A recent study of the American Social Security program by the Brookings Institution in Washington, DC, was published in the June 2011 edition of the National Tax Journal. The author of the article entitled “Social Security Reconsidered”, Henry J. Aaron, outlines the issues facing Social Security, a subject that is of particular interest in this time of rising federal debt and deficits.
Social Security was designed to assure a basic income for those Americans who have retired (Old Age), death benefits to the bereaved (Survivors) and financial support for the disabled (Disability Insurance), all indexed for inflation. This is coverage that is not and was not generally available in the private domain. For the fiscal year 2011, outlays from the Social Security program are expected to reach $750 billion, the largest domestic spending program in the federal government. In 2008, the recipients of funds from this entitlement program received half or more of their income from Social Security and a rather surprising 22 percent received all of their income from Social Security. Some economists have determined that the impact of the Social Security "blanket" has wide reaching impacts on the economy by affecting the individual savings rate. Obviously, it is a much used and greatly needed support program for Americans over the age of 65. Unfortunately, in the future, it appears that the "security" part of this social program may well not exist.
When the Social Security Act was signed into law in 1935 by President Franklin Roosevelt as part of his New Deal program, it was decided to fund the program with payroll deductions (taxes) rather than from general government revenue. This meant that early beneficiaries collected far more in Social Security benefits that they paid in taxes. Calculations show that beneficiaries born before 1935 have collected and will generally collect more in benefits than they paid in taxes; the difference being funded by those who were born after 1935. The program is also designed with benefit caps; this provides annual benefits that are larger relative to earnings for low income earners. On the other hand, high income earners tend to live longer on average than low income earners resulting in larger overall lifetime Social Security benefits (in 1982 this difference was 1.9 years for those who were 65; this rose to 5.3 years for those who were 65 in 2006). This is somewhat countered by higher Survivor and Disability benefits that are paid to lower income earners.
Social Security actuaries project that spending on this program will rise by 1.2 percent of GDP between the years 2010 and 2030 and then fall by 0.2 percent between 2030 and 2050 as baby boomers die and are replaced by a smaller cohort of seniors because of the slow decline in the birthrate over the past 30 years. The Congressional Budget Office sees the future slightly differently with Social Security payments reaching 1.8 percent of GDP between 2010 and 2030 and falling to 1.5 percent of GDP between 2030 and 2050. To put Social Security spending into perspective, the program accounts for 20 percent of all non-interest government spending. If the federal government wishes to reign in the debt-to-GDP level before it reaches a critical level, overall budget deficits must be controlled before 2030. While there are proponents for cutting Social Security benefits as part of a package of cost control measures, the author feels that such cuts will not kick in quickly enough to stabilize America's debt-to-GDP level.
Every year, the trustees of the Social Security program prepare a report outlining their projections for the future of the program that attempt to envisage outlays and revenues for the next 75 years. These outlays and revenues are expressed as a percentage of payrolls that are subject to the payroll tax that funds the Social Security program. In 2010, the report stated that revenues would average 14.01 percent of payroll and that outlays (benefits) would average 15.93 percent of payroll over the next 75 years. Right off, one can readily see that Social Security will be paying out more than it is bringing in as payroll tax revenue by 1.92 percent of payroll. Kind of reminds me of most government programs today, doesn't it?
Looking back, Congress attempted to close this funding gap back in 1983 through the use of legislation. Unfortunately, the legislation set revenues to exceed outlays for only the first part of the 75 year projection with the plan of leaving a small residual reserve in the 75th year and deficits in the 76th year and beyond. That is where the problem cropped up. As the years have passed (28 of them since 1983), the number of deficit years has increased as the 75 year period rolls forward in time. As each year passes, an additional deficit year is added to the end of the equation and one less surplus year is left behind at the beginning. Approximately five-sixths of the gap in funding that is today projected for 75 years in the future is due to the rolling forward of the projection period. The other one-sixth of the funding gap is due to economic factors, individual disability, new legislation and changes in demography.
Let's examine the role of Social Security in the overall budget deficit scheme. The Social Security program is funded by a trust fund, a massive $2.6 trillion at the end of 2010. Funds accumulated within the trust fund grow as their assets accumulate interest earnings. For that reason, the Social Security trust fund reserves are projected to grow until the year 2025. At that point, Social Security outlays will begin to exceed revenues from both interest earnings and payroll taxes. The excess reserves will be exhausted in 2037 and at that point, the gap between what is spent on Social Security and what is taken in will reach 1.3 percent of GDP. This gap in funding will then be added to America's debt-to-GDP ratio.
