The Tax Attic with Jerry Coon

How can the Social Security system be fixed?

 

Jerry Coon, Enrolled Agent

 

Why does it need to be fixed? Without some adjustments or fixes, the system will be totally bankrupt in about 2037, even though it has a two trillion dollar surplus at this moment in time. If no adjustments are made, when the system goes bankrupt, it will be run on a money-in, money-out basis. According to projections, there will only be enough money coming in to support benefits going out at a 75% level, i.e. benefits will be immediately reduced by 25%.

There have been a number of reports issued with ideas of what can be done to put off reaching this 2037 bankruptcy date. According to the U.S. Department of the Treasury’s paper titled “Social Security Reform: The Nature of the Problem,” “Social Security can be made permanently solvent only by reducing the present value of scheduled benefits and/or to increasing the present value of scheduled tax benefits… only these changes can restore solvency permanently.”

Translation: Cut benefits and/or raise taxes. The present value of scheduled benefits is calculated to be $13.6 trillion dollars. This figure can be reduced in a number of ways. The bottom line is you and I would draw less in benefits over our retirement years or will pay more in taxes.

First, benefits can be cut by 20%. According to the experts, cutting benefits by 20% immediately would put the system on a firm footing for at least the next 75 years and perhaps permanently. No other changes would have to be made.

Second, barring this major change, the age at which retirement benefits can be accessed can be raised. Currently, the maximum full retirement age is 65 for those born in 1937 or earlier, increasing to age 67 for those born in 1960 or later. Most everyone, however, can begin drawing at age 62, albeit with up to a 30% reduction in benefits.

When President Roosevelt initiated Social Security, benefits could be accessed only when reaching age 65. Back then, coincidentally, the life expectancy was 65 so the system was stacked to not pay out many benefits. There was no drawing at age 62, even with a reduced benefit.

Theoretically, if the age 65 life expectancy had been adjusted for the increasing life expectancies, full retirement age would be closer to age 75 now. Increasing the full retirement age to 75 would dramatically decrease the $13.6 trillion present value figure.

Third, the early-drawing age of 62 could be raised to age 65, for example, or the current 30% penalty could be increased to 50%.

Fourth, the disability system could be revamped. Currently, if a taxpayer becomes disabled, the amount of benefit paid is equal to what that taxpayer would draw at full retirement age. This could be reduced to 80% or 90%.

Evidently, with the collapse of the economy and many taxpayers out of work, there are record numbers of people applying for disability. These record numbers are not factored into the $13.6 trillion dollar present value of benefits figure. It might be imperative to adjust the disability benefit figure just to keep 2037 at 2037.

Fifth, the system could implement an asset-based formula. If a taxpayer has assets above a set figure, say $300,000, benefits begin to phase out. When the assets are above $600,000, the taxpayer will not receive benefits that year. Each year stands on its own. Everyone realizes this would create an administrative nightmare, but there are a few countries in the world that seem to have transitioned to this type of system.

Of course, the flip side of decreasing benefits is raising taxes. This side of the equation does not lower the present value of benefits, but it brings in more money to pay the benefits.

First, currently, each employee pays in 6.2% of their wage into the Social Security system. The employer matches this 6.2% for a total of 12.4%. Increasing this tax to a total of 15.9%—6.95% for the employee and 6.95% for the employer—would bring in sufficient funds without cutting benefits to also put the system on firm footing for the next 75 years and perhaps permanently.

Second—and this is President Obama’s favorite—currently the 12.4% is paid on the first $106,800 of wages. Under the President’s plan, the 12.4% would be paid on all wages. There would be no maximum. Make $500,000; pay 12.4% on the full $500,000. Make $1,000,000; pay 12.4% on the full $1,000,000. In the interest of fairness, I would think these people would be entitled to higher benefits, so this would also serve to increase the present value of benefits.

Third, presently up to 85% of benefits can be taxable. With a stroke of the President’s pen, 100% of all benefits could be taxable 100% of the time. It could happen.

The only two stand-along changes available are to reduce benefits by 20% or increase payroll taxes to 15.9%. All other changes would require a little bit of this and a little bit of that. It will be interesting to see how this turns out—2037 will get here sooner than any of us ever thought. This is Jerry Coon signing off. 

Jerry Coon is an Enrolled Agent. He owns Action Tax Service on Northland Drive in Rockford. Contact him at www.actiontaxservice.com.

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