Signed into law in 1935, Social Security has become one of the most popularly supported social programs ever introduced by the U.S. federal government. Originally designed to provide retirement benefits to the elderly, Congress identified additional segments of the population for which there was no financial safety net in the years that followed. To remedy what was deemed a deficiency, and in some respects an injustice, in the manner in which the nation assisted its citizenry, survivors benefits were added in 1939 and disability benefits in 1956.
To the chagrin of both elected officials and the general public, persistent funding issues have plagued Social Security for decades calling into doubt the long-term solvency of the program in its current form. This is not a new problem. Past and current generations have sought to improve the continued viability of Social Security through a combination of tax and eligibility age increases. Unfortunately, these previous attempts have proven unsuccessful in guaranteeing the program’s financial sustainability for perpetuity. Many current office holders have similarly called for increases in the retirement age, taxes, or both, either unaware or unwilling to accept that rather than actually solving the problem, such proposals require a future generation to make ever more drastic changes to the system.
While there is some debate by the fringe of society as to whether or not the federal government has the obligation, or conversely, the right, to administer programs such as Social Security, the majority of Americans agree that the role of government is to serve the public good. Moreover, given the widespread popularity of the Social Security program, it must be concluded that the program’s current form is considered reasonable and just by most. Any proposal that seeks to change the structure of Social Security in its current form must seek not to replace, but rather improve upon those egalitarian aspects that serve the greatest number, such as reducing the regressive nature of payroll taxes. It is, however, also essential that structural changes not be implemented that would create an undue burden on those who benefit least by the redistributive properties of social programs as a whole.
An analysis of Social Security’s beneficiaries and the program’s overall framework suggests some guiding principles that must be adhered to when considering modifications, foremost of which is fairness. In addition, any changes must have no affect on current retirement, disability, or surviving beneficiaries or those who have made plans based on promises of the current system and have insufficient time to adjust. A dichotomy exists in regards to timing in that substantive systemic changes should be made gradually enough to provide for continued current and future obligations, while also quickly enough to allow future retirees to adjust to and plan for the new system. If the proposal allows for privately held accounts, then parameters must be in place limiting equity exposure based on factors such as age, account value, etc. Maximum expenses for eligibility to provide investment services must be mandated by law, and an entity must be created to oversee Social Security investment and/or insurance providers.
No wonder so many politicians simply want to increase taxes and let another generation deal with the problem. Even a very cursory examination demonstrates the inherent complexity of issues associated with structural changes of Social Security; however it has become clear that the current system cannot be maintained for all time.
This work provides a brief overview of proposed changes to the Social Security system. It is not intended to be a comprehensive solution to the problems currently facing the program, but rather a point of reference for future debate.
Under current law, the Social Security portion of payroll taxes is 12.4% of the first $90,000 of earnings. Half of this tax is paid by the employee, the other half by the employer. Given this, the total Social Security tax burden for someone making $90,000/year or less is 12.4% of their income, while those earning $360,000/year are required to contribute only 3.1% of their income. Granted, those earning $360k will not receive a higher benefit than those earning $90k; however, prior to the time of benefit collection the system is inherently regressive. Furthermore, if the individual making $90k is single, with no heirs, and passes away at 60 years old he/she will receive nothing from the system, thus a tax in hopes of receiving some future benefit does not entirely justify its regressive nature.
Unlike many recommendations already in the public arena, this work suggests reducing the combined Social Security tax to 10% for the first $250,000 of earnings, falling to a combined rate of 6% for income between $250k and $325k. When an employee’s earnings exceed $325k, the employer’s obligation drops to 0, however the employee will continue to contribute 3% to $450k and 1.5% there after.
While this method is still somewhat regressive on the face, it is significantly less so. It provides adequate funding for the new system and makes a considerable contribution to transition costs. As you shall see, it is also fair in that higher income earners will have far more to gain in pure dollar terms from the Two-Tiered system that follows.
Tier one provides of a base level of support for all qualified U.S. workers much like current Social Security. Benefits are tied to quarters of participation without regard for income furthering the egalitarian aspects of the guaranteed system and increasing the guaranteed income benefit for lower income workers. It is funded by the employer contribution as well as employee contributions in excess of the maximum eligible for Tier two private accounts.
Tier two is a private account with the right to be passed on to heirs. Moneys may be invested in government bonds and/or mutual funds. The maximum equity exposure is based on the age of the participant and the total value of the account. The maximum equity exposure for those under the age of 30 would be 50%. Account value in excess of the required minimum threshold can be invested in any available investments at the discretion of the account holder. Tier two is to be funded by 2.5% of the 5% contributed by the employee, increasing by .5% every 2 years until year 10, at which time the employee may contribute his/her entire portion, up to a maximum of $5,000/individual, $10,000/married couple, indexed for inflation. Any employee designated tax collections above said limits are to be used to further fund tier one. This plan helps mitigate some of the additional tax burden borne by the higher wage earners. At initial proposed levels a married couple would need to earn $200,000 to contribute the full $10,000 to the private accounts. By paying 2.4% less on the first $90,000 of income and placing $10,000 into a private account, a couple earning $200,000 is $1160 better off than they are under the current system. Granted, the guaranteed benefit from tier one will be less than is currently guaranteed, but not when the time value of money is considered.
At the discretion of the account owner, a portion of moneys in the privately held accounts may be used to purchase private life insurance in a benefit amount not to exceed $250,000 indexed for inflation. In the event of death of the account holder, his/her heirs would be entitled to the value of the account, the life insurance benefit if any, and the reduced death benefit as paid by tier 1.
At the discretion of the account owner, a portion of moneys invested in the privately held accounts may be used to purchase private disability insurance in an amount providing a tax-free benefit of up to 60% of the then current salary not to exceed $36,000 indexed for inflation. In the event of the disability of the account holder, he/she would be entitled the disability benefit as provided by the private insurance as well as the reduced disability benefit as paid by tier 1.
Participants will be eligible to access Tier 2 funds at the age of 55. Tier 1 may not be used until 65.
Investment Options and Expenses
- U.S. treasuries are to be purchased at no cost
- Total expenses for eligible equity funds are not to exceed .80 percent, except in the case of foreign and small cap funds that may have expenses up to 1.1%
- Total expenses for eligible bond funds will not exceed .65%
- If an individual opts to annuitize the privately held assets in tier 2, the insurance company must offer a guaranteed rate not less than the then current rate on the 10 year treasury
While many aspects of this work have already been discussed in public forums, a cogent plan has yet to be presented to the American public. Current resistance to giving individuals some control over their financial well-being during retirement, and in turn securing the fiscal health of Social Security, is based on fear and ignorance. It is the responsibility of those who support improving the Social Security system through the introduction of free market principles to educate the populace; it is their obligation to devise a just system that will not allow the victimization of those they seek to help.