Discussions regarding the cutting of Social Security benefits are fraught with hints of political suicide. Both the Republicans and Democrats have been able to agree on one thing; significant cuts in Social Security should not erode the benefits of current or soon-to-retire beneficiaries because they have less ability to save additional funds to comfortably retire. It has already been proposed that maintaining current program benefits apply to everyone over the age of 45 or 55. While this is comforting on one level (to retirees), it is disturbing because it means that it will take longer for funding balance in the Social Security program to take place over the decades to come This will result in less than meaningful reductions to the debt-to-GDP level.
Let’s look at possible changes that could be made to the Social Security program to ensure its future. First, revenues and benefits must be set at levels that keep the trust fund in balance as shown here:
1.) Revenues: Over the next 75 years, the gap between benefits and taxes has a present discounted value of $5.4 trillion or 0.6 percent of GDP. This compares to the Bush II tax cuts that equaled two percent of cumulative GDP over the 8 years of his Presidency.
2.) Benefits: When looking at the level of benefits, the ratio of United States Social Security benefits to cash earnings ratio is in the bottom quarter of 18 of the OECD nations and only two-thirds of the OECD average. Despite having one of the highest wage levels among 18 OECD nations, the pension wealth associated with the Social Security program finds the United States in 17th place with Social Security pensions falling 40 percent below the 18 nation OECD average. On top of that, Social Security benefits have grown less rapidly than total earnings because of the ceiling placed on taxable earnings; the increases in earnings above the ceiling of $106,800 has risen sharply and are exempt from Social Security payroll taxes.
For balance to be achieved, a cut in benefits of approximately 15 percent for all Americans or an increase in payroll taxes of 2 percentage points or a combination of the two would result in balance between revenue and benefits on the average over the next 75 years. Another option, raising the normal retirement age, would act as a cut in benefits. Unfortunately, as in the case of the 1983 legislation, in actuality, the gap would still remain at about half of its projected size in year 75 because buildups of funds in the early years would only offset deficits in the later years and would not solve the problem after the 75th year.
Mr. Aaron proposes the following:
1.) Vertical Redistribution: Since life expectancy has risen more rapidly for higher income earners and earnings inequality has increased, total benefits paid over a lifetime also increase, particularly to high income earners. In this proposal, Mr. Aaron suggests that cutting benefits for high income earners would assist in balancing the funding gap.
2.) Variation in Benefits by Age: Benefits are currently indexed to ensure that purchasing power is constant. Some economists recommend reductions in the indexing so that pensions would not rise as quickly as inflation. Unfortunately, this would work against those who are extremely elderly since they would have more years of less-than-indexed pensions. As well, these are the very people that may well have outlived their savings.
3.) Raise the Age of Initial Eligibility: This would change the Social Security balance situation very little since early savings in benefits paid are offset by later increased retirement benefits. On the other hand, delaying retirement has other more noteworthy impacts on the economy and raising the age of initial eligibility may intensify this, particularly since the labour force participation level among older workers has increased. This increased labour force participation increases tax revenues, boosts GDP and may result in the lowering of government spending on benefits for retirees.
4.) Raise the Wage Base: Growth in the wages of high income earners since 1983 has meant that the proportion of earnings that is subject to payroll taxes has been reduced to 84 percent, down from 92 percent in 1937. If the wage base were raised, this would result in the immediate generation of additional revenue, particularly if benefits were not raised in conjunction with the higher wage base.
In conclusion, unless changes to the Social Security program are made soon, the problem becomes increasingly worse as the years pass meaning that swift action is imperative. This issue will become increasingly difficult to solve as demographic changes result in fewer and fewer young Americans paying into the system that is being used by more and more baby boomers. The author, Mr. Aaron, notes that the structural deficit inherent in the system is most easily resolved by increasing revenues rather than by decreasing benefits. Unfortunately, raising taxes is something that is regarded as extremely unpalatable, particularly when the increased revenue will be used to fund a program shortfall that many Americans will not live to see.
Here's a quote from President Franklin Roosevelt:
“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program”
We shall see.