Social Security’s Future Isn’t Secure

Social Security is our most popular but most expensive domestic program. It has sharply reduced the poverty among the elderly and raised the incomes of many non-poor elderly.

Despite these impressive accomplishments, and some major improvements enacted in the 1983 Social Security amendments, Social Security still faces serious problems.

Social Security is not about to run out of money. The retirement benefits of the current elderly are secure. But lurking just about the corner is a major deficit in hospital insurance and an impending astounding surplus in the retirement part of the program. Thereafter, we face the dilemma of financing the retirement of the baby boom generation.

In addition to an uncertain financial future, Social Security continues to create adverse incentives and contains serious inequities. These are not reasons to scrap the current system. But they are serious enough problems that we must soon begin to look for ways to improve it by making it more cost conscious and target effective.

First, some simple facts. The Social Security Administration projects future benefits, taxes and therefore the surplus or deficit for the retirement, disability and hospital insurance parts of Social Security. Under the intermediate assumptions about such factors as the rate of economic growth, life expectancy gains and fertility rates, there is a modest long-run deficit in retirement and disability programs of several hundred billion dollars, about 0.5% of taxable payroll over the next 75 years. This deficit will increase somewhat with the new lower tax rates next year, since Social Security receives back income taxes paid on one-half of benefits for well-off retirees.

Enormous Future Surplus

The retirement and disability programs are expected to build an enormous surplus from about 1990 to 2020. Indeed, it is expected to be as large as the entire regular national debt! This surplus is considered necessary to prevent subsequent disruptive tax increases during the baby boomers’ retirement. But we have never been able to run such surpluses in the past. If we use these surpluses to raise benefits, the deficit will skyrocket. If we cut taxes or bail out health insurance, we can expect multitrillion-dollar tax increases as the baby boomers retire. The Social Security tax rate alone would exceed 20%.

If we accumulate such a large surplus, we will have to deal with intense pressure in the government bond market. Currently, the Social Security trust funds are only allowed to purchase government securities. If the surplus starts to become large relative to the national debt, should we allow Social Security to buy corporate stocks and bonds, real estate, international securities?

In short, Social Security’s future is uncertain and subject not only to economic and demographic booms and busts but also to political manipulation.

Serious inequities continue under Social Security, and their dimension is not widely appreciated. A typical family, for example, stands to gain or lose much more in Social Security over its lifetime than in the much more intensely and openly debated income tax reforms that we just passed.

For example, a two-earner couple born in 1945, making $50,000, split evenly between them, is projected to pay $124,000 more in taxes than it receives in benefits. This is more than the median value of a house. Many people receive no additional benefits for literally years of Social Security tax payments, and such persons are most likely to be second earners in couples, divorcees and widows.

Worse yet, many well-off retirees receive a substantial multiple of what they and their employer paid in, plus interest.

Some of Social Security’s problems are an inadvertent byproduct of impressive gains in life expectancy for the elderly, combined with the baby boom. When the baby boomers retire, the ratio of workers to retirees will plummet from the current three to one to only two to one. The Census Bureau estimates that the fraction of the population over the age of 85 will triple in the next couple of decades.

Call for Privatization

The twin pillars upon which rapid Social Security benefit increases were based were rapid economic growth and the relative poverty of the elderly. But productivity growth unfortunately has plummeted since the late 1960s, while the relative income of the elderly has improved substantially. The per-capita income of the elderly exceeds that of the general population, and many of the elderly are financially as well or better off during retirement as they were during their working years. (But some of the elderly have been left behind).

The financial solvency and related problems of Social Security have led some to call for privatization of Social Security. While greater reliance on private saving for retirement is desirable, I believe complete privatization would be a mistake. It ignores two vital features of the system.

First, Social Security provides benefit payments adjusted for inflation for the remainder of one’s life and continues to provide benefits for a surviving spouse. The private market cannot currently provide such financial instruments, called index annuities.

Only the government could guarantee a return higher than inflation. Any private provider would run the risk of earning a return on their investment lower than the inflation rate, as occurred frequently in the 1970s. If we desire private provision, we would need the government to issue bonds that guarantee a return above inflation so that the private issuers of index annuities could purchase these bonds as collateral.

Second, consider what happens to the generation working when Social Security is privatized. They get zapped twice: once to pay for their own retirement and again (perhaps by income taxes) to pay for current retirees.

There are intermediate alternatives that deserve serious attention, short of complete privatization on the one hand or continuation of the existing system in its current form on the other.

For example, we could separate the welfare and insurance goals of the system. We should give everyone an identical return on his or her taxes under the primary tier of the system, regardless of family status or other features. Hence, all claims for additional benefits could be dealt with in the second tier, an explicit welfare system for the indigent elderly whose primary benefits are insufficient to lift them out of poverty.

The return credited to contributions would depend upon the performance of the economy and demographic trends. This would imply slower increases in Social Security benefits than currently projected--but not funded--especially for well-off retirees. Lower-income retirees would be fully protected in the future, financial solvency restored to the system, while major inequities and uncertainties in benefit payments would be resolved.