Social Security: A plan both parties can love (and hate)
A proposal from former advisers to President Bush, President Clinton, and Sen. McCain combines tax hikes and investment accounts.
By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) The debate over Social Security reform has taken a backseat in the nosebleed section - to other issues on the Hill this year. And it's likely to remain there at least until the mid-term elections in November are over.

But economists and academics continue to chew over ways that could garner enough support on both sides of the aisle to shore up the projected shortfall in the system and still provide adequate benefits to workers.

On Monday, one such group of experts met at the American Enterprise Institute to discuss a proposal that its authors have billed as nonpartisan.

The plan was created by Jeffrey Liebman, who served as a special assistant for economic policy to President Bill Clinton; Maya MacGuineas, who served as Social Security adviser to Sen. John McCain (R-Ariz.) during the 2000 presidential campaign; and Andrew Samwick, a former chief economist on President Bush's Council of Economic Advisers.

The LMS proposal contains elements that Republicans and the White House might like notably the creation of investment accounts as well as elements that Democrats critical of accounts might appreciate notably, raising the cap on the amount of wages subject to the Social Security tax.

It also contains plenty of politically difficult options for anyone on the Hill, like effectively cutting benefits by increasing the retirement age and changing the benefits formula.

"There's something for everyone to hate," MacGuineas said. Even the authors, each of whom would have produced a different plan more to their liking, she said. "This is our second best plan. But that's the thing most likely to succeed."

Given the highly partisan nature of the Social Security debate, the LMS proposal likely won't be the final bridge across which all parties will skip to resolution.

But it may contain elements that prove to be new starting points for lawmakers' negotiations.

Here are some of the major changes called for in the LMS proposal:

Increase the payroll tax rate

Currently, workers pay 6.2 percent of their wages into Social Security and their employers pay in another 6.2 percent. Under the LMS proposal, that worker's portion would increase gradually until in 2018, the worker would pay an additional 1.5 percentage points, for a total of 7.7 percent of earnings.

Raise the taxable wage cap

Currently about 83 percent of all earned income in the country is subject to a 12.4 percent Social Security tax (half paid by the worker, half paid by the employee).

The proposal would raise that maximum to 90 percent the level where it was in 1982.

Effectively, that means workers would pay the tax on the first $171,600 of earned income, up from the current $94,200.

A worker making $171,600 today pays $5,840 a year in Social Security tax (6.2% x $94,200). Under the LMS proposal, he would pay $13,213 (7.7% x $171,600).

Raise the retirement age

Currently, the age when a retiree can collect full Social Security benefits is increasing from 66 to 67 by 2022. The LMS proposal would raise it to 68 by 2017 for anyone 62 or younger that year.

It also would gradually increase the early retirement age for Social Security benefits from 62 to 65 for anyone born in 1955 or after

Create mandatory investment accounts

Every worker would have an investment account into which the equivalent of 3 percent of his earnings would be invested. Half of that would come from workers' increased contribution (1.5 percent of earnings) and half would come from the extra revenue being paid into Social Security thanks mostly to the widening of the taxable wage base.

Until 2018, while there is still a surplus of revenue being paid into Social Security, that surplus will subsidize workers' contributions. So the worker wouldn't pay a full 1.5 percent of his earnings into the account until 2018.

Similar to the federal government's thrift savings plan for government employees, workers could invest their money in any of 15 funds that fall within five investing styles.

In retirement, the account balance would be converted to a lifelong annuity that would guarantee payment for a minimum of 10 years. So in the event a person dies soon after retirement, his or her heirs would receive payments for up to a decade.

Opponents of accounts say that subjecting Social Security money to market risk defeats the purpose of Social Security, which is supposed to act as a base guarantee of income in retirement.

They note that workers who retire into a bear market are likely to see a big hit to their Social Security investment accounts, just as they will in their 401(k)s.

Account proponents note that Social Security is already subject to political risk (Congress can change benefits at anytime and the government spends the extra money paid into the system on other programs) and demographic risk (fewer workers will be paying into the system to support Baby Boomer retirees).

"We're not account junkies," MacGuineas said. But the authors see investment accounts as a way to diversify and hedge a worker's overall risk when it comes to Social Security, she said.

Cut benefits

These and other changes, including a change in the formula to pay out traditional benefits, effectively will cut how much Social Security replaces a worker's income.

The traditional benefit combined with the annuity from the investment account would replace 35 percent of the average worker's income on a pre-tax basis, the authors estimate. That's down from 41 percent today.

But combined with the increased revenue from worker contributions and a widening of the taxable wage base, those benefit cuts will also help to substantially lessen the funding gap the system faces under current law over the next 75 years, according to estimates from Social Security actuaries and the Congressional Budget Office. Top of page

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