President Obama Believes This Is the Best Social Security Fix -- Is He Right?
President Obama has a solution to fix and expand Social Security
While speaking in Elkhart, Ind., two weeks prior, Obama called for expansion of the Social Security program to protect current and future retirees. In the words of the President,
"It's time we finally made Social Security more generous and increased its benefits so that today's retirees and future generations get the dignified retirement that they've earned."
IMAGE SOURCE: WHITE HOUSE ON FLICKR.
What did President Obama propose as the solution to fix Social Security's current woes and make this vision a reality? None other than the most popular solution (by far) as voted by readers in a 2014 poll from The Washington Post -- raising the payroll tax cap on earnings.
As it stands in 2016, income up to $118,500 is subject to the Social Security payroll tax of 12.4%. Normally you and your employer split this tax down the middle, 6.2% each, but self-employed persons face the full brunt of this 12.4% tax. For the average household earning around $51,000 annually, every single dollar earned is subject to the payroll tax. However, for a multi-millionaire, only the first $118,500 of income is subject to the payroll tax. The payroll tax earnings cap moves higher by the nominal rate of inflation each year.
Getting Paid Dividends Getty
The allure of raising the payroll tax cap is that only around 10% of the population is earning in excess of $118,500 annually, meaning it would only affect a small percentage of the population -- a population that President Obama believes can afford to pay more. It's unclear what shape a payroll tax earnings cap increase might look like. Some legislators have suggested removing the cap completely and exposing all income to the payroll tax, while others have offered a conciliatory increase where an exclusionary gap would exist between the current year earnings cap and some arbitrary higher figure, say $250,000. Thus, earned income between $1 and $118,500, as well as $250,000+, would be liable for the payroll tax.
Would Obama's Social Security solution fix and expand the program?
Of course the big question is "would it work?" Based on research conducted by the Center for Retirement Research (CRR), the answer would be a resounding "No."
According to the CRR, many of the most popular solutions to fix Social Security simply don't cover the full breadth of the income shortfall. Raising the payroll tax earnings cap would take care of about 30% of the financial shortfall of the program, and very likely could extend the date by which its excess cash reserves are exhausted. However, simply taxing high-income individuals doesn't assuage Social Security's long-term problems.
Other popular solutions, such as raising the retirement age, changing how cost-of-living adjustments are calculated, or privatizing Social Security and allowing for investment in higher return assets such as the stock market, all fail to close the expected cash shortfall caused by longer life expectancies and baby boomers retiring. In fact, based on CRR's data, you could combine all four of these most popular options and you still wouldn't completely close the projected budget shortfall.
IMAGE SOURCE: PIXABAY.
Another thing to keep in mind is that Obama didn't suggest maintaining benefits, but expanding them for current retirees and future generations of retirees. The above figures take into account simply maintaining the status quo. Expanding benefits is an entirely different beast, and implementing any combination of the aforementioned solutions would likely put legislators miles away from an actual fix.
My best guess is that a solution to fix Social Security is probably going to include a payroll tax hike across the board, regardless of income, as well as potential means-testing that reduces benefits on well-to-do persons. The 2015 Board of Trustees report estimated that a 2.68% tax increase, or presumably a 1.34% increase for employer and employee, would take care of the upcoming deficit woes. The Trustees suggest that the longer Congress waits to enact these tax increases, the higher the increases would need to be to cover the projected cash shortfall.
Regardless of the type of solution, we can say with some degree of certainty, utilizing CRR's data, that simply having wealthier individuals pay more isn't going to cover the projected deficit. This probably means more discussions to come on how to best fix Social Security, and all the more reason for you to ensure that you have alternate sources of income available (401(k), IRAs, or pension) when you retire.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.