How will Social Security be fixed?

In nine years, Social Security will celebrate its 100^th birthday.  Today it is estimated 69 million people receive monthly Social Security checks. For full disclosure, I am one of them.

Of course, people can save for their retirement while they are working. But what was discovered during the 1930s was not everyone did, either because some had other financial goals or they didn’t earn enough income to accumulate sufficient savings for retirement.  Hence, many senior citizens had to continue working and never retire, or live with financial stress in retirement.

Social Security addressed this problem in two ways.  First, it requires workers to save for retirement by applying a Social Security tax to their earnings.  Second, Social Security deposits the  tax revenues into one account, and then uses a formula to distribute money to retirees. While higher income people generally receive more from the collective Social Security account, there is some re-distribution from savings of higher income individuals to lower income individuals imbedded in the formula.

There’s another important element of Social Security.  It is a “pay as you go system.”  This means the contributions of current workers are not saved for their retirement, but instead are used to help current retirees.  This happened because when Social Security was started, existing retirees were immediately helped.  Hence, Social Security began with each generation depending on previous generations for funding.

This “pay as you go” system can periodically set up Social Security for a funding problem. This happens when the generations funding Social Security are not able to generate enough money for retirees.  Forty years ago, during the 1980s, this happened when the number of retirees was increasing faster than the number of workers.  We are seeing the same situation happen today, although, fortunately, not to the degree as in the 1980s.   Still, today’s demographics will require adjustments to Social Security to allow the program to continue operating.  It is estimated that 2032 will be the year when Social Security will not have enough funds to prevent cuts in payments to retirees.

The 1980’s fix for Social Security was multi-faceted and included reducing benefits and generating more revenues. For example, on the benefits side, the age for receiving full Social Security benefits was increased, thereby lowering pay-outs. On the revenue side, the Social Security tax rate was increased. Also, federal employees became eligible for Social Security Social and therefore started to pay Social Security taxes.                       

As happened in the 1980s, a federal commission will likely be appointed in a few years to develop a solution for Social Security. The big debate will be over the type of adjustments that will be needed  to save Social Security.

One approach is to maintain the current structure of Social Security, and require tax increases for those paying into the system and enact decreases in Social Security checks to those receiving payments. These changes could apply to all workers, or they may be adopted only for higher income workers.

An alternative approach is to significantly change the Social Security system, primarily by giving workers more control over how their Social Security payments are invested. This is called “privatizing Social Security.”

Currently Social Security revenues are required to be invested in US Treasury securities, which are totally safe and repaid when the term of the security ends.  Privatizing Social Security would mean workers would control where their Social Security taxes are invested, which could even include stocks.  The idea is most investments pay higher earnings than Treasury securities, which would mean the retirees would receive a bigger retirement check. 

But there are important questions about privatization.  What if the investments lose money?  In the “pure” version of privatization, the retiree would lose.  There could also be fees for private investing. But perhaps most importantly, if retirees have to rely only on their earnings to generate retirement funds, will retirees who had modest earnings while working be much worse off than with the current system?

There’s also the issue of what happens to existing retirees if all workers’ Social Security taxes and earnings go to themselves?   The current “pay as you go” system would no longer exist.  There would likely be a challenging transition for several years, as countries that have privatized their retirement system have discovered.

In essence, the question is, do we want to keep Social Security with some changes, or replace it with a required private retirement system?

So, get ready for “Round Two” of the fight to save Social Security.  It will be here soon.  It’s a real fight that will need real answers, just as in the 1980s.  The big question is, what will those answers be?  You can help decide.

Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.  His new book, North Carolina in the Anxious Age, will be published by The UNC Press in October.