Social Security is a social insurance program. The United States Social Security program provides benefits for retirement, disability, and death. There has been a great deal of public discussion recently, largely spawned from President Bush’s 2005 State of the Union address, when he said that “on its current path, [Social Security] is headed toward bankruptcy… by 2042 the entire system would be exhausted and bankrupt” (C-SPAN, 2005). This essay examines that statement from an economic perspective and analyzes some of the highly publicized proposed solutions. While historical aspects of the program will be mentioned peripherally, “Social Security” within this context refers to only the defined-benefit pension plan, with a specific focus on the retirement benefits.
How Social Security Works
The Social Security Act was signed into law under President Franklin D. Roosevelt in 1935. As originally drafted, the program was far less ambitious than it has become. It outlined a wealth transfer system whereby current workers were taxed at a rate of 2%, paid equally by the worker and the employer. While both the defined benefits and the tax rate have changed, the fundamental act of transferring wealth via payroll tax from current workers to retirees remains in effect presently (Wikipedia, 2006). SocialSecurity.Gov
In the years since the act was first signed into law, the program has expanded to include medical insurance to the elderly through Medicare, disability insurance, and the expansion of participation to include nearly all workers. Whereas half of workers in 1935 were exempt from the program, it is now nearly impossible to avoid participation. The defined-benefits pension portion of the program is funded today by a 12.4% tax split evenly between employers and employees. Medicare is funded and accounted for separately with a 2.9% tax, also split between workers and employers (Social Security Online, 2005). These taxes are imposed only on the Social Security wage base, or “Contribution and Benefit Base”. The wage base was $90,000 in 2005, having risen dramatically since the 1983 Amendments to Social Security (Social Security Online, 2005), signed into law by President Reagan based on recommendations from a commission chaired by Alan Greenspan. This amendment allowed for adjustments to both the wage base and benefits payments based on the National Average Wage Index, an index compiled by the Social Security Administration, rather than direct congressional direction through a statute. SocialSecurity.Gov
Social Security has run a surplus since its inception. Since 1983, the program has run a dramatic surplus. However, due to unified budgeting, the practice of including social security surpluses (or shortfalls, were there any) in the government’s general accounting, these receipts have served to offset annual budget deficits. As of 2005, the Social Security program has amassed a surplus of $1.86 trillion (Social Security Online, 2006). However, this “result[s] in the issuance of Treasury bonds to the [Medicare and Social Security] trust funds in years of annual cash flow surpluses” (Social Security Online, 2005). This means that government “buys” bonds from itself. Furthermore, “since neither the interest paid on the Treasury bonds held… nor their redemption, provides any net new income to the Treasury, the full amount of the required Treasury payments to these trust funds must be financed by some combination of increased taxation, increased Federal borrowing and debt, or a reduction in other government expenditures” (Social Security Online, 2005). These bonds are also excluded from the accounting of the National Debt. Ultimately, this means that the Social Security Trust Fund is merely an accounting ruse and that these paper surpluses have long since been spent through mismanagement of funds. Despite political rhetoric to the contrary, the current Social Security system is entirely a “pay as you go” program. Funding to retirees, beneficiaries drawing income from the system, is provided directly from current worker contributions. SocialSecurity.Gov
Finally, Social Security is a regressive tax, since the tax rate drops as income rises. According to the U.S. Census Bureau, nearly 15% of the American population earned over $100,000 in 2002 (2003, p. 23). Thus, the top 15% of wage earners paid a smaller portion of their wages than the 85% of Americans in the lower and middle socioeconomic classes.
The Social Security Crisis
Much of this attention has been created because the Bush Administration has proposed to privatize portions of the social security program. Because, as outlined above, there are no underlying economic assets in the Social Security Trust Fund, the system’s solvency is dependent entirely on current receipts. Changes in demographics, including an earlier average retirement age, a longer average lifespan, and a large group of soon-to-be retired workers, the Baby Boom generation, have all contributed to a reduction in the ratio of workers to beneficiaries. In 1950, there were 16 workers paying into the system for each retiree drawing from it. This had fallen below 4 as of 2000 and continues to decline (Goldman Sachs, pp. 4, 11). As President Bush said in 2005, “instead of sixteen workers paying in for every beneficiary, right now it’s only about three workers. And over the next few decades that number will fall to just two workers per beneficiary. With each passing year, fewer workers are paying ever-higher benefits to an ever-larger number of retirees” (C-SPAN, 2005).SocialSecurity.Gov
It is estimated that the first shortfall will occur in 2018 (C-SPAN, 2005), “a day of reckoning, [when] retiree benefits will exceed payroll tax receipts” (Washington Post, 2005). Furthermore, because current surpluses are included in the unified budget, the decreasing surplus is contributing to growing deficits today. The deficits will have to be paid for through spending reductions, tax increases, or additional debt, all of which would have a contractual effect on gross domestic product over the medium and long term.
