The only way to fix Social Security

By Jeanne Sahadi, CNNMoney.com senior writer
August 20, 2008

McCain and Obama have said how they would attack problems in the retirement safety net. But as president, neither will be able to do it his way entirely.

NEW YORK (CNNMoney.com) -- John McCain and Barack Obama both talk about how they would put Social Security on sound financial footing.

The program will face the first signs of a financial crunch within a decade and have to rely on Uncle Sam - who's in hock already - to make up for the shortfall.

But no matter the next president's preferred fixes, he'll have to do a lot of compromising with Congress.

Sure, any solution is likely to have elements the president favors. He will have veto power, after all. John McCain favors slow growth in benefits over raising taxes. Obama prefers just the opposite. But any voter who can fog a mirror shouldn't be surprised to see both types of changes coming down the pike.

"To get through the Senate, [changes to Social Security] will need 60 votes. So it will have to include both Democratic and Republican ideas. It's got to have buy-in from all sides," said Ron Gebhardtsbauer, head of the actuarial science program at Penn State and a former senior pension fellow at the American Academy of Actuaries.

Reform proponents say if the next president is serious about fixing the system he should act fast. "Delay will only make the changes ultimately needed ... less attractive, more painful and more precipitous," according to a statement earlier this month from the American Academy of Actuaries.

Measuring the shortfall
Social Security is projected to start taking in less tax revenue than it has promised to pay out by 2017 because Baby Boomers will have retired in droves. By 2041, the system will only be able to pay out an estimated 78% of promised benefits.

Despite a revenue shortfall, full benefits are expected to be paid out between 2017 and 2041. The system will draw on its trust fund, a collection of special-issue bonds from the government, which borrowed prodigiously from the program's surplus over the years.

But since the country is already running a deficit, the government will have to borrow more money to pay back its debt to Social Security. That's a little like giving with one hand and taking away with the other.

Add the trust fund bonds to the system's projected 75-year revenue hole and the government will have to come up with a way to address a shortfall approaching $7 trillion, according to David Walker, president of the Peter G. Peterson Foundation and former head of the U.S. Government Accountability Office.

Of the two presumptive presidential nominees, Obama has been the most specific about how he might bolster Social Security. His advisers have said he would consider imposing a tax rate of between 2% and 4% on income over $250,000. The new tax would start a decade after taking office. Half of it would be paid for by employees and half by their employers. Currently, Social Security is funded by a 12.4% payroll tax - also split between workers and their companies - on the first $102,000 in wages.

If implemented, however, Obama's idea would only take care of a small part of the problem. Since the tax hike wouldn't go into effect for 10 years, how much money it's likely to raise depends heavily on future economic growth. But if the hike were implemented today, it would raise $396 billion over 10 years, according to the Tax Policy Center.

"Obama's proposal is only a down payment on the bigger reforms needed to bring the system into fiscal balance," said Roberton Williams, principal research associate at the Tax Policy Center.

Indeed, Gebhardtsbauer said, "they'll need other fixes."

Range of fixes on tap
There's a grab-bag to choose from. Reductions on the benefit side include increasing the age at which a retiree can collect full benefits. Today, the retirement age is 66 and on track to rise gradually to 67. Actuaries recommend that any reform package include further increases in the retirement age that have built-in adjustments to account for expected increases in life expectancy.

Other options include changing the formula by which growth in benefits is calculated for current workers or how the annual cost-of-living adjustments are made to benefits.

On the tax side, lawmakers could increase the amount of income subject to the payroll tax that funds Social Security. Or they could increase the tax rate on that income. Or all retirees could be required to pay income tax on their Social Security benefits.

None are welcome options. That's why experts say that to make reform less onerous for future retirees, lawmakers should mix and match - and make it snappy.

If lawmakers wait until 2017 to make changes to Social Security, their options for making relatively painless ones will shrink, since a large portion of the 78 million Boomers will have started receiving benefits. "You're probably not going to change the benefit of someone already retired," Gebhardtsbauer said.

Their options will be further constrained by other problems. Barring changes, Uncle Sam will also be contending with a long-term deficit for Medicare approaching $34 trillion, or nearly 5 times that of Social Security.