Options for Reform

Aug 10, 2010 | Social Security

We've talked a lot about the long-term outlook for Social Security (it is insolvent), its impact on the federal budget (it will increase debt held by the public in most future years), and why reform must go beyond solvency to also think about sustainability. But even once we all agree the program is in need of reform, it is important that we decide how.

In thinking about major Social Security changes, there are really only a few major levers. On the benefit side, they are:

  • The Retirement Ages - Currently, the normal retirement age is 66 (moving to 67), and workers are allowed to begin collect reduced benefits as early as age 62. Either of these ages could be increased (though increasing the early age would have little effect on solvency).
  • Computation Years - Social Security benefits are calculated by looking at a beneficiary's highest 35 years of earnings (indexed to wage growth). Increasing the number of years in this formula would bring down the average by introducing new lower and/or zero wage years.
  • The "PIA" Formula -  After one’s wage-adjusted average earnings are computed, benefits are calculated based on a progressive formula that offers 90 percent of the first $9,100 of earnings, 32 percent of the next $45,900, and 15 percent of any remaining income (the bend-points are indexed to wage growth). These PIA factors (90/32/15) can be adjusted, as can the bendpoint levels ($9,100/$45,900). Additional bendpoints and with different factors can also be added as a way to modify the progressivity of the the formula.
    • Price Indexing - One type of PIA change would essentially reduce all the bend-point factors gradually in order to ensure that initial benefits would growing only with prices -- as opposed to growing with wages as they currently do. "Progressive price indexing" takes this concept by applies it only to the highest earners, while protecting lower earners and offering those in the middle a hybrid formula.
  • Cost of Living Adjustments (COLAs) - Once their initial  benefits are calculated, beneficiaries recieve annual cost-of-living adjustments based on a measure of inflation known as the Consumer Price Index. Many economists believe that this index overstates inflation, and benefits should instead be calculated based on the "chained-CPI". Alternatively, explicit COLA reductions could be enacted into law.

In addition, the following levels are available on the revenue side:

  • Payroll Tax Rates - Currently, Social Security is financed mainly through a 12.4 percent payroll tax split evenly between employers and employees. This rate could be raised.
  • Payroll Tax Max - The existing 12.4 percent payroll tax only applies to income below $106,800 (indexed to wage growth). This taxable maximum could be increased, or even eliminated altogether. If increased, policymakers will need to decide whether to credit additional taxable earnings for the purpose of benefit calculations. Some versions of this option would increase the taxable maximum, but offer a "donut hole" within which the tax would not apply.
  • Other Sources of Revenue - Instead of (or in addition to) working through the payroll tax, other revenue sources could be used to finance Social Security benefits. Already, a portion of benefits are subject to the income tax -- and those revenues are filtered back into the Social Security system. One option would be to increase the amount of benefits we subject to the income tax. Another option might be to enact a surtax on income above a certain level.

Though other options do exist, most existing reform plans rely almost entirely on the levers described above. Each can be dialed and pulled differently, resulting in difference results. Some of these options can be found in CRFB's very own Stabilize the Debt budget simulator A more extensive list can be found from the Social Security Actuaries and the Congressional Budget Office.

Try putting together your own plan based on the options available. Make sure you achieve solvency, but be sure that you are also getting to eventual cash flow balance so that your plan is sustainable.

Good luck!