benefit for much longer than the program was originally designed for.
  • Growing income inequality that's allowed the well-to-do easy access to preventative medical care and medicine, which has pushed their life expectancies considerably higher than lower-income folks, who may not have this ease of access to medical care. This increased longevity is what allows the rich to collect a relatively larger Social Security check for an extended period of time.

If Social Security's asset reserves are exhausted, and Congress hasn't passed any new laws to raise more revenue for the program, the Board of Trustees has forecast the need to cut benefits on an across-the-board basis for current and future retirees by 23%. Doing so would sustain payouts through 2091 without the need for any additional benefit cuts over the next 75 years.

However, with so many seniors currently reliant on Social Security, and a large percentage of workers still projected to depend on the program in some capacity during retirement to make ends meet, a 23% cut in benefits could prove devastating.

Democrats' and Republicans' primary Social Security solutions have issues

How do we fix Social Security's issues? Simple: Lawmakers in Washington, D.C., need to act. And the good news here is that there's no shortage of solutions to resolve Social Security's estimated $12.5 trillion cash shortfall between 2034 and 2091.

Unfortunately, the respective core solution offered by Democrats and Republicans has a flaw that'll keep them from being a slam-dunk fix.

How Democrats propose fixing Social Security

Democrats in Congress have proposed a number of solutions to resolve Social Security's impending cash crunch, as well as put more money into the pockets of seniors. Some of these fixes include switching Social Security's inflationary tether to the Consumer Price Index for the Elderly (CPI-E) from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), and increasing payouts to older seniors who've received Social Security payouts for at least 20 years. But the primary solution Democrats stand behind is raising or eliminating the maximum earnings tax cap associated with Social Security's payroll tax.

As of 2018, Social Security's 12.4% payroll tax applies to earned income between $0.01 and $128,400. This $128,400 figure represents the maximum taxable earnings cap, meaning any additional wage income above and beyond this amount is exempt from Social Security's payroll tax. What Democrats in Congress want to do is raise this cap or eliminate it completely, which would require the well-to-do to pay more into the program.

Why raise the payroll tax cap? To begin with, wealthier workers are far less likely to be reliant on Social Security income during retirement than low- or middle-income workers. Therefore, subjecting more of their wage income to the payroll tax shouldn't have a materially big impact on their ability to make ends meet during retirement.

Additionally, it's the solution with the greatest amount of support from the American public. The reason being that roughly nine out of 10 working Americans owes tax on every cent of wage income they earn. In other words, approximately nine out of 10 workers make less than $128,400 a year in wage income. Adjusting the cap upward would only impact a relatively small percentage of working Americans and, in theory, level the playing field.

Why the Democrats' plan is flawed

Even though the fix proposed by Democrats has quite a bit of public support, it also comes with a notable issue: Raising the payroll tax cap would completely ignore why the cap exists in the first place.

Each October, when the Social Security Administration (SSA) announces its inflationary-based adjustments for the upcoming year, it lays out, among other things, its updated maximum monthly benefit at full retirement age. In 2018, no retired worker can receive more than $2,788 a month in benefits at their full retirement age. This maximum monthly payout exists as a result of the maximum earnings tax cap.

In other words, the entire reason not all wage income is taxed is because the SSA limits what it'll pay retired workers each month. Even if you made $5 million a year, the most you're going to receive at full retirement age in 2018 is $2,788 a month. Raising this cap isn't particularly fair to well-to-do workers because they aren't likely to see a cent in added retirement benefits despite having to pay considerably more into the Social Security program.

How Republicans plan to solve Social Security's cash shortfall

On the other hand, rather than raising additional revenue, Republicans aim to resolve Social Security's funding shortfall through gradual cuts to the program's expenditures.

The GOP thesis is that increased longevity has created most of Social Security's issues. When signed into law in 1935, the Social Security Act was designed to provide benefits to low-income workers for a few years during retirement. Remember, the average life expectancy in 1940, when payouts first began, was considerably lower than it is today. However, after a roughly nine-year increase in life expectancy since 1960, the average retired worker is pulling a benefit from Social Security for a considerably longer period of time, draining its asset reserves. In fact, the SSA notes that the average 65-year-old typically lives for another two decades.

The GOP solution is to gradually increase Social Security's full retirement age -- i.e., the age at which a retired worker qualifies to receive 100% of their benefit. Currently set to peak at age 67 in 2022 for persons born in or after 1960, Republicans would prefer to increase this to somewhere between age 68 and 70. In doing so, one of two things would happen. Either workers would be required to wait longer to receive 100% of their benefit, or workers could continue to claim early and accept a steeper permanent reduction to their payout in the process. Either way, it would mean that future retirees would be paid less in lifetime benefits, saving the program money over time and resolving its $12.5 trillion cash shortfall.

Why the GOP's solution is flawed

Raising the full retirement age is the second-most popular solution among the public behind increasing the payroll tax cap. Still, that doesn't mean it's without flaws.

One of the bigger problems with raising the full retirement age is that it would unfairly punish lower-income workers. Eligible retirees that have no sources of income due to unemployment, or aren't in the best of health, may have little choice but to file for benefits early. If the full retirement age is increased, those folks filing for benefits at age 62, the earliest claiming age possible for retired workers, could see their payout permanently reduced even more than it already would be.

The GOP's fix also punishes future retirees. Though it would protect the payouts of current retirees, workers set to retire in the decades to come could be at risk of having their benefits cut via an increase to their full retirement age.

Compromise is needed

Ultimately, neither plan is perfect. But if Democrats and Republicans worked together to find a middle-ground solution, there's a good chance it would address both parties' concerns, as well as garner the support of current and future retirees.

But can a compromise be reached? That's the $64,000 question.

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.