Five Ways to Fix Social Security

Published June 9, 2005

Anyone who knows anything about Social Security knows it is an intergenerational income transfer program. The transfer is from the young to the old. This sort of Ponzi scheme works only if the number of those paying increases at a faster pace than the number of those receiving. Given the slowing of population growth in the United States, the Ponzi scheme cannot survive.

When Social Security system started as “Old Age, Survivors, and Disability Insurance (OASDI)” in the 1930s there were more than 30 taxpayers supporting each beneficiary. Today there are only three taxpayers per beneficiary. In another 30 years, there will be only two taxpayers per beneficiary.

In the 1930s, average life expectancy in the U.S. was 57 years. Quite frankly, setting the age for retirement benefits at 65 years meant the majority of people would die before they’d be eligible to collect.

Today, average life expectancy is 75 years. A system that was financially feasible when only a few survived to collect is infeasible when most are expected to live a decade or more collecting benefits.

Social Security cannot continue as it is currently structured, so change is inevitable. The only public policy choice to be made is which type of change is most palatable. The approaches fit into the following categories: (1) privatization, (2) means-testing, (3) increasing the retirement age, (4) increasing population growth, or (5) raising taxes.

(1) Privatization aims at harnessing the growth of our capitalist economy to make future retirement payouts. Over the past 80 years, shares of stock in U.S. companies, on average, have grown in value by an inflation-adjusted compound rate-of-return of 7.6 percent per year. If the current Social Security taxes for a person who worked at minimum wage for his or her entire working life were invested at these rates of return, it would grow to an inflation-adjusted $500,000. This would be sufficient to purchase a lifetime annuity paying $37,000 per year–which compares very favorably to the average $11,460 per year Social Security benefit.

(2) Means-testing would focus on the insurance aspect of the original Social Security plan. In the 1930s, few workers had pensions from private employers. A person too old to work faced destitution. Insuring against destitution, like insuring against fire, is a feasible approach to Social Security. If only those who would otherwise be poor were eligible to collect Social Security, there would be no crisis. It is the attempt to pay benefits for everyone that is infeasible. Imagine how expensive fire insurance would be if everyone had to be paid regardless of whether they suffered fire damage.

(3) Raising the retirement age would be another way to head off the crisis. People live longer today, medical care is better, and work is less physically demanding, so Americans can be expected to work longer. Increasing the age at which people become eligible for Social Security to somewhere in the 80s would put the program on an actuarial par with the demographics of the 1930s.

(4) If each new generation of Americans were larger than the generation that preceded it, more workers would be paying into the Social Security system. There are two ways to increase population growth in the U.S.: (1) raise the birthrate or (2) increase immigration by taking in more working-age adults from other countries. The latter option would be less costly. Either way, though, we’d have to accommodate exponential population growth to keep Social Security running as an intergenerational income transfer system.

(5) Finally, we could try to keep Social Security running by increasing tax rates. The downside of this option, though, is its negative effect on economic growth. Increasing taxes encourages outsourcing production to other countries. In the long run, the economy will grow more slowly. Depending on which side of the Laffer curve we are on, an increase in Social Security taxes may even result in lower revenues, making the crisis worse.

We have no choice but to choose one of the five Social Security reform approaches outlined above. “Business as usual” is not an option.

John Semmens ([email protected]) is an economist and public policy advisor to The Heartland Institute in Chicago.