Social Security: A tale of two menus

Editor's note: This is Scott Burns' final column. He is retiring after 40 years of writing a personal finance column.

Recent columns brought lots of reader mail. The columns criticized proposed legislation from Rep. Sam Johnson, R-Texas. His bill is an effort to make Social Security solvent. Some readers were angry because I "just criticized." I didn't propose a better solution.

I didn't like the bill for a reason: It would "save" Social Security by making deep cuts in future benefits. Only cuts were on the menu. The younger you are, the deeper the cuts.

That's not my understanding of fixing something. It's like saying, "We made the operation a success, but the patient's died."

So let's compare two menus. One is the Johnson menu of benefit cuts. In his plan, workers would continue to pay employment taxes at the same rate. So benefit cuts amount to a tax increase on future workers. They'll get less for the taxes they pay. Some would call this "taxation without representation" for the young.

The other side of the coin is a menu of tax increases and tweaks. They will preserve current benefits for future workers.

Here's the basic arithmetic. The Social Security trustees say the program is short 2.66 percent of payroll over the next 75 years. In current dollars, the shortfall amounts to $11.6 trillion. So we can either cut benefits by $11.6 trillion or raise new tax revenue of $11.6 trillion.

That $11.6 trillion figure is good for dramatic effect, but it's more useful to think about the 2.66 percent payroll figure. The Johnson bill closes the gap with three changes that cut spending by 2.94 percent of payroll over the next 75 years.

The first change is to use a different method for calculating cost-of-living adjustments. Increases would be smaller. Savings: 1.25 percent of payroll.

The second change replaces the current benefit formula with a new formula. It provides lower future benefits, a savings of 0.85 percent of payroll.

The third change increases the age for receiving full benefits from 67 to 69, a savings of 0.84 percent of payroll.

Each of those changes works to reduce future benefits. By 2080, a medium-income worker (about $49,000 today) would have 28 percent less in promised benefits at 65. The loss would increase to 34 percent by age 95. Higher-wage workers would do worse. Lower-wage workers would do better.

Now let's consider different proposals. I found them in "Social Security Works! Why Social Security Isn't Going Broke and How Expanding It Will Help Us All." The authors are Nancy J. Altman and Eric R. Kingson. They offer a menu of different choices that would increase revenues. More revenue means paying promised benefits. The choices are in Appendix B at the end of the book.

The authors' first change would raise the taxable wage base over time. It's currently $127,200. Readers suggested this solution a lot. It would add 1.95 percent of taxable payroll to revenue.

Their second change would apply a dedicated tax increase of 10 percent on incomes over $1 million. This would add another 1.50 percent of taxable payroll to program revenue.

The third change increases the current Social Security contribution rate. Now 6.2 percent, it would rise by 1/20th of a percentage point a year on both employers and employees. The increase would stop when the rate reached 7.2 percent after 20 years. This would add 1.41 percent of payroll over the period.

These three changes total 4.86 percent of payroll, well over the 2.66 percent shortfall. That leaves plenty of room for negotiation. It's also possible changes from both menus would do the job. For example, increasing the wage base cap (1.95 percent) and using a different cost-of-living tool (1.25 percent). Combined, they cover the gap at 3.20 percent of payroll.

A still better solution, from former presidential candidate Rand Paul, is more radical. He called for the elimination of the employment tax. He would replace it with a corporate value-added tax. Since it would cover all wages (value-added) paid by corporations, it would raise more revenue.

Too radical? I don't think so. It's time for real change. The employment tax has been our fastest rising and most regressive tax for more than half a century. Our politicians like to harp on the individual income tax. In fact, most Americans pay more in employment taxes than in income taxes. So true tax reform begins with the employment tax.

• Scott Burns is a principal of the Plano, Texas-based investment firm AssetBuilder Inc., a registered investment adviser.

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