Alicia Munnell, head of the Center forRetirement Research at Boston College.

Any proposal to close Social Security's financing gap shouldconsider the creation of a trust fund that could earn enoughinterest to keep the program running for the next 75 to 150 years,according to a newpaper from the Center for Retirement Research at BostonCollege.

As it stands now, Social Security is structured as a pay-as-yougo program whereby taxes on the income of current workers (andtheir employers) are used to pay benefits to current retirees. Dueto payouts that exceeded what retirees had paid into the programwhen it began in the early 1930s and the declining ratio of workersto retirees, the program's current trust funds—there are two, onefor retiree benefits and one for disability benefits—are togetherpoised to deplete their reserves by 2035. At that point, retireebenefits would be reduced by about 25 percent.

“The full amount of the shortfall can be attributed to the factthat the program does not have a trust fund producing interest,”according to the center's report written by Director AliciaMunnell, Senior Research Advisor Wenlian Hou, and AssociateDirector of Research Geoffrey Sanzenbacher. It calls thatinterest-producing fund “the missing trust fund.”

Clearly, something needs to be done to shore up the program tomaintain benefits at current levels. Most of the suggested remediesto date include raising the FICA tax that funds Social Security,eliminating the cap on income subject to that tax (currently$132,900), and cutting benefits, or a combination of two or more ofthese ideas.

Policymakers could raise taxes permanently if they wanted tomaintain current benefit levels, or they could increase taxestemporarily until a large enough trust fund is built up to fullyfund the program for 75 to 150 years, according to the center'sreport.

The latter solution would include not only raising the payrolltax and eliminating the cap on income subject to it but alsoraising the income tax. The report doesn't provide specifics on howmuch the income tax would need to increase but explains why themove should be considered.

“One could argue that these additional costs should not be bornesolely by workers through taxation of their earnings but insteadshould include some taxation of capital income as well,” the reportnotes.

To fund the program for 150 years, the payroll tax alone wouldhave to increase by 4.5 percentage points or by 3.7 percentagepoints if the income cap was also eliminated. If, in addition, theincome tax was raised, the payroll tax would need to rise by only2.8 percentage points, according to the report.

The report concludes: “In theory, any of these could be raisedpermanently by a moderate amount, effectively paying the missinginterest from the missing trust fund, or by a larger amount,ultimately replacing the missing trust fund before returning taxesto their current level. But the real issue is that the costimplications of the missing trust fund are worth considering in anyproposal to close Social Security's financing gap.”

From: ThinkAdvisor