Imagine that you’re a 40-year-old sitting down to do some retirement planning. You know that you’ll turn 67 — your Social Security full retirement age — in 2049. That’s 14 years after the Social Security trust fund is projected to run out of money. What assumption should you make about how much you’ll get from Social Security? Unfortunately, there’s no clear answer to that question because lawmakers haven’t addressed Social Security’s impending financial shortfall. By acting soon, Congress can lift the burden of uncertainty that looms over workers’ retirement planning.
To address the Social Security shortfall, Congress will have to adopt tax increases, benefit cuts, or other spending cuts. Those measures will be unavoidably painful. By waiting to address the problem, however, Congress is inflicting another, entirely avoidable, harm: Americans cannot properly plan for retirement because they do not know what Congress will ultimately do to their taxes and benefits.
Social Security is financed by payroll taxes. Current benefit payments are larger than current tax receipts and the excess payments draw down the Social Security trust fund (which reflects past tax receipts that exceeded benefit payments). Under current law, when the trust fund runs out in 2035, benefits will need to be cut approximately 20 percent to bring them in line with revenue.
It’s unlikely that Congress will tolerate a sudden, large benefit cut for people already receiving benefits. But how Congress will act to avoid this outcome is not known. Congress could raise payroll taxes to cover promised benefits. Or Congress could cut benefits for those who are far enough from retirement that they have time to plan for it. Or Congress could kick the can, changing the law to finance promised benefits through debt. Servicing that debt would eventually require tax increases or spending cuts in the rest of the federal budget.
With those options in mind, consider the uncertainty facing that hypothetical 40-year-old. Suppose you make a guess about how Congress will reform Social Security and you formulate your retirement plans around that guess. Then 2035 rolls around and your guess turns out to be wrong: Congress surprises you with a different reform.
In a recent working paper, my co-authors and I computed how much you should be willing to pay to have Congress pass that reform now, rather than waiting until 2035. More precisely, we compare two scenarios. In the first scenario, a reform plan is adopted and implemented in 2035; that is, reform comes as a surprise. In the second, the same reform plan is adopted today, with implementation still occurring in 2035; that is, individuals have time to plan for the changes. We analyze how much people would be willing to pay to trade the first scenario for the second — that’s the value of advance knowledge about Social Security reform.
The exact amount someone might be willing to pay varies depending on the circumstances, including the assumption the individual makes and the actual reform adopted. But there are circumstances in which middle-aged individuals would be willing to part with more than a month’s salary to know today — and have an extra decade or more to plan for — the reform that will be implemented in 2035. Essentially, that’s the cost to them of lawmakers’ procrastination.
That makes Social Security reform an urgent matter. Fortunately, many Democrats and some Republicans have embraced Social Security reform plans. Many Democrats have signed onto the Social Security 2100 Act, which closes at least part of the Social Security shortfall by increasing taxes on higher earners (while raising benefits for many lower earners). And the Republican Study Committee has released a plan that closes the Social Security shortfall by reducing benefits, primarily for higher earners.
With Joe Biden in the White House and Republicans set to control the House of Representatives, Republicans and Democrats need each other to pass meaningful reform. It’s time for the two sides to talk to each other and compromise. Republicans will have to agree to some tax increases, and Democrats will have to agree to some benefit cuts.
Closing Social Security’s financial shortfall will require painful sacrifices. But lawmakers’ procrastination adds unnecessarily to this pain by subjecting young and middle-aged people to uncertainty about how the shortfall eventually will be addressed. That uncertainty can be avoided by acting now, rather than waiting until the last moment, to fix Social Security. Congress should let workers know what their future holds.
Sita Slavov is a nonresident senior fellow at the American Enterprise Institute and a professor of public policy at the Schar School of Policy and Government at George Mason University. Follow her on Twitter @SitaSlavov.