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Sunday, Dec 21, 2014

Step Back From the Fiscal Cliff

December 3, 2012|7:43 am

According to the 2012 Social Security Trustees Report, benefit payments under Social Security are 36% higher than what is provided for by the scheduled Social Security tax rates. This is only one example of the fiscal irresponsibility we have allowed our leaders to engage in. Fortunately, at least for Social Security, the deficit problem is fixable in an equitable way, with minimal damage to the economy.

The wrong way to fix Social Security is to increase Social Security taxes, or to cut Social Security benefits by raising the retirement age. Raising taxes exacerbates the damage Social Security is already doing to the economy. Social Security taxes reduce after-tax incomes, which we the people compensate for by reducing savings. After all, with Social Security intact there is less need to save for retirement, right? But without savings, where does the economy generate the capital to invest in new factories and equipment, which provide better paying jobs? No, we can't afford to raise Social Security taxes.

Admittedly, there is some logic to cut Social Security benefits by raising the retirement age. We do live longer, active lives, especially in retirement, than when Social Security was introduced in the 1930s. But a higher retirement age doesn't work very well for the many workers in physically demanding jobs. Sure, the white collar professional can easily stay on the job until 70, but what about the rest of the workforce? Realistically, there is too much variation in wellness and fitness among workers at ages over 60 for a one-size-fits-all retirement age solution.

The better way to solve the deficit position of Social Security is to directly address the root cause of the problem: there are not enough workers in the coming generations to support the current and future retirees at the level of benefits they've been promised. To face the problem squarely, workers today are less likely to have children, or if they do have families, they are likely to raise smaller families than their parents.

Raising a child costs the average American couple $235,000 (not counting the cost of college), according to the annual government report on such matters; almost half a million dollars for two children (there are some cost savings for the additional children). Bringing up the next generation of well-behaved, educated, responsible, tax-paying citizens is hugely important to the future of America, not just the future of Social Security. Yet there is no societal recognition of a job well done by parents. Instead, the couple that chooses to bank the extra half million over raising a family can enjoy a higher standard of living during their working years, and still get a Social Security benefit paid for by the taxes on the children raised by others.

Here then is a three step solution to the deficit position of Social Security:

Step one: Redefine the basic Social Security benefit so that it relies on the taxes paid from one's own earnings, plus the taxes paid by workers who don't survive to collect benefits. By my actuarial computations, this level of benefits is less than two thirds the present level. However, a cut of the basic benefit to two thirds the present level is likely enough of a cut to do the job.

Step Two: Introduce a new Social Security benefit, the parents' pension benefit, which pays an additional pension at retirement to parents of children who have completed high school. For each of the first two children who complete high school, the parents' pension benefit increases the basic Social Security benefit by 25%, for a maximum parents pension benefit equal to 50% of the basic Social Security benefit.

The mathematically minded reader will already realize that for workers with two children, the two steps above result in a total Social Security benefit that is exactly the same as what they would receive under the present rules. Workers who raise only one child receive a combined Social Security benefit that is 16.7% less than present rules, and workers who raised no children that complete high school will receive a benefit 33.3% less than present rules.

Step Three: Phase in the program over a 25 year period. For five years, make no changes to benefits for retiring workers. Then for each of the next 20 years, implement the parents' pension and the reduced basic pension in 5% increments each year, for newly retiring workers. This will allow plenty of time for workers to adjust their savings plans to accommodate their family planning choices.

When the system is fully implemented, Social Security will be on solid actuarial foundations, without an increase in Social Security taxes, and without a cut to benefits by raising the retirement age. In fact, there is a good likelihood that Social Security taxes could actually go down, or that Social Security pension benefits could be increased! My research indicates that a parents' pension benefit may encourage the nurturing of educated, responsible children, leading to an actuarial surplus in Social Security.

Now that's the way forward.

Gordon C. Boronow is Assistant Professor in the School of Business and Leadership at Nyack College. His research interests are macroeconomics, social insurance, and behavioral economics.
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