Disclaimer: The Retirement Choice Act is not a true piece of legislation, but it should be. I present my ideas with legislative titles, because it gives a name for people to rally behind.
We can all agree that Social Security needs some help. There are a handful of debatable ways to handle this time bomb of fiscal catastrophe. First, we need to deal with the fact that it’s not sustainable. According to current projections Social Security will run out of funds by 2037. We also need to make sure Congress doesn’t use the money for anything other than our retirement. Third and last, we should be given a choice as to what happens with those funds. It’s our money after all.
How To Pay for It
One of the few ways to deal with the issue of Social Security not being able to pay for itself is to eliminate the cap on the amount of earned income which is taxable. It appears like we have a regressive tax system for Social Security capped at $110,100. Any income over that amount isn’t taxed for Social Security. Why should the lower tax bracket pay more in taxes relative to their income than the rich? It doesn’t make sense.
The Income Cap on the Social Security Tax
Some clarity is needed here. I really wish we could just get rid of the cap and the budget shortfalls in Social Security would magically disappear. They won’t. The reason being is that by adding high income earners to the tax pool you are also required to pay them benefits down the road. Therefore, the multimillionaire paying more in Social Security taxes gets more in his Social Security check when he or she retires. The money he is putting in doesn’t go towards making sure the program doesn’t go bankrupt, it actually makes the situation worse, because they now have to pay out more. It all comes down to the formula used for deciding how much benefits to provide based on taxes taken in and they don’t add up. I’m feeling an inclination to get into the history of how this happened, but I’ll refrain (you can find that in the links below). How can we fix the formula?
The Bowles-Simpson Commission
Well we have a good start here. There was a lot going on with President Obama’s commission to deal with the deficit by Alan Simpson and Erskine Bowles, but we are going to only look at their proposed changes to Social Security. They dealt with long-term solvency by increasing revenues and trimming benefits in the years to come. Most of it I would cut, but there are a few gold nuggets in the proposal including a change to the formula.
- They suggested by 2020 state and local employees start paying into Social Security. This doesn’t help since it only adds more people to the problem. More taxes and more benefits, while we still have a bad formula.
- They do suggest changing the progressive benefit allocation percentages (part of the formula) in such a way to create more revenue and add more benefits for the poor. Without getting into the math this part would be very helpful, but isn’t a fix-all.
- After 2012, the retirement age would be linked to the average life expectancy of all Americans, which tends to rise, thus reducing the cost of benefits. This roughly equates to about a one month increase per year. Not much.
- They also suggest changing the benefit allocations from being connected to the Consumer Price Index (CPI) to a chained CPI. As you can imagine this reduces benefits for everyone and gets worse as you get older, thus saving money. I’m not a fan of this part and would axe it. What’s the point of fixing the system on the back of your aging grandmother?
- It increases benefits for people who have been in the program for more than 20 years offsetting some of the issues with the chained CPI. The two combined would reduce benefits across the board saving money in the long run. Unless someone can show me an additional benefit, I don’t see why we should resort to these mechanism to cut costs when you can do it in a much simpler fashion such as raising the retirement age gradually like with indexing the retirement age to the average life expectancy.
- It would also gradually increase the cap on taxable income to include 90% of wage earners. This only adds more taxes and more benefits and more problems. I’m not opposed to this, since more people would get benefits, but it doesn’t solve much. Even with the formula adjustment these high income earners being capped at 90% of the populace doesn’t help enough.
The Bowles-Simpson Commission helps with the long-term costs of Social Security. I would accept it over nothing, but I’m not suggesting nothing. Read on.
The Alternative Minimum Tax Exemption
The Alternative Minimum Tax exemption, which reduced the Social Security tax to 4.2% instead of 6.2% on household income under $110,100 (2012 caps) and saved people a lot of money should be made permanent, but capped at a household income of around $50,000 (This number is a suggestion based on the Forbes article.). This makes the tax more progressive.
Whatever the changes are they should be revenue neutral. If this means reducing the cap on the AMT or eliminating it all together (except during a recession) than we need to do it. If we need to raise the retirement age by a year or two in order to maintain solvency, then so be it. I would rather retire later and pay higher taxes than not have Social Security at all. We cannot buy something with money we don’t have.
If eliminating the cap on income doesn’t help, the Simpson-Bowles Commission only does a little, and the AMT makes things worse, what’s left. Below are my proposals (actually I stole these from well known economists such as Charles Biahous and others).
