The puzzles and pieces of Social Security

Nobel laureate Peter Diamond helps sort it all out.

Craig McAdams relaxed next to the boardwalk on Jan. 20, in Hollywood, Fla.Joe Raedle/Getty

After the State of the Union address, Social Security and Medicare are, according to the declarations of both parties, off the short-term chopping block. Still, fiscal experts rightly note that both programs will have to be adjusted if they are to provide expected benefits over the longer term.

To shed some analytic light on the true choices and trade-offs ahead, I recently spoke with Nobel Prize-winning economist Peter Diamond, institute professor emeritus at MIT and an expert on Social Security, about that program.

Herewith, a few things worth knowing and mulling.

The problem isn’t profligacy

It’s true that Social Security’s long-term finances aren’t sustainable. But that’s not because the nation’s public-pension program is somehow extravagant. The real long-term driver of those costs are demographics: A disproportionately large generational cohort — the baby boom, born from 1946 to 1964 — is now retiring and claiming benefits. Further, today’s longer lives mean a longer average period receiving Social Security. Although the program automatically adjusts for the cost of living, unlike some other nations’ public pension plans, it does not automatically adjust for longer lives, noted Diamond. That means policy makers must periodically do so.

Disaster doesn’t loom

Despite all the warnings about the Social Security trust fund running dry in 2034, even if that is allowed to happen, that won’t spell the end of Social Security benefits. Rather, it will mean that Social Security will only be able to pay out in benefits to retirees what it takes in in revenues from current workers. The bad news: That would leave the program with an initial gap of about 23 percent between scheduled benefits and revenues. The good news: That means Social Security would continue to pay more than three-quarters of scheduled benefits.

Big cuts aren’t foreordained

Ultimately, this is a political choice, not an ineluctable process, which means that a significant reduction in benefits isn’t inevitable. The other obvious solution is to increase the revenues to the program, which could be combined with slowly adapting benefits to longer lives.

“More revenue could come from a combination of extending payroll taxation to include very high earners and slowly and modestly raising the payroll tax rate,” said Diamond, who offers this fact that nudges in that direction: An increasing share of total earnings is above the level at which the Social Security payroll tax ends, which is $160,200 for 2023. In 1983, 90 percent of all earned income was subject to that tax. In 2021, only 81 percent was. That’s because of the sharp increase in earnings at the top.

Or other outside income could be added. Unearned income isn’t taxed, for example. However, the MIT economist emeritus believes it’s wise to stay with the original design as a program funded by payroll taxation.

As a barometer of the broad public support for Social Security, Diamond noted that public opinion polls show Americans favor an increase in the payroll tax over a reduction in benefits. “It is the only tax around where people are willing to be in favor of taxes on themselves,” he said.

That said, history shows that any increase in the payroll tax would be most acceptable politically if phased in slowly.

Stop-gap funding

The baby-boom bump in Social Security payouts won’t last forever because the boomers won’t live forever. That reality allows for another possible partial solution: A loan from Treasury to help tide Social Security over, to be repaid as program changes are phased in. If past is prologue, a solution may well not be agreed upon until the relative last moment, which means such a loan would help ease some of the pain of the adjustment.

A sage gauge of the fair-age stage

One of the changes already being talked about is delaying the Social Security retirement ages. Currently, one can begin receiving benefits at 62, though payments are reduced by about 30 percent. Full retirement clicks in from 66 to 67, depending on one’s year of birth.

Changing the early retirement age of 62 would be particularly unfair, Diamond thinks, because those who take early Social Security tend to have worked more physically demanding jobs, to have less income, and to face shorter life expectancies.

What’s more, the savings there would be minimal because recipients who don’t take benefits at 62 — or for that matter at their full retirement ages — see increased payments for each year they wait.

A parting caution

When it comes to Social Security, don’t accept professions of good intentions.

“Given the large past differences in the approaches of the two parties, it is important that citizens press members of Congress to be specific about their views on fixing the program,” Diamond said. “And it’s just as important that voters let their members of Congress know their own views.”