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It Is Time To Start Fixing Social Security - Remove Payroll Income Cap

Maybe because of my European upbringing - being Danish and growing up in Spain - I have had the fiscal conservatism instilled in me by my Scandinavian parents but saw the opposite extreme of poor fiscal discipline in Spain. I am not afraid of paying taxes as long as I get my money's worth.

As we know, social security is in deficit mode. This means the plan is taking in less revenue than what it pays out - not a sustainable path in the long-term if current workers want to rely on social security benefits as their primary source of income in retirement.Social Security Deficit(click to enlarge)

Source: Wikipedia

The U.S. has a progressive tax rate scheme where higher earners pay higher taxes than those that earn less. However, one overlooked fact is that earnings above $113,700 for 2013 do not have to contribute the obligatory social security tax or payroll tax. This seems counter to the intent of an overall progressive tax scheme. Why should higher earners not have to continue paying into funding social security? One argument is that benefit payments are not aligned with incomes earned once people retire. However, the counter argument to that is that, typically, higher earners are also higher savers and therefore do not need social security as lower earners do to maintain a certain life style.

Maybe the time has come to address the social security shortfall head-on. Stop capping income and have everyone contribute the same pro-rata amount. I would not argue for a drastic overnight switch. A measured and more tolerable phased-in measure could be instituted to stretch the transition to full payment over say a 5-year period.

The risk of instituting a drastic overnight higher rate on higher earners is that it could have second derivative effects on the broader economy as consumer spending, which makes up 70% of U.S. GDP, could take a hit and thereby cause a moderation in GDP growth if not worse - a recession. A measured phased-in approach would minimize the impact of any drastic change and allow for a natural and adapted adjustment that would minimize the second derivative effects on the broader economy.

The reality is that U.S. workers do not save enough for retirement. A recent study found that 57% of U.S. working households have less than $25,000 in retirement savings. The social security dilemma is caused by demographics. People are living longer and stretching out benefit payments. Social security has taken the form of a guaranteed government pension where many folks have come to rely on it to pay for their living expenses. Unless savings is mandated upon all U.S. workers in similar fashion to Australian or certain European models to be self reliant in securing retirement income then social security remains, in many cases, the only alternative left for many retirees.

I am not going to delve into the different layers of addressing social security such as means-testing (fancy phrase for, if you have your own money, you don't need the government's - read "our" - money), or any other measure. The intent of this piece is to provoke you to ask some tough questions and come to some reasonable solutions to address one of the more critical structural deficits that will keep on growing unless addressed head-on. Demographic trends are not going to reverse anytime soon as 10,000 baby-boomers retire every day (or are they? - this is debatable and maybe addressed in a separate thought piece).

The time may have come to remove the income cap on payroll tax so that indeed the progressive tax scheme is indeed so and stave off growing deficits if not turn the statistics around back to neutral/surplus. For those that would argue that they are against paying higher taxes, I would say - "Give up your social security check if you'd like." Regardless, I was always reminded by my parents that I should always rely on myself. Saving outside of social security will help secure a comfortable retirement when the day comes. Any social security benefit then can be icing on the cake. Start saving if you have not started already regardless of goals.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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