Warren Buffett's Social Security Solution Works, But Has Drawbacks

Here are five words that can strike terror into the more than 62 million people currently receiving a Social Security monthly benefit, as well as the estimated 175 million working Americans covered in some way by the program: "Social Security is in trouble."

This article originally appeared in the Motley Fool.

Social Security's problems, explained

According to the Social Security Board of Trustees' newest annual report, which was released in early June, America's most important social program is undergoing a significant change in 2018 that we haven't witnessed for 36 years. Beginning this year, and continuing through 2034, more is expected to be paid out to beneficiaries than will be collected in revenue. Though this net cash outflow is expected to start out small (just $1.7 billion in 2018 and $0.2 billion in 2019), the 10-year forecast indicates it will balloon to $169 billion in 2027. By 2034, the program's $2.9 trillion asset reserves are expected to be completely depleted.

Yet seniors and future retirees can take comfort in knowing that Social Security isn't going anywhere, even if it exhausts its excess cash. The 12.4% payroll tax on earned income, along with the taxation of Social Security benefits, will continue to generate income that the Social Security Administration can disburse to eligible beneficiaries.

Still, removing $2.9 trillion from the equation isn't without its consequences. Without this excess cash, Social Security will lose any interest income that it had been generating. Last year, it reeled in $85.1 billion in interest from the federal government. As a result, the trustees have forecast the need for a 21% across-the-board cut to benefits by 2034. Implementing such a cut would sustain payouts to eligible beneficiaries through the year 2092, without the need for any further cuts.

How has a program that's been paying benefits for 78 years come to this? It has to do, in part, with changing demographics. For example, the retirement of baby boomers from the workforce is pushing down the worker-to-beneficiary ratio. We've also witnessed increased longevity (which is allowing retired workers to receive a payout for an extended period of time), as well as growing income inequality.

The other part of the problem lies squarely with Congress. Lawmakers have known for no less than 33 years that Social Security wasn't going to remain solvent over the 75-year projection period that the trustees examine annually. However, it's been 35 years since lawmakers have overhauled the program. The longer Congress waits to fix Social Security's estimated $13.2 trillion cash shortfall between 2034 and 2092, the more painful it'll be on the American public.

Warren Buffett has a bipartisan solution to fix Social Security

But don't think for a moment that possible solutions to this mess don't exist.

Famed buy-and-hold investor, and the third-richest person in the world according to Forbes, Warren Buffett has offered suggestions on how to fix Social Security for more than a decade. What might surprise you is that despite offering his political support mostly to Democrats in the past, his Social Security fix would involve core ideas from each of America's two major parties.

Keeping in mind that Buffett penned an op-ed column in The New York Times in 2011 chastising politicians for tax reform that favors the rich, it's probably no surprise that the Oracle of Omaha strongly favors lifting or eliminating the earnings cap associated with the 12.4% payroll tax on earned income.

As of 2018, Social Security's payroll tax is applied to all wage income up to $128,400. Any earned income above this amount is exempt. This means that while more than 90% of all Americans are earning less than this amount and, therefore, paying into Social Security on every dollar they earn, the well-to-do are seeing some, or a large portion, of their income, go untouched by the payroll tax. The Social Security Administration estimates that roughly $1.2 trillion in earnings wasn't subject to the payroll tax in 2016.

Buffett has also opined that adjusting our perception of the retirement age may be in order. In a 2006 shareholder meeting, Buffett said, "Perhaps the idea that 65 isn't the right age for retirement anymore is correct and more change is needed." The idea of raising the full retirement age, or the age at which the Social Security Administration will pay 100% of your retirement benefit, is the core solution offered by Republicans. It's currently set to peak at age 67 for those born in 1960 or later.

The logistics behind raising the full retirement age are simple to understand. Workers would be given a choice: wait longer to receive their full payout, or claim early and accept a steeper permanent reduction in their monthly payout. Either way, lifetime benefits paid to workers would be reduced over the long haul, thereby saving the program money.

If this bipartisan approach were implemented, it would almost certainly put Social Security on more solid footing over the long term.

Buffett's plan would work, but there would be losers

However, there is a catch to Buffett's proposed Social Security fix -- and it's a catch that's plagued every single Social Security proposal to date. Namely, someone will lose. No matter how lawmakers tweak the program, someone will come out worse off afterward.

For instance, if the maximum taxable earnings cap is raised, a majority of working Americans wouldn't even notice. That's because they're already paying into the program on every dollar they earn. But it would require people with higher income to pay more into the program. The catch: These higher earners wouldn't see an extra cent in benefits when it's their turn to retire and collect a payout. The reason the cap exists is that the Social Security Administration limits the monthly payout at full retirement age at $2,788 in 2018. Under Buffett's proposal, the wealthy clearly come out as losers.

Future generations of working Americans would lose out, too. Raising the full retirement age would effectively protect the payouts of existing retirees, and likely pre-retirees who are just a few years away from hitting their 62nd birthday (i.e., the initial eligibility age for claiming a Social Security benefit). But millennials and Generation Z probably wouldn't be as lucky. A gradual increase to the full retirement age would reduce their lifetime benefit collection potential, placing a greater burden on these younger generations to save and invest for their future.

Don't get me wrong: Buffett's bipartisan approach is exactly what lawmakers in Washington should be considering when looking for answers to Social Security's looming $13.2 trillion cash shortfall. But the plain-as-day truth is that no matter what solution is ultimately chosen, it'll have flaws, and someone will come out a loser.

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