The Social Security Fix That Would Send Tax Rates Soaring

There are only a handful of ways to shore up Social Security. Sens. Bernie Moreno and Elizabeth Warren are backing one of the most expensive.

Sen. Bernie Moreno (R–Ohio) recently announced that he was working with Sen. Elizabeth Warren (D–Mass.) to eliminate the cap on Social Security taxes. Moreno would be a very odd Republican if he thinks this is a good idea, or else he simply doesn't understand the math.

Under current law, employees and employers each contribute 6.2 percent in Social Security payroll taxes on the first $184,500 in income. By eliminating the cap, that 6.2 percent tax would become a new top marginal tax rate. For example, a taxpayer in California would pay a 37 percent federal income tax rate, a 13.3 percent state income tax rate, a 1.45 percent Medicare tax, a 0.9 percent additional Medicare tax, and a 6.2 percent Social Security tax, for a top marginal rate of 58.85 percent. For self-employed people, who pay both sides of payroll taxes and Medicare taxes, the top marginal rate would rise to 66.5 percent—among the highest marginal rates in the world.

We should be having hard conversations about the future of Social Security. Of course, this has been true for a while. With collapsing birth rates and rising life expectancy, a declining pool of workers will be unable to generate enough revenue to support an ever-increasing class of benefit recipients. Everyone knows this.

The big question is what to do about it. There are only a handful of ways to shore up the program:

1. We can raise the retirement age.
2. We can reduce benefits.
3. We can raise the cap on Social Security earnings.
4. We can raise Social Security tax rates.
5. We can means-test the program.
6. We can privatize it.
7. We can do away with it altogether.

In terms of the math, eliminating the cap on Social Security earnings unsurprisingly has the largest impact and can actually go a long way toward making the program solvent. But is it worth having top marginal tax rates in the 60s to preserve the program? This is a hard question we need to answer.

The last time marginal tax rates approached this level was in 1979, when a 70 percent tax rate applied to income above about $215,400 (which would be just over $1 million in today's dollars). Back then, it was understood that with all the available deductions and credits, even very wealthy people paid nothing close to the 70 percent top rate. Even in the 1950s, with a top rate of 92 percent, the effective rate for those in the top tax bracket was about 42 percent. Marginal rates in the 60s today, by contrast, would be inescapable—there are very few deductions and credits available to offset them. The government's take as a percentage of gross domestic product would go to European levels and beyond.

If we find that unappealing, we could simply raise the payroll tax rate by a percentage point or two, which would also have a measurable impact. This would be preferable to abolishing the cap altogether, and as a side benefit, lower-income workers would be contributing more as well, so the burden would not entirely fall on the wealthy. But again, this has a much smaller impact than doing away with the earnings cap and would only be a temporary fix.

Conservatives are generally in favor of raising the retirement age, which is eminently reasonable, because not only are people living longer, they're staying healthier for longer. The minimum retirement age is currently 62, and if you know any 62-year-olds, they're probably in pretty good shape. The idea that someone could or would stop working at age 62 nowadays seems hard to justify. People reach full retirement age at age 67, and we could easily raise the full retirement age to 70, perhaps grandfathering in people born before an arbitrary date, such as 1980.

When Social Security was first implemented, average life expectancy was much lower, the ratio of workers to beneficiaries was much more favorable, and the actuarial mathematics behind it worked. However, raising the retirement age, while worthwhile, has even less of an impact than raising tax rates.

What's interesting is that people are starting to have some honest conversations online about actually reducing benefits, the ultimate political third rail. But the reality is that Social Security benefits can be very generous. If you had a hypothetical married couple who each retired at the maximum age of 70, they'd collectively be receiving about $124,000 a year in benefits in retirement, assuming they were high earners during their working lives. Benefits are much lower for those who retire earlier, but it's important to understand that baby boomers, as a class, are fabulously wealthy. And yes, while there are those who are indigent, the vast majority of them don't necessarily need the benefits. Reducing benefits could have a large impact on the solvency of the program, but politically, it is the hardest to accomplish.

One very popular idea is means-testing the benefits. For example, if a hypothetical senior citizen had assets in excess of $2 million, they would then be ineligible to receive Social Security. Many years ago, billionaire Ken Langone was a big proponent of means-testing benefits. There are a few problems with this. The first is that if one has paid into the system for decades, it seems unfair to then deprive them of benefits, no matter how well they have handled their financial affairs. The other is that in order to do this, you'd have to create an entire bureaucracy at the IRS for determining someone's wealth. (Once you have the IRS in the business of counting assets, it is just a hop, skip, and a jump to wealth taxes.) Also, means-testing benefits is mostly symbolic—it doesn't do much to preserve the solvency of the program.

People have been talking about privatizing Social Security for years, going all the way back to 2005, when President George W. Bush and Treasury Secretary John Snow actually made an honest attempt at it. The idea was that we would all contribute to personal retirement accounts that would be invested in stocks and bonds. There was an enormous backlash to the proposal, and Bush retreated on it.

From an academic standpoint, privatizing Social Security makes much more sense than the current system. The annual return on a 60/40 portfolio of stocks and bonds has averaged about 9 percent in the last 50 years, while the rate of return on Social Security is negligible. We would all be richer in the end. But there is an aspect of this that the privatization proponents haven't considered: Stocks and bonds can lose value, and if we have a protracted bear market, and people experience a drawdown in their retirement savings, the politics around that will be a nightmare. The capital markets do not reliably return 9 percent a year—sometimes it is more, sometimes it is less. There have been long periods of time when the stock market has returned zero or negative. The fact is that we aren't all cut out to be investors. Having said that, Canada has a public pension program that invests in private financial markets, managed by the Canada Pension Plan Investment Board, which has done quite well. It is a superior system to ours, so it can be done.

Finally, we could simply abolish the program altogether—the most libertarian and radical of the proposals. People would be responsible for saving for their own retirement. Of course, some people wouldn't, and they'd be living at a subsistence level in old age. The interesting thing is that most people have been operating under the assumption that Social Security won't be around forever, so they have been contributing aggressively to tax-advantaged retirement plans such as IRAs and 401(k)s. Many people are anticipating using Social Security as a supplement to retirement savings, not a replacement for them. And there is a certain social Darwinism to abolishing it that is attractive to some people.

Outside of abolishing Social Security or privatizing it, all of the choices are unappetizing, and many people would argue that taxes are high enough, for crying out loud. Raising the cap on Social Security earnings, as Moreno and Warren want to do, would seem to be a nonstarter. But these ideas are gaining traction in today's political climate. There are only so many more years that we can kick the can down the road.