President Bush has outlined a solution centered around the establishment of Personal Retirement Accounts. This is an opt-in program that would allow younger workers to allocate a portion of their payroll taxes to privately held retirement accounts. These accounts would be highly regulated and offer limited flexibility to the worker, but would nonetheless be separated from the general social security fund and thus unavailable to the unified budget. As a young worker myself, this sounds like a positive idea at first glance. However, from an economic perspective, this does nothing to resolve the underlying problem, the fact that the ratio of workers to beneficiaries is dropping. Privatization, in fact, exacerbates the problem, because the allocation of funds away from the current social security program means that there will be fewer dollars available for current beneficiaries.
Another point of controversy is the manner in which benefits increases occur. They are currently increased automatically based on the National Average Wage Index, as described above. This index tracks wages, not inflation, and should thus cause Social Security benefits to echo overall improvements in the nation’s standard of living. Due to expansionary economic growth, each successive generation should be better off than its predecessor. This means that, given a consistent worker-to-beneficiary ratio, it should be both possible and plausible to expand social security benefits indefinitely. Switching to a price-indexing model effectively maintains the standard of living at the time of the transition. While this seems trivial, it fundamentally alters the philosophy behind the Social Security program from a pension plan, where retirees receive benefits akin to the amount they paid into the program, to a form of welfare, guaranteeing only a basic level of support as defined at the time of transition. For example, if current benefits had been price-indexed at 1990 price levels, than basic services would not include any improvements in the standard of living since 1990, such as wireless communication or access to the internet. “Price indexing would preserve the purchasing power of Social Security benefits [at today’s levels], but these benefits would represent an ever-declining percentage of earnings before retirement” (Munnell & Soto, 2005, p.1). SocialSecurity.Gov
One suggestion that is popular among politicians from the Democratic party is to actually exercise the Social Security Trust Fund. If it were possible to return the nearly two trillion dollars currently owed to the Trust Fund from the general federal budget, this would delay any shortfalls until 2042 according to Social Security trustees, or 2052 according to the Congressional Budget Office (Washington Post, 2005). This represents getting the general federal budget in order and generating a surplus annually to repay the debt to the trust fund. This is a very positive suggestion that would have a great deal of positive side effects. Increasing the national savings rate would tend to lower interest rates, spawning further business investment, increasing the aggregate supply curve. The improved growth would also tend to delay the 2042 day of reckoning, since the estimate includes a relatively anemic annual growth in gross domestic product of only 1.8% (Washington Post, 2005). This would certainly alleviate the crisis in the immediate term. Still, the fundamental issue of a decreasing worker-to-beneficiary ratio would remain.
The 1983 Amendments to Social Security were inappropriate. The solvency of the Social Security system was not in serious jeopardy and the hike in payroll taxes was used to hide lack of fiscal responsibility in the general federal budget at the time. “In 1983, Congress knew that new revenue would be used to reduce the budget deficit, not saved to fund future obligations. But when the time came to pay back Social Security, it was understood that the burden would be shared by taxpayers and the government at large” (Washington Post, 2005).
I believe that social security is a worthwhile institution that works relatively well and needs only minor updating. The simple, hard truth is that the worker-to-beneficiary ratio needs to be increased back to a manageable level. From 1950 to 1997, the average life expectancy at birth for both genders was 68.1. The same figure in 1997 was 76.5, an improvement of over eight years (Moody, 2006). This would imply that a similar increase in retirement age over time is appropriate. In 1950, the worker-to-beneficiary ratio was 16 to 1, and the payroll tax was 3%. Benefits, such as a provision for early retirement and disability benefits, were added throughout the 50s, and the tax was steadily increased to 6% by 1961 (Wikipedia, 2006).
Setting aside the political difficulties of implementation, I propose the following changes. First, the unified budget should be dissolved. Legislators cannot be allowed to raid the coffers of our national pension system to cover up their own inability to manage a budget. In return, the federal government should be forgiven the nearly two trillion dollars they’ve already stolen from the pension fund. The American people were lied to in 1983, but that’s water under the bridge at this point, and there are enough fiscal difficulties that will be created by the removal of the Social Security surplus from the budget as it is.
Secondly, the retirement age should be shifted upwards to increase the worker-to-beneficiary ratio. This is difficult politically, but it addresses the problem directly and definitively. A sliding scale retirement age, with congruent benefits definitions for early retirees, should be implemented. Including the number of years worked in this formula also seems like a fair stipulation that would partially make up for the regressive nature of payroll taxes. For example, a worker with little education who began working and contributing to the system at 16 should certainly be entitled to withdraw benefits earlier than a privileged, highly educated citizen who delayed entering the workforce until the age of 30. Not only does the lower-skilled worker have a shorter life expectancy, but more has been contributed to the system relative to the benefits ultimately received, since benefits are based on 35 years of work history.
Finally, payroll taxes should be lowered to match the reduced benefit liabilities. This would provide a stimulus to the economy and encourage spending. A baseline Trust Fund reserve should be immediately established through the issuance of bonds. The payroll tax should then be lowered to a break-even point, including the interest and modest repayments on these new bonds. A drop in payroll taxes would immediately provide economic stimulus. Savings passed on to workers would spawn additional consumption and increase the aggregate demand curve. Savings passed on to employers would spawn additional investment, increasing the aggregate supply curve (Tucker, 2004, pp.284-293).
Both Keynesian and supply-side ideologists should be pleased by this proposal. The additional growth would also help reduce the impact the removal of social security surplus receipts would have on the general budget.