Waiting to address a shortfall could worsen problems, analysts warn

By Jay Fitzgerald
Globe Correspondent / June 12, 2011

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Social Security, the federal government’s old age pension system, is under increasing pressure as baby boomers begin to retire in vast numbers, draining the system’s trust fund and adding to concerns about the nation’s long-term debt.

Specialists agree Social Security’s financial woes aren’t nearly as complex or immediate as those facing Medicare, the health insurance program for the elderly that must contend with rising medical costs as well as increasing enrollment.

But with Social Security projected to exhaust its main trust fund by 2036, economists believe Washington has to act soon to show nervous financial markets that it’s addressing the nation’s burgeoning debt, starting with the federal government’s largest program — Social Security.

“The sooner we act on it, the better,’’ said Andrew G. Biggs , a resident scholar specializing in public pension systems at the American Enterprise Institute, a Washington think tank. “Social Security is probably the one program you can compromise on in Washington. You could theoretically split the difference, through a combination of tax hikes and benefit cuts.’’

History: Created in 1935 during the Depression, Social Security was designed to provide a minimum safety net for the elderly, many of whom lived in bitter poverty in an era when few had pensions. Over the course of its 76 years, Social Security became the “third rail’’ of American politics, zapping politicians who dared push too hard for changes to the popular program.

President George W. Bush learned that when his proposal to partially privatize Social Security fell flat with lawmakers, who had no desire to overhaul the program.

Though nervous about touching the system, Congress has periodically intervened to keep it solvent. In the 1980s, a presidential commission led by Alan Greenspan, later the Federal Reserve chairman, recommended adjustments that many believed put Social Security on solid footing for decades.

The problem: Social Security’s problem is relatively straightforward: Too many people will retire in coming years, and revenues from the system’s payroll taxes won’t keep up with benefit payouts.

The number of Social Security recipients is expected to explode to about 72 million people by 2021, up from today’s 55 million, while the annual cost of the program will leap to $1.27 trillion from $733 billion, according to the Congressional Budget Office.

Already, the annual cost of Social Security benefits is outstripping revenues from payroll taxes, requiring the system tap its reserve fund, said Henry J. Aaron, an economist and senior fellow at the Brookings Institution, a Washington think tank. Eventually, the $2.6 trillion fund, composed mostly of Treasury bill holdings, will be depleted — by 2036, according to projections.

After the fund is emptied, Congress — and the nation — would face simple and stark choices to meet obligations to the elderly: slashing benefits, raising payroll taxes, or both.

Economists say Social Security’s financial problems are big, but not complex. Since there are no hospitals, doctors, and other providers to negotiate prices with each year, Social Security doesn’t need the type of radical overhaul that many believe Medicare needs.

“Relatively small adjustments [to rules and taxes] would fix it,’’ said Aaron.

Potential solutions: Biggs said an immediate 2.2 percentage point increase in the Social Security payroll tax, to 14.6 percent from the current 12.4 percent, would keep the system solvent for more than 75 years, well into the second half of this century. Such an increase would cost a worker making $50,000 a year about $1,100 annually.

But raising taxes during this economically fragile time could hamper business and consumer spending, said Biggs. And while congressional Democrats may support a tax increase solution for Social Security, Republicans controlling the House of Representatives generally oppose higher taxes.

As a result, any compromise would likely contain a mix of tax increases and benefit reductions. For example, the earliest age to qualify for Social Security benefits, now 62, could be raised, in part to reflect longer life expectancies.

Lawmakers could also explore “means testing,’’ in which wealthier recipients receive lower benefits or pay more into the system, or both, economists said.

Whatever solutions lawmakers choose, it’s better they act soon, economists said. Each delay compounds the program’s financial problems, which in turn would require more drastic tax increases, benefit cuts, or both.

“If we wait too long,’’ said Biggs, “we’re only going to be in rougher shape down the road.’’