Social Security reform initiatives and policy considerations

Social Security Reform

Can Social Security Be Reformed?

Doing nothing to fix our Social Security system will cost us, as well as our children and grandchildren, an estimated $10.4 trillion, according to the Social Security Trustees. The longer we wait to take action, the more difficult and expensive the changes will be. -- White House Press Release, January 11, 2005

Today, Social Security is the largest of all government programs and has represented the primary basis of economic support for millions of Americans, including retired persons, disabled persons, and family members of workers who have retired, become disabled or who died for 70 years (What is Social Security? 2005). The programs administered by the Social Security Administration have unquestionably contributed to the economic well-being of the United States in the past, but many observers are questioning whether there will be anything left in the system after the baby boomers get through with it in the coming years. Reformers caution that the longer policymakers wait to fix the problems facing Social Security today, the more expensive it will be for future generations. Others suggest that the entire system should be done away with entirely, or modified to allow for private investment accounts of some type. Everyone seems to agree that something should be done, and the sooner the better, but no consensus has emerged to date. To this end, this paper provides the background and an overview of the Social Security Administration and its programs, followed by an examination of the importance of these programs to the nation's economic well-being. A review of some of the current reform initiatives and an analysis of the viability of Social Security to meet its obligations in the coming years is followed by a summary of the research in the conclusion.

Review and Discussion

Background and Overview. On August 14, 1935, President Franklin D. Roosevelt signed the Social Security Act and payroll taxes were first collected in January 1937; the president also signed legislation in 1939 that provided benefits for survivors and dependents (What is Social Security? 2005). Today, "Social Security" is actually an umbrella term for several programs, including Old-Age and Survivors Insurance, Disability Insurance Supplemental Security Income administered by the Social Security Administration (SSA) (SSA Strategic Plan 2003-2008, 2003).

According to Diamond, Lindeman and Young (1996), reports from the Old Age, Survivors', and Disability Insurance (OASDI) trustees indicate an increasing deficiency in the program's long-term financing. "From the perspective of annual flow," they say, "the reports project that the deficiency will grow to between 3 and 5% of annual payroll after the year 2020 and will amount to approximately 15% of program spending over the next seventy-five years" (1). Even more importantly, though, these reports estimate that unless corrective action is taken now, the Social Security program will be insolvent by the year 2030, a range entirely within the retirement years of the baby boom generation. More disturbing for these soon-to-be-retirees, the date at which the Social Security trust fund stops being a net contributor and becomes a net claimant on the federal budget has advanced to the year 2013 in these projections (Diamond et al. 1996). These reports are especially troubling for many older people today who firmly believed that the 1983 Social Security amendments had completely "fixed" the Social Security program, at least through the imminent onset of the baby boomers' retirement in the year few years. Finally, and perhaps most troubling of all for the younger generations of Americans, reports in the news media have assumed new dimensions of skepticism concerning whether Social Security will be able to pay out anything at all when they reach retirement age (Diamond et al. 1996).

Importance of Social Security Programs to the Nation's Economic Well-Being. According to the SSA's "The Future of Social Security" (January 2005), "Social Security provides older Americans with a dependable monthly income with automatic increases tied to increases in the cost of living. . . . It provides a base of economic security in today's society through a valuable package of retirement, disability and survivors insurance" (2). In a recent press release from the White House (January 5, 2005), the point is made that "Social Security provides a critical foundation of income for retired and disabled workers. For one-third of Americans over 65, Social Security benefits constitute 90% of their total income. Hispanics, African-Americans, and unmarried elderly women are even more reliant on Social Security" (Social Security 3).