- Adjust the benefit distribution percentages to create more income and provide more help to the poor as suggested in the Simpson-Bowles Commission.
- Link the retirement age to life expectancy, an adjustment of approximately one month a year increase at the moment.
- Prevent Social Security surpluses from being spent and require the government to pay back what it has already taken. Surpluses will be used for projected future shortfalls on tax income relative to benefit payments. Surpluses created due to election choices based on the options (Option 2 specifically) below will be paid to beneficiaries spread out over an average life-span index.
- Beyond all my hesitations, I would completely eliminate the cap on income which is taxed. The reason being is with the implementation of an adjusted benefit distribution the high income earners contribute more to the plan than they get back in benefits. This would be even more effective with the following addition.
- With the Simpson-Bowles Commission they suggested changing the current spread of benefit contributions from 90% of AIME (Average Indexed Monthly Earnings) for low-income earners, 32% for middle-income, and 15% for high-income to a four tier progressive spread of 90%, 30%, 10%, and 5% of their AIME. I would add a fifth tier of 3% on the highest income earners say households making over $1,000,000 a year or more would be taxed at the 6.2% Social Security tax and receive 3% of their AIME in retirement, with a benefit (not for purpose of taxable income) cap of $6,500 no matter their AIME benefit allotment. In a single year someone making a million dollars would be taxed at 6.2% ($62,000) and receive in retirement income of 3% of AIME ($30,000). The numbers don’t quite work out like this, but it gives you an idea how we can produce a bit of revenue here.
- I would only continue the AMT Exemption during times of economic crisis or if they project surpluses justified the loss revenue.
It’s My Money
I believe in freedom. I believe we should be given the choice to act stupidly or wisely. Deciding whether to go to a fast food restaurant or cook a beautiful healthy meal at home should be a choice. The same stands for Social Security. Each tax payer should be given three choices in regards to his or her benefits with the default option being Option 1 below. Once per year during tax time a person can elect one of the following choices to either make his or her first selection or adjust future contributions. You can even decide if you want fifty percent to go into one option and fifty percent in another (You cannot do partial distributions to Option 3. Its all or nothing). The point is you have a choice.
Option 1: Hands Off
Can it be any simpler? With this choice everything stands as it was. Think in terms of your money sitting in a zero interest account till you reach the golden age of retirement. It’s what we have now and it’s not that much fun, but you can keep it if you want it.
Option 2: Government Invests
With this option our government would invest in foreign treasuries (which they do anyways) and the like administered by the Federal Reserve with oversight by the Senate based on an annual review. The Senate would not be able to veto investment decision by the Federal Reserve except with a super majority. The Senate cannot submit recommendations either, eliminating political influence in the investment allocations. If investment allocations are vetoed the Federal Reserve would have to submit a proposal for new allocations to be passed by Congress requiring only a majority vote in both houses. With this choice, you get all the earnings at time of retirement as an increase in your standard benefits spread out over the average life-span of an individual. You should also be able to see the growth of your Social Security account online throughout the years.
Option 3: Self Managed
This one is my favorite. With each paycheck the amount of Social Security taxes taken out of your paycheck will automatically be deposited into a retirement account of your choice similar to a Traditional IRA, but with no caps and you cannot remove the funds until you reach the age of retirement. These can be managed by a broker or by you through something like an Etrade or Scottrade account. These accounts are not insured by the Federal Government. With choices are consequences, good and bad.
How will this work based on the current formula of benefit distribution using the Average Indexed Monthly Earnings, which uses a 36 year spread? Each year the Federal Reserve will calculate the percentage of participants selecting Option 2 and allocate that percentage of funds into their investment program and the rest of the funds will continue as normal. As for Option 3, you can only elect this choice if you are in the bottom three income brackets. This will prevent the top earners from leaching away the savings proposed in the formula adjustments. The years you select Option 3 will not be counted towards your AIME if you decide to select one of the other options at a later date.
Ultimately, the problems of Social Security stems from sustainability and choice. Both of these issues are solved in the fictitious Retirement Choice Act.
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Links: Forbes: Revenue Neutral 2012 Fixes to the Social Security Tax and the AMT | Social Security Changes | Why Raising Social Security’s Tax Cap Wouldn’t Eliminate Its Shortfall | Chained CPI | Analysis of the Simpson-Bowles Commission’s Effect on Social Security | Benefit Formula Adjustments