Fiscal conservatives are right: Given bigger budget problems outside of Social Security, the benefits that have been promised may be unaffordable "” even with significant tax hikes.
But so are liberals: Social Security is hardly generous to begin with, and significant benefit cuts could leave a big hole in the safety net for future retirees, who will face great risk of living long enough to deplete their savings.
The problem isn't simply one of politics: The only logical goal for Social Security reform is an affordable and effective safety net that meets both the nation's fiscal challenge and the responsibility of caring for an aging population, but none of the proposals on the table have reflected both priorities. They either rely too heavily on tax increases or cut away critical protections, and in some cases they do both.
There's only one route to Social Security reform that can limit the need for tax hikes while still meeting the needs of both the working class and the broad middle class: A safety net that is firmer for low earners than high earners early in retirement, with benefit cuts gradually unwinding to provide robust support for older retirees of all income levels.
To understand why, first consider two liberal proposals, one from former Social Security Commissioner Robert Ball and another co-authored by White House budget director Peter Orszag. Both of these are relatively high-tax plans, yet both also prescribe significant cuts in very old age on top of early retirement penalties that will soon reach 30% for those retiring at 62.
After a 30% penalty, a single person retiring now after a full career earning $30,000 a year (in today's terms) would receive only a poverty-level benefit. Those early retirement penalties "” the crack in Social Security's foundation "” make additional benefit cuts untenable in very old age.
The aim should be to restructure benefits in a way that encourages workers to extend their careers to attain a stronger level of support in retirement. Yet up until now, the only ideas for doing so would cut away critical parts of the safety net. For example, if the retirement age were raised to 70, retirees who opt for benefits at 62 would face a 43% benefit cut for life.
Some suggest raising the earliest age for benefits to 65 in tandem with a hike in the retirement age to 70, keeping the maximum early retirement penalty at 30%. Yet this approach could still leave those who retire at 65 and outlive their savings to scrape by on an insufficient Social Security check. It also would pull away the floor of income support for those who may depend on Social Security early in their 60s.
While it makes sense to reduce the incentive for retiring too early and to encourage longer careers, we need to build in the equivalent of a fail-safe function so that those who don't "” or can't "” respond to changed incentives aren't deprived of critical support.
Under a new provision called Old-Age Risk-Sharing, the maximum benefit cut would come in the first year of retirement and fully unwind over 20 years to ensure a robust safety net in very old age, when almost everyone will depend on it.
The design of Old-Age Risk-Sharing also recognizes that higher earners tend to have more personal savings and a broader range of work skills that make them better able to handle less support from Social Security in their sixties.
Under Old-Age Risk-Sharing, a career-average earner ($42,000 in 2009) retiring after 2032 would face an upfront benefit cut of 20%, which would gradually phase out over 20 years to keep the safety net intact. However, thanks to enhanced incentives for delayed retirement, that worker could fully overcome this upfront cut and attain an extra measure of income security in very old age by working two years past the official retirement age.
A lower earner would face a 10% upfront cut that could be overcome with one extra year of work, while a high earner would need to work three extra years to overcome a 30% upfront benefit cut.
In addition to preserving the safety net for those who live to an advanced age, there is another advantage to front-loaded benefit cuts: The savings come much faster. Compared with a flat benefit cut of similar scale that phased out after 20 years, savings from Old-Age Risk-Sharing would be roughly 40% greater in 2030.
Another constructive way to encourage longer careers while closing Social Security's shortfall would be to raise the official retirement age one extra year to 68 while gradually lifting the earliest retirement age to 64.
This would limit the maximum early retirement penalty to 25%, producing a greater level of income security in very old age than that offered by the current system. What's more, it could be done in a way that maintains a level of income support for those who need it in their early 60s, with benefits ramping up as careers wind down. Workers would still be able to receive 50% of their benefit at age 62, with the full benefit phasing in by age 68.
Together, Old-Age Risk-Sharing and an increase in the retirement age to 68 would erase 70% of Social Security's official shortfall, or about 50% of the full funding problem that recognizes that the trust fund won't help pay the bills.
This is in line with what could be saved by raising the retirement age to 70 on the same time table. But the combination of Old-Age Risk-Sharing and a retirement age of 68 would yield a much more effective safety net. A worker claiming Social Security at 65 would enjoy a benefit that is 14% greater in very old age than if the retirement age were simply raised to 70.
This blog post was adapted from my book, "A Well-Tailored Safety Net: The Only Fair and Sensible Way to Save Social Security" published by Praeger.
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