Today, more than 156 million workers are protected by the various programs administered by the Social Security Administration, and more than 47 million people are recipients of retirement, survivors and disability benefits from Social Security. In fact, by all accounts, the entire elderly population (defined as people aged 65 years or older) in the United States has benefited from the programs administered by the SSA in substantive ways, with the sole exception of the Hispanic segment (Hungerford, Iams, Koenig & Rassette 2002). In fact, Social Security has been credited with decreasing poverty rates for the elderly since 1976, a point in time from which median real income has increased (median income relative to that of the working-age population has remained relatively stable since that time) (Hungerford et al. 2002). The program was designed, though, at a time when most people were not expected to live long enough to collect any benefits (Bolter 2005).

According to Hungerford, Iams, Koenig and Rassette (2002), "Of the five sources of income for the elderly, Social Security remains the most prevalent and important. While both the rate of receipt and the share of aggregate income from Social Security benefits stayed relatively steady over the past 25 years, the average real Social Security benefit increased because of rising wages" (12). The second most important source of income for the elderly in America is income from assets; during the same 25-year period, this source of income tended to fluctuate. Hungerford and his associates point out that asset income for the elderly is more responsive to minor changes in nominal interest rates and bond yields because this segment of the population is more likely to hold interest-bearing assets such as bonds rather than stocks (Hungerford et al. 2002).

Current Reform Initiatives. A wide range of political, consumer and business interest groups, as well as the executive branch of the U.S. government have all proposed fundamental changes in the structure of the Social Security system (Niggle 2000). The majority of these reform proposals have involved some type of privatization of the system. According to Niggle, the term privatization in this context means some combination of:

(l)

Transforming the system from a pay-as-you-go (PAYGO) system into a prefunded system;

(2)

Changing the asset composition of the system's portfolio from special issue, nonmarketable U.S. Treasury securities toward a heterogeneous portfolio including private securities (corporate equities and bonds); and (3)

Allowing private management of at least part of the asset portfolio by either individual participants, their chosen representatives, or a quasi-public board of portfolio administrators (790).

In its most radical approaches (what Niggle terms "strong" and "pure" privatization), the existing system would be gradually phased out and replaced with private contributions into retirement accounts that were individually managed; account-holders would enjoy complete freedom in choosing their portfolios and would not be provided with any state-guaranteed social insurance or guaranteed retirement income. The advocates of these proposals cite the increasingly gloomy deficit projections for Social Security funds in the future, combined with the relatively low projected rates of return on contributions to current and future system participants as the primary reasons for adopting these alternatives. Other arguments for this type of reform have included an expected increase in the rates of saving and investment resulting from privatization, and in some cases, approval of the resulting decline in the relative size and power of the national government (Niggle 2000).

In a special to the Washington Times, Peter Ferrara (2003) points out that for a number of years now, official government reports from the Board of Trustees have made a powerful case for pursuing fundamental Social Security reform. Despite the consistently (and increasingly) grim nature of these reports, Ferrara emphasizes that the reality of the situation is even worse: "These reports do not adequately take into account the prospects for much longer life expectancies during the next century due to advanced, high-tech medicine. Substantially increasing the number of retirement years will greatly increase the program's benefit obligations and long-term deficit" (A15). According to SSA's "Frequently Asked Questions about Social Security's Future" (2005), "Many reform plans, including those put forth by the President's Commission to Strengthen Social Security, preserve scheduled benefits, including cost- of-living increases, for near-retirees" (depending on the proposal, a "near-retiree" is defined as ages 50 to 55 years and older) (2).

The most recent White House press release on the president's position on Social Security (January 11, 2005) reports that the president does not want to increase payroll taxes, and is in favor of voluntary personal accounts as part of a comprehensive solution to the existing approach. According to the press release, the president believes that, "Personal accounts give younger workers the opportunity to receive higher benefits than the current system can afford to pay, and provide ownership, choice, and the opportunity for workers to build a nest egg for their retirement and to pass it on to their spouse or their children" (Social Security 4). As his second terms begins, the president has stated that he wants to work with Congress to develop an alternative framework wherein taxpayers would have a choice between using the personal investment accounts or to simply continue to draw their benefits as they do now. Finally, the White House press release on Social Security notes that, "Any proposal will include limitations on the risk of investments permitted in personal accounts and will include low-risk, low-cost options like broad index funds similar to those currently available to federal employees" (5).

