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Social Security Commission Lays Out the Painful Facts

4 min readBy: Scott Hodge

President Bush’s 16 member Commission to Strengthen Social Security has issued a highly readable interim report on the financial challenges facing the system. Although it makes no specific recommendations, the report does make a strong case as to why Social Security should be transformed from a pay-as-you-go system that transfers wealth from current workers to today’s retirees, into a system built on saving and investing.

Critics have charged that the report (available at paints too bleak of a picture of Social Security’s long-term financial condition. But to make such a charge is to in fact criticize the projections made by Social Security’s own actuaries, from which much of the Commission report’s findings are drawn.

According to the Commission, Social Security’s financial problems stem directly from its flawed design: it is a pay-as-you-go system that requires a steady (or growing) pool of workers to pay taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es to fund the benefits of current retirees. In many respects, the system’s financial problems have been brewing for nearly 60 years. In 1940, there were more than 40 workers for every retiree. By 1960, there were five workers for every retiree. Today, there are just 3.4 workers for every retiree. By 2050, actuaries estimate, the ratio of workers to retirees will fall to 2 to 1.

Needless to say, the only way to continue to finance such a system is by increasing the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. burden on current workers. In the early 1980’s, when the system last faced the threat of spending more on benefits than it collected in taxes, lawmakers chose this path as the solution. The cash surpluses that Social Security is currently enjoying today are the result of that payroll tax hike.

But as the Social Security Trustees projected in their most recent Annual Report, these current cash surpluses will turn to deficits in 2016. While small at first, these deficits “will eventually grow very large: $194 billion in 2025, $271 billion in 2030, and $318 billion in 2035 (in 2001 dollars).” In today’s dollars, the system’s cumulative deficits total more than $22 trillion through 2075. In present value terms, the system’s unfunded liability stands at $12 trillion.

Technically, admits the Commission report, “the program could redeem government bonds in its Trust Fund to pay full benefits until 2038.” But the existence of these bonds does not solve the problem. Indeed, says the report, once Social Security begins redeeming those bonds in order to cover its liabilities, “the nation will face the same difficult choices as if there had been no Trust Fund at all.” In other words, the only way to meet these shortfalls is to raise taxes (either payroll or income), borrow from the public, or cut other government spending.

To be sure, most Americans – and, unfortunately, most members of Congress – believe that the Social Security trust fund contains real assets that can be drawn upon to pay future benefits. But the Social Security “trust fund” is like the federal highway trust fund and some 110 other federal funds, merely an accounting device and not an actual financial entity. The Clinton administration’s FY 2000 budget put the issue very clearly:

These [Trust Fund] balances are available to finance future benefit payments and other Trust Fund expenditures – but only in a bookkeeping sense. … They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large Trust Fund balances, therefore, does not, by itself, have any impact on the Government’s ability to pay benefits. (FY 2000 Budget, Analytical Perspectives, p. 337).

The ramifications of failing to address the system’s liabilities soon are significant says the Commission. For example, to close the funding gap by 2040 would either mean a payroll tax hike of 37 percent, a benefit cut of at least 26 percent, or $7 trillion in new public debt.

While the system’s massive liabilities should be motivation enough to spur Washington to reform Social Security, the poor rate of return that younger workers can expect from their years of contributions should be the final straw. Social Security actuaries estimate that a single, 31-year-old male with average earnings can expect a 1.13 percent return on his lifetime’s contributions. A 30-ish, dual-income couple with medium to low wages can expect a 2.24 percent return on their lifetime payments to the system. The rate of return for minority workers is even worse.

One of the guiding principles that President Bush outlined for the commission is that any plan to modernize Social Security must include individually controlled, voluntary personal retirement accounts. If implemented properly, investment-based personal accounts would not only improve the system’s poor rate of return, but they would also reduce the system’s unfunded liabilities. While critics will say that moving to such a system would mean as much as $1 trillion in “transition costs,” these costs must be weighed against the cost of doing nothing.