Alicia Munnell, head of the Center for Retirement Research at Boston College

Any proposal to close Social Security's financing gap should consider the creation of a trust fund that could earn enough interest to keep the program running for the next 75 to 150 years, according to a new paper from the Center for Retirement Research at Boston College.

As it stands now, Social Security is structured as a pay-as-you go program whereby taxes on the income of current workers (and their employers) are used to pay benefits to current retirees. Due to payouts that exceeded what retirees had paid into the program when it began in the early 1930s and the declining ratio of workers to retirees, the program's current trust funds—there are two, one for retiree benefits and one for disability benefits—are together poised to deplete their reserves by 2035. At that point, retiree benefits would be reduced by about 25 percent.

“The full amount of the shortfall can be attributed to the fact that the program does not have a trust fund producing interest,” according to the center's report written by Director Alicia Munnell, Senior Research Advisor Wenlian Hou, and Associate Director of Research Geoffrey Sanzenbacher. It calls that interest-producing fund “the missing trust fund.”

Clearly, something needs to be done to shore up the program to maintain benefits at current levels. Most of the suggested remedies to date include raising the FICA tax that funds Social Security, eliminating the cap on income subject to that tax (currently $132,900), and cutting benefits, or a combination of two or more of these ideas.

Policymakers could raise taxes permanently if they wanted to maintain current benefit levels, or they could increase taxes temporarily until a large enough trust fund is built up to fully fund the program for 75 to 150 years, according to the center's report.

The latter solution would include not only raising the payroll tax and eliminating the cap on income subject to it but also raising the income tax. The report doesn't provide specifics on how much the income tax would need to increase but explains why the move should be considered.

“One could argue that these additional costs should not be borne solely by workers through taxation of their earnings but instead should include some taxation of capital income as well,” the report notes.

To fund the program for 150 years, the payroll tax alone would have to increase by 4.5 percentage points or by 3.7 percentage points if the income cap was also eliminated. If, in addition, the income tax was raised, the payroll tax would need to rise by only 2.8 percentage points, according to the report.

The report concludes: “In theory, any of these could be raised permanently by a moderate amount, effectively paying the missing interest from the missing trust fund, or by a larger amount, ultimately replacing the missing trust fund before returning taxes to their current level. But the real issue is that the cost implications of the missing trust fund are worth considering in any proposal to close Social Security's financing gap.”

From: ThinkAdvisor

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To Fix Social Security, Finance the 'Missing Trust Fund'

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