Social Security Insolvency Accelerating, Study Says

Published July 1, 2005

The recent annual report issued by the Social Security Board of Trustees demonstrates with undeniable clarity that Social Security faces a looming financial crisis. Worse still, the report shows Social Security’s lurch toward insolvency has accelerated.

In just a little more than a decade, Social Security will begin to run a deficit, the study shows. Deficits will continue and amplify every year well beyond the turn of the next century. Despite early protestations from many on Capitol Hill that “there is no crisis,” few serious observers of the current state of Social Security hold out hope the system can survive as presently constructed.

Cash Flow Will Slow

The primary problem lies in Social Security’s pay-as-you go structure. Social Security is not a savings plan. The money Americans pay into the system is not used to finance their own retirements; rather, it funds benefits for current retirees.

For much of the program’s history, that structure worked fine. But just a few years from now, the number of workers paying into Social Security will dwindle, while the number of retirees receiving benefits will balloon.

For example, in 1950, the ratio of workers to retirees was 16 to 1. Today that ratio is only 3.3 to 1. When today’s younger workers each retirement age, that ratio will be cut to 2 to 1.

President Rejects Tax Hike

It’s not difficult to see the problem. And the willingness of many leaders in Washington to address the problem marks a rare moment of fiscal prudence and responsibility in our nation’s capital.

Solutions, however, have thus far proved elusive. In his State of the Union Address to Congress earlier this year, President George W. Bush laid out some principles to guide Congress through the reform debate. He has ruled out tax increases, for two reasons.

First, increasing the payroll tax rate could have serious effects on the supply of labor and thus strangle the U.S. economy. The Social Security payroll tax is already the largest tax 80 percent of all Americans pay. This 80 percent represents primarily lower- and lower-middle-income households.

Second, Congress already has raised the payroll tax 20 times throughout history, and solvency still eludes us. The original Social Security tax was only 2 percent. Today workers and their employers pay a combined 12.4 percent. The millions of self-employed persons pay the entire amount.

Raising taxes again without real assurance that the proceeds would actually belong to those paying the taxes would allow Congress to spend more on other programs or lower other taxes without dealing with Social Security’s fundamental long-term financing shortfalls.

Private Accounts Suggested

Bush also has insisted that any and all changes to Social Security not affect Americans who are 55 years old or older. If you were born before January1, 1950, your Social Security would not change one bit.

Bush’s final principle is that younger workers should be given the right to choose whether to invest a portion of their payroll taxes in personal retirement accounts. Essentially, this proposal would allow folks to divert some of their Social Security contributions into safe stock and bond funds, much like those enjoyed by federal employees through the Thrift Savings Plan.

Personal Retirement Accounts are not a new idea. Nobel Prize-winning economist Milton Friedman considered something similar to personal retirement accounts as far back as the 1950s. The father of Social Security, President Franklin Roosevelt, envisioned a self-sustaining retirement program that relied on personal investment.

But Bush is the first president in recent times to push for such a reform.

One of the frequent criticisms of personal retirement accounts is that they don’t alleviate Social Security’s solvency crisis. That is a false charge. Indeed, personal retirement accounts are an integral component to the solvency puzzle.

Benefit Cuts Only Alternative

Only through personal accounts can we assure that contributors to the Social Security system have the legal, moral, and political right to their pension benefits. Roosevelt had these rights in mind when the program was conceived. Otherwise, the ultimate pension received will be at the whim of Congress–because no individual participant in the current Social Security system has any legal rights to future benefits.

Interestingly, attaining “solvency” can be used to justify either a tax increase or a benefit cut. Assuming Bush and the Republican-controlled Congress are not going to raise taxes leaves only one option, and it’s not a popular one: Reduce benefits for future retirees.

Personal retirement accounts and the promise of higher investment returns through the use of capital markets allow Congress and the president to change the formula through which traditional benefits are calculated, without cutting the overall benefits to future retirees.

True, the mix of benefits would change. Some benefits would come from the traditional formula and some would come from personal accounts. But personal accounts have the potential to actually increase benefits.

No New Costs Added

There are costs associated with reforming Social Security. If taxes are not raised, then debt will be issued to finance the contributions. But these costs do not constitute new debt. The so-called “costs” of reform are already there. They’re part of the current system and will continue to grow unless reforms take them fully into account.

The full, official measure of the government’s commitment to pay future retirement benefits in excess of future payroll taxes amounts to $12 trillion (in present value terms) under the current system. Just like debt, this cost grows with interest as time passes. Hence, transforming the system by introducing personal accounts won’t create “new” costs. It will only make existing costs more visible.

This transition does not necessarily relieve future workers’ tax burden, given that they will be paying off the debt, just as they would with the continuation of pay-as-you-go financing. For the next generation to have lower overall taxes, the current generation of workers would need to contribute to the transition through additional savings.

Social Security needs fixing. Far from adding to the problem, personal accounts would be an integral component to this invaluable plan’s long-term solvency.

Thomas R. Saving ([email protected]) was appointed by President Bill Clinton as a Public Trustee of the Social Security and Medicare Trust Funds in 2000 and was a member of President George W. Bush’s Commission to Strengthen Social Security. Saving is director of the Private Enterprise Research Center and distinguished professor of economics at Texas A&M University.