Here's how Social Security can be fixed

"Social Security's Disability Insurance (DI) Trust Fund now faces an urgent threat of reserve depletion, requiring prompt corrective action by lawmakers if sudden reductions or interruptions in benefit payments are to be avoided. Beyond DI, Social Security as a whole as well as Medicare cannot sustain projected long-run program costs under currently scheduled financing."

These are the opening lines of the 2015 annual report from the Boards of Trustees of Social Security and Medicare. The annual report analyzes the current and projected status of the two programs.

The report goes on to state that Social Security and Medicare account for 42 percent of federal program expenditures in fiscal year 2014 and that future increases in spending for these programs will continue to put pressure on the federal budget.

In other words, spending for these programs is almost half of the total federal budget, and any attempts to reduce the federal budget deficit needs to address Social Security and Medicare. It will take tough choices regarding tax increases or benefit reductions to make a meaningful dent in the federal budget deficit.

The report projects that the DI Trust Fund will be depleted by late 2016, the same year that was projected in last year's report. The report warns, "Lawmakers need to act soon to avoid automatic reductions in payments to DI beneficiaries in late 2016."

The report projects that the trust fund for retirement benefits will be depleted in 2034, one year later than projected in last year's report. This shouldn't be accepted as good news: It's like the captain of the Titanic saying "Oh good, we're only three miles away from the iceberg, not two miles like we previously thought."

It's important to know that if the Social Security retirement trust fund is depleted, retirees at that time will still receive about three-quarters of their benefits, since workers will still be paying their FICA taxes in support of the program.

While a 25 percent benefit reduction would certainly be bad news, the program wouldn't go away entirely. Doomsday predictions that you'll never get anything from Social Security aren't realistic.

The combined long-term deficit for the retirement and disability portions of Social Security is 2.68 percent of taxable payroll. This means that over the long run the deficit can be eliminated through some combination of tax increases and benefit adjustments, with an aggregate value of 2.68 percent of the pay of all workers in the Social Security system.

To put this into perspective, for a worker earning $50,000 per year, 2.68 percent of pay is $1,340 per year. If all workers combined accepted some mix of tax increases or benefit reductions of this approximate value, the Social Security deficit would be reduced significantly or even eliminated. While these potential tax increases or benefit reductions wouldn't be good news, they certainly don't represent an insurmountable problem.

Another way to look at the overall magnitude of the problem is that in 2007, Social Security amounted to about 4.1 percent of our nation's gross domestic product. That cost is projected to rise to 6 percent of GDP by 2037. So we need to deal with a cost increase amounting to about 1.9 percent of the overall value of our nation's goods and services.

Put this way, it seems like a solvable problem.

The most likely candidates for tax increases and benefit reductions that would close the long-term funding deficit include:

  • Raising the earnings threshold for calculating taxes and benefits (currently $118,500 per year)
  • Raising the FICA tax rate (currently 12.4 percent for employer and employee combined)
  • Raising the retirement age for future retirees
  • Changing the benefit formula to reduce monthly benefits for future retirees
  • Reducing the cost-of-living increase for current retirees
  • Reforming the disability program such that benefits are reduced

In this process, lawmakers will need to consider the extent to which large numbers of citizens are reaching retirement age with meager retirement savings.

The Trustees Report also projects that the Medicare Hospital Insurance trust fund will be depleted in 2030, the same year that was projected in last year's report. At that time, revenues from taxes paid by current workers would support about 86 percent of benefits paid for hospital costs for retirees (Part A of Medicare). So Medicare's hospital benefits can still be paid even if the trust fund runs dry, but at a reduced rate.

Note that benefits under Medicare Parts B and D, covering outpatient costs and prescription drugs, are not paid by trust funds and aren't included in the above analysis. These programs are supported by premiums collected from retirees and general federal revenues.

As you can see, fixing our Social Security and Medicare challenges involve some hard choices. But that's what leaders are supposed to do -- and with some well-thought-out changes, they can.