Social Security looms for next president

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NEW YORK (CNNMoney.com) -- For a brief moment this week, the housing crisis took a back seat to another once hot-button economic issue: the financial health of Social Security.

The Social Security trustees issued their annual report Tuesday, and it showed how soon the system will run into trouble.

The problem is well-known: Funded by taxes on workers' wages, the Social Security system currently takes in more funds than it has promised to pay out to retirees. And the federal government has been borrowing those surplus funds over the years. But that surplus is shrinking, and eventually the system won't be able to pay out all of the promised benefits.

The trustees estimate that by 2017, the funds going in to Social Security will be less than the benefits promised.

The government will cover the difference by paying back the surplus it borrowed plus interest, which could be a problem, given other big-ticket items that lawmakers want to fund in the next few years. Namely, reforming the Alternative Minimum Tax and extending some or all of President Bush's tax cuts.

By 2041, the trustees have estimated that the trust fund - that is, the money the government owes the system - will be tapped out and in-coming funds would cover only 78% of promised benefits.

"Whereas Social Security has been helping to prop up the budget, it will become a diminishing resource," said Robert Bixby, executive director of the Concord Coalition, a deficit watchdog group.

And the effects of that decline will be felt during the next president's term.

Shoring up Social Security generally involves raising taxes or reducing benefits.

Democrats typically have opposed benefit reductions while Republicans have opposed tax increases.

Republican presidential candidate John McCain and his Democratic rivals Hillary Clinton and Barack Obama have all said that they would seek bipartisan solutions.

But the few proposals they have floated so far are either too vague or don't fully address the long-term funding concerns, Bixby said.

Clinton, for instance, has pledged to stop the practice of the federal government borrowing the surplus paid into Social Security.

That's a noble idea, said Bixby, but difficult to achieve because the government relies on the money. In addition, it doesn't address the longer-term shortfalls.

Clinton also has indicated that she would not favor eliminating the cap on the amount of income subject to the Social Security tax. Currently, the first $102,000 of wages are subject to the 12.4% payroll tax. Typically, half the tax is paid by workers, and the other half is paid by employers.

Obama, meanwhile, has said he wouldn't favor increasing the retirement age or cutting benefits, but he would consider increasing the amount of wages subject to the payroll tax. He would favor doing so by subjecting all wage income to the payroll tax with the exception of income that falls within what's called a "donut." A donut protects a certain portion of income (e.g., between $100,000 and $200,000) from the payroll tax and could be phased in over decades.

That solution alone will raise some revenue but won't go far enough to fully establish long-term solvency, Bixby said.

Plus, it's not clear yet whether Obama, in exchange for raising the payroll tax burden on very high-income taxpayers, would also support increasing the benefits paid out to them when they retire. If so, that would negate to some extent the additional funding raised by his donut proposal.

So, too, would his plan to create a credit worth up to $500 per working person ($1,000 per family) to offset the Social Security tax on the first $8,100 of earnings. The credit would start to phase out for people with incomes between $150,000 and $200,000.

McCain has said his preference is to shore up funding by reducing growth in benefits without raising taxes. But just how that's done isn't clear.

Unlike his Democratic rivals, McCain has expressed support for individual investment accounts as a way to augment Social Security benefits. But his campaign has indicated he no longer favors diverting payroll taxes from Social Security to fund those accounts - a centerpiece of President Bush's Social Security reform proposal.

That's an idea Democrats might find more amenable, but "the question is, how will you fund them? You have to find a new source of revenue," Bixby said.

One option is to create a tax incentive for people to save in those accounts and another is to mandate that a small percentage of payroll tax (on top of the amount paid into Social Security) be deposited in the add-on accounts.

Either way, that's a potential cost to government coffers, too.