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Yes, we can fix Social Security (but it won't be pretty)

The fiscal cliff negotiations are reviving the debate about that other financial elephant in the room: Social Security.

Under current government estimates, Social Security could face funding shortfalls in about two decades if nothing changes. That’s because the U.S. population is aging -- and generally living longer.

That sounds like a disheartening scenario for workers who are currently paying into Social Security and worry that they won’t get as much out of it once they retire.  About half of the Americans polled by Pew Research Center earlier this year believe it’s not likely there will be enough money in Social Security and Medicare to maintain current benefit levels into the future.

But experts say there are ways to fix Social Security. Politicians just may not like trying to sell those changes to the American people.

It has happened before, though. In the mid-1980s, none other than President Ronald Reagan, working with Democrats in Congress, oversaw a major overhaul of the nation’s retirement safety net.

That’s something many say seems less likely these days.

“There are politicians – and especially in the Senate but also in the House as well – who could work together and come to an agreement,” said Alan Auerbach, a professor of law and economics at the University of California, Berkeley. “But they’re not the majority of Congress.”

Experts say there are two ways to fix Social Security, and neither of them are pretty: reduce benefits or increase revenue.

Reduce benefits
One of the few parts of the fiscal cliff negotiations that President Barack Obama and House Speaker John Boehner seem willing to compromise on involves a change in the way Social Security increases are calculated going forward. 

The proposed switch to calculating cost of living increases using the chained Consumer Price Index instead of the current method would result in smaller annual Social Security raises. That’s because that method assumes that people change their spending habits when prices go up.

Proponents say the switch could save billions and is a more realistic method of how Americans really adjust to rising prices.

But opponents say the chained Consumer Price Index isn’t a good way to measure the needs of older and disabled Americans, because their expenditures are disproportionately focused on things like health care. A family of four may choose to eat more chicken if beef prices go up, but an elderly person can’t easily choose to spend less on heart medicine, they argue.

 “It’s the biggest hit on the people that couldn’t take it,” said Dean Baker, an economist with the liberal-leaning Center for Economic and Policy Research who is opposed to the measure.

One of the longer-term options for reducing benefits is to simply tell people they have to wait longer to get their full benefits. By extending the age at which you can get full benefits, proponents argue that Social Security would be keeping up with trends toward longer life expectancies.

But opponents, including CEPR’s Dean Baker, say that a closer look at the data shows that the bulk of improvements in life expectancies have come from wealthier Americans. They say a broad-based increase in the age at which people can get benefits would punish less wealthy Americans, who haven’t seen such big life expectancy gains.

Andrew Biggs, resident scholar with the conservative-leaning American Enterprise Institute, argues that another option would be to dial down benefits for middle- and high-income people while maintaining the current system for the poorest Americans.

Biggs argues that if wealthy people are told to expect less Social Security, they have more leeway to prepare for it than poor people.

“If you cut my Social Security benefits I’m going to react by saving money and working longer,” he said. “That’s good for the economy.”

Another option would be to reduce the Social Security benefits available to spouses. Some critics argue that’s growing outdated now that more women work and earn their own Social Security payments.

“It’s kind of a relic from a different era,” Baker said.

Increase revenue
Under the current rules, the maximum taxable earnings for Social Security in 2012 is about $110,000. Some argue that an easy fix would be to simply raise the cap on Social Security taxes to include higher wages. 

Baker, of CEPR, proposes raising the cap to around $190,000, reflecting the growing wealth at the top of the income scale. Raise it higher than that, he said, and wealthy earners will just start finding ways to dodge it.

But others say that it’s unlikely politicians will propose raising taxes on high earners now, when many expect those taxpayers to already see increases as part of the fiscal cliff negotiations.

“The timing of it just seems kind of awkward,” Auerbach said.

Another option would be to add an across-the-board increase in payroll taxes that go toward Social Security. Although that would help solve the system’s future funding woes, experts say it’s also likely to be a hard sell in these tough times.

For one thing, Americans may already be facing higher payroll taxes in 2012. For the past two years, Americans have enjoyed a payroll tax holiday that reduced the amount of money they paid toward Social Security, but that could end in the coming year.

“I suspect that’s going to be a not very attractive option right now,” Auerbach said.

Politicians may be nervous about proposing any reform to Social Security that costs more or results in fewer benefits, but Americans seem to accept that some changes are needed.

About 66 percent of those polled by Pew Research Center said they would support raising payroll taxes on high-income earners, while 55 percent said they would support reducing benefits for high-income seniors.

Just 38 percent said they’d support raising the eligibility age.