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Social Security Reform Background. The Social Security program is a pay as you go system. It relies on current Social Security payroll taxes to pay for retirement benefits for current retirees, disability insurance for workers and survivor benefits for families and children. In 2003 the earnings of 153 million workers were subject to payroll taxes, and benefits were paid to 46 million people. Social Security benefits comprised all or nearly all family income for a third of all beneficiaries and were the major income source for nearly two thirds of all beneficiaries. The Social Security system from the outset was designed to serve multiple and at times conflicting goals -- to assure that the poorest recipients had a sufficient level of benefits, and that workers who paid more taxes received somewhat more benefits. Over time Congress expanded benefits, added related programs such as Supplemental Security Income (SSI), Medicare and Medicaid, and in 1972 added the COLA, an automatic annual adjustment of benefits for inflation. According to the Social Security Administration (SSA), Social Security and SSI have played a significant role in the improved economic security of Americans, reducing poverty among the elderly by 37% over the past 30 years. In responding to short- and long term financial problems, Congress has also slowed the program's growth, most notably in 1983, by raising the amount of earnings subject to the payroll tax and raising the age of beneficiaries who could receive full benefits. The Social Security program has two sources of dedicated tax revenues: a payroll tax on earnings split evenly between employees and employers, and income tax on some Social Security benefits. These revenues are credited to the Old-Age and Survivors Insurance and Disability Insurance programs. Social Security has been taking in more money than it has been paying out since the 1980s, and will continue to do so through 2017. The surplus is used to purchase interest bearing Treasury bonds. In early 2004 the surplus was more than $1.5 trillion, earning more than $80 million in interest annually. The SSA system is an efficient one, spending less than 0.6 cents in administrative costs for every dollar paid out in benefits. In 2018 Social Security benefit costs will begin to exceed revenues. The SSA can then redeem its treasury bonds to pay benefits in full until 2042, according to the SSA, or until 2052, according to the Congressional Budget Office (CBO). After that time, the SSA estimates that the program could fund 73% of its obligations or, according to the CBO, 81% of the obligations. Projecting Social Security taxes and spending for an "infinite" future, the administration projects an unfunded liability of $11 trillion for Social Security. Using a more standard 75 year yardstick, the Congressional Budget Office (CBO) projects an unfunded liability of $3.7 trillion. Both estimates assume a conservative rate of growth in the economy and Social Security revenues. Several things explain the anticipated shortfall: an increase in retirees (the Baby Boom), increased life expectancy and a decrease in the birth rate. In 1950 there were 16 workers paying payroll taxes for each person receiving benefits. Today there are 3.3 workers for one beneficiary, and in 2030 there will be two workers for one beneficiary. Concluding that the Social Security system is in crisis, President Bush recently called for its overhaul. While he has not yet presented a comprehensive or detailed plan of action, as a preliminary matter he called for two changes. One would permit younger workers to invest varying amounts of their Social Security payroll taxes in private accounts. Another would change the basic formula for determining Social Security benefits at the time of retirement; instead of adjusting an employee's earnings to reflect increases in wages, earnings would be adjusted for inflation. Other parties to the debate, including AARP, acknowledge the need for reform, but argue that the president has exaggerated the crisis and failed to distinguish between reforms that will restore fiscal balance and those that will not. Private Accounts Traditionally, Social Security benefits have been the third, risk-free leg of retirement -- in addition to pensions and private savings. They have been a guaranteed lifelong component of retirement, protected against inflation by the COLA. Proponents argue that private accounts would give people in the lower half of income distribution access to financial markets for the first time and, more generally, improve work incentives, increase national savings and reduce the financial burden on future generations. Opponents argue that private accounts would undermine guaranteed lifelong benefits, shift risk to the individual (often inexperienced) investor, result in administrative costs that would eat up gains earned in the market and greatly increase the deficit. All parties agree that private accounts will not make Social Security solvent. Rather, if funds are diverted to private accounts, the diversion would create a shortfall of between $1 and $2 trillion in funds available to pay current retiree benefits during the first 10 years. Inflation Adjustment In determining the basic Social Security benefit (the primary insurance amount or PIA), the SSA applies a complex formula to a worker's average indexed monthly earnings. Earnings are adjusted over a period of 35 years to reflect standards of living near the time of the worker's retirement. And a progressive formula is designed to ensure that benefits replace a larger proportion of retirement earnings for people with low earnings than those with higher earnings. In addition, the SSA adjusts benefits at the end of each year by the amount of increase in the consumer price index (CPI). The administration has indicated it intends to change the formula for calculating first-year Social Security benefits. These benefits would be calculated using inflation rates instead of wage increases over the worker's lifetime. Since wages rise considerably faster then inflation, the new formula would reduce the growth of benefits, slowly at first and more quickly by the middle of the century and, by some estimates, eliminate the Social Security shortfalll over the century. Average Social Security benefits now equal about 42% of earnings; under the new formula the benefits would fall to about 20% over time. Opponents claim the proposed formula will prevent elderly people from participating in the rise in the national standard of living, consigning them to an outdated second-class status in retirement. Of critical importance, they contend, it will not assure that the poorest recipients, those who depend primarily on Social Security for retirement income, will receive a sufficient level of benefits. AARP notes that the initial average Social Security benefit is $995.00, an amount which today must be supplemented in order to provide a decent standard of living. The issue is particularly critical for widows, unmarried women, and elderly women living in poverty. Other Proposals AARP argues that raising the wage cap for payroll taxes, bringing all new state and local government employees into the system, diversifying the trust investment beyond Treasury bonds, and adjusting the COLA to more accurately measure inflation could solve about two thirds of the solvency gap. Robert Pozen, former member of the President's Commission to Strengthen Social Security, supports private accounts, but argues that there should be protection for the benefits of low wage workers. He proposes progressive indexing in which low income workers would be in the current system of wage indexing, high income earners would move to complete price indexing and those in between would be subject to a combination or wage and price indexing. Social Security reform raises complex social and economic issues. The challenge is to find a solution or combination of solutions that will assure that Social Security provides a fair and adequate benefit to recipients and ensure the system's solvency.
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