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How Social Security Works

Solving the Social Security Problem

In theory, there are two easy answers to any budget problem: increase income (in this case, raise the percentage taken out of workers' paychecks for Social Security) or reduce spending (in this case, cut the amount paid out in Social Security benefits). In reality, neither of those solutions is simple, since raising taxes is never a popular political decision, and cutting Social Security benefits will negatively affect millions of retirees.

The raw numbers bring these potential changes into perspective: According to the Trustees' report, an increase of 1.89 percent in the Social Security payroll tax would keep the account full for the next 75 years. To achieve similar results, benefits would have to be cut 13 percent.

President Bush has made a different proposal, one that has resulted in a great deal of controversy. He wants to allow people to put some of their Social Security payments (up to 4 percent) into privately held accounts that would be invested in the stock market. Supporters of this plan say that stock market gains will offset future deficiencies in the Social Security system. They also note that this privatization would give Americans more control over their earnings, as they would own their own retirement accounts instead of simply turning the money over to the government.

Opponents of privatizing Social Security list several reasons why they think it would do more harm than good:

  • Social Security is efficient, spending slightly more than half a cent out of every dollar paid out on administrative costs. Private Social Security accounts used in other countries waste as much as 15 cents per dollar [ref].
  • Taking money away from government-run Social Security would gradually weaken the system. Eventually, the benefits it would be able to provide would shrink tremendously.
  • Estimates of increased earnings from private accounts may be based on overly optimistic stock market projections.

Bush has also offered another plan which he calls "progressive indexing." Under the current system, cost-of-living increases are tied to the CPI-W. Progressive indexing would keep that system for workers making $30,000 per year or less. High-income workers would get increases tied to the CPI-U (Consumer Price Index for All Urban Workers), which doesn't go up as fast as the wage index because it covers a larger percentage of the U.S. population [ref]. Workers earning an income in the middle of the two would get cost-of-living increases based on a formula that combines wage and price growth. The end result would be an overall cut in benefits, with higher-income workers bearing most of the cuts over time.

Another proposal involves raising the $90,000 cap on income taxable for Social Security. Variations involve creating a new surtax on income above $90,000, usually between 2 and 6 percent. This would put more money into the system without increasing the tax burden on lower-income workers.