Some defenders of the current Social Security system suggest that a "mere" 2.2 percentage point increase in the payroll tax would be sufficient to solve the systems financial problems. Of course, "mere" is a relative term. If enacted, that tax hike would cost roughly $75 billion in fiscal year 1998 -- the equivalent of a 10 percent increase in everyones personal income taxes. But more important, the suggestion that Social Securitys problems can be solved by a 2.2 percentage point increase in the payroll tax is seriously misleading.
The claim of a 2.2 percent solution is based on a measure of Social Securitys fiscal health, called actuarial balance, which counts surpluses accumulated in the programs trust funds as genuine savings. But the trust funds contain nothing but a stack of Treasury IOUs that will require additional taxes or borrowing from the public to redeem. The more accurate measure of Social Securitys fiscal health is the programs operating balance -- that is, its annual earmarked tax revenues minus its annual outlays. That balance is projected to turn negative in 2013 and widen to an annual deficit of $734 billion, or 4.8 percent of payroll, by 2031, the last full year the trust funds are technically "solvent." Even if the 2.2 percent solution were enacted, Social Security would still face large and steadily growing operating deficits starting in 2020.
Entirely apart from the savings fallacy, there are other serious problems with the 2.2 percent solution:
The 2.2 percent figure assumes that the reform would take effect at the beginning of calendar year 1998. Thus it is already out of date. Each year Congress waits, the magnitude of the tax hike required to balance the Social Security trust funds rises.
The solution is not permanent. In fact, an additional tax hike would be required every year to keep the trust funds in balance over a full 75 years.
The 2.2 percent solution is based on the Social Security trustees "intermediate" projection. If we accept the trustees "high-cost" projection, whose key economic and demographic assumptions more closely reflect historical experience, the necessary tax hikes would be at least twice as large.
The 2.2 percent solution focuses only on the programs solvency. But simply raising taxes (or cutting benefits), while it may balance the Social Security trust funds, does nothing to redress the programs other underlying problems, most notably the declining rate of return for young workers.
Ultimately, the real issue in Social Security reform is, not how to meet some official solvency test, but how to ensure Social Securitys economic sustainability and generational equity. This can best be done by transitioning to a funded system of personally owned accounts.