Social Security revamp

Within the next few years, Barack Obama is likely to fulfill his pledge to try to revamp Social Security despite the political pitfalls involved, financial experts said. That most likely means a package of tax increases and benefit reductions that would fall most heavily on upper-income wage earners.

The Obama administration will attempt the first significant changes since the early 1980s because Mr. Obama needs to make substantial cuts in the federal deficit to assure financial markets spooked by the recession and the credit crisis.

In addition to tax increases and benefit reductions, Mr. Obama likely will push for an increase in the mandatory retirement age.

“The long-term budget issues are so significant that they leave no slack in the budget to do anything,” said Eugene Steuerle, vice president of the non-partisan Peter G. Peterson Foundation, Washington. “If Obama really wants the economic recovery to work, financial markets react better by seeing a budget in balance.”

Mr. Obama is likely to tackle Social Security by the fourth year of his administration, said Mr. Steuerle, a deputy assistant Treasury secretary under President Ronald Reagan. The president-elect could wait until more urgent issues of the economic recovery and the financial bailout are addressed, or he could package some of the proposals together.

The new administration's efforts will preserve the guaranteed benefits and social insurance structure, a departure from the failed attempt by President George W. Bush after the 2004 election to carve private accounts out of Social Security, experts said.

Mr. Bush’s efforts kindled a firestorm among Social Security beneficiaries who feared losing the retirement benefits on which they had been counting.

“Obama should learn from Bush’s experience that all ideas should be on the table and basic principles should be followed,” said David Madland, director of the American Worker Project at the liberal-leaning think tank Center for American Progress, Washington.

Social Security benefits will exceed payroll tax revenue starting in 2017, although the system’s trust fund can cover scheduled benefits until about 2041. The U.S. would have to set aside $4.3 trillion today to cover the deficit expected to accumulate in the next 75 years.

The federal government as a whole faces a record $1.2 trillion budget deficit for the current fiscal year, not counting the costs of an economic stimulus to be considered by Congress, according to Congressional Budget Office projections.

Mr. Obama said at a Jan. 7 news conference that restructuring Social Security and Medicare would be “a central part” of his efforts to reduce the federal deficit. The president-elect offered no details but said he would reveal more when his administration’s budget is released next month.

“Social Security is a fixable problem, moreso than Medicare,” said Andrew Biggs, a fellow at the conservative-leaning American Enterprise Institute in Washington. “This would be a confidence builder.”

Social Security is being squeezed because Americans are living longer while having fewer children to work and pay taxes to finance retirement, according to the non-profit Urban Institute, Washington.

During his election campaign, Mr. Obama proposed levying a surtax of between 2% and 4% on earnings above $250,000 a year. Currently, only the first $106,800 of wages are taxed.

Mr. Obama’s proposal poses administrative problems that might cause him to back off this plan, Mr. Steuerle said.

Still, experts agreed, any Obama proposal will likely impose payroll taxes for the first time on wages above the current limit. He could stick to his campaign proposal for wages above $250,000 or try to stretch the current taxable-wage ceiling as high as $180,000.

“This is the most probable direction because there’s been such a huge increase of wages at the top of the income scale,” said Melissa Favreault, senior research associate at the Urban Institute.

The widening income disparity in the past 25 years has lowered the percentage of U.S. wages that are taxed under Social Security to 84% in 2006 from 90% in 1984, she said.

An assortment of benefit cuts also are likely in store, including a freeze on automatic annual increases for higher wage earners and an increase in the mandatory retirement ages of 62 and 66.

“Raising the retirement age is the easiest way to do things because people are healthier, they’re living longer and jobs are less strenuous,” said AEI's Mr. Biggs, a former deputy commissioner of the Social Security Administration.

Perhaps the most detailed clues to the new administration’s direction are to be found in a Brookings Institution paper co-authored by Peter Orszag, who was appointed by Mr. Obama to head the White House’s Office of Management and Budget. The paper was originally published in 2003.

In this paper, “Saving Social Security: A Balanced Approach,” Mr. Orszag and Peter A. Diamond, institute professor in the economics department at the Massachusetts Institute of Technology, outlined “a balanced reform plan” that “preserves the program’s basic structure” while targeting tax increases and benefit cuts on higher-income wage earners.