Analysis of Future Trends. The 2004 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, was released on March 23, 2004; the report provides the current and projected future financial status of the trust funds administered by the Board (The 2004 OASDI Trustees Report 2004). In their report, "The Future of Social Security," the SSA points out that despite the popular belief that Social Security taxes are held in interest-bearing accounts that are specifically designated for future individual retirement needs, the fact is that Social Security is a pay-as-you-go retirement system: "The Social Security taxes paid by today's workers and their employers are used to pay the benefits for today's retirees and other beneficiaries" (3). Although the experts do not seem to be able to agree on much else about the dilemma, almost everyone appears to agree that if anyone but the federal government was operating the Social Security programs as they exist today, they would probably be prosecuted for running a Ponzi scheme. In her essay, "The Historical Continuum of Financial Illusion," Marietta (1996) points out that:

Social Security is sometimes offered as an example of a rational Ponzi that relies on a steadily increasing pool of contributors in a system of continuous transfer payments from later to earlier payers. The concept of a rational or irrational Ponzi illustrates that because borrowing is selling a claim to future income, it is a statement of faith in the future (by both sides of the contract). The question is whether the faith is misplaced, that is, irrational given full information. The operators of a Ponzi scheme may well have such a faith rather than a criminal intent, misplaced though the faith may be (emphasis added). (80)

According to Marietta, a Ponzi scheme is any type of system of unproductive investments that is made to seem lucrative; in such systems, funds are merely transferred from late investors to early investors and those who are operating the scheme. Because the inflow of investment in such scams is not infinitely expanding, any type of Ponzi scheme is doomed to self-destruction unless there is another source of revenue available to augment the existing pool. "There are two ways to state the above," Marietta suggests, "that a venture is only a Ponzi if it collapses, or that some Ponzis may not collapse, depending if one wants to narrow or broaden the definition" (80). Today, Social Security remains a struggling but viable program only because it is still taking in more money than it is paying out in benefits, with the excess funds being deposited into the program's trust funds. As a result, the deposits over the 70-year history of SSA have provided sufficient reserves in the trust fund to meet ongoing needs; however, demographic shifts in the American population are going to place enormous strains on the system to meet the needs of the retiring baby boom population, and the number of active workers compared to the number of retirees is going to continue to decline precipitously in the future. In this environment, the dwindling number of actively employed American workers is expected to become increasingly resentful of having to support more and more retirees, and this intergenerational resentment has become the focus of much research today. While this research will not likely provide any earth-shattering results (no one wants to feel like they are paying more than their fair share after all), this new focus does tend to highlight just how complex the problem has become for policymakers in the 21st century.

According to "The Future of Social Security," "There are now large 'reserves' in the trust funds, but even this money is small compared to future scheduled benefit payments. In 2018 benefits owed will be more than taxes collected, and Social Security will need to begin tapping the trust funds to pay benefits" (5). This suggests that the administrators of Social Security are, in fact, operating a thinly disguised Ponzi scheme. Marietta notes that, "The namesake Ponzi was the most simple and direct form of this type of financial illusion; but the principle of employing ever increasing liabilities to cover past liabilities, to the potential detriment of the later lenders, can be altered, camouflaged, and developed into other more advanced forms" (80). Indeed, while the experts have been unable to agree on a precise date, the SSA projects that the trust funds will be exhausted by 2042. "At that time," they say, "Social Security will not be able to meet all of its benefit obligations ... If no changes are made" (emphasis added) (The Future of Social Security 6). According to intermediate projections from the 2004 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds:

2018: Spending for benefits would exceed tax income for the first time. The trust funds use interest on their securities to make up the difference.

2028: Spending for benefits would exceed revenues plus interest on the securities. The fund begins redeeming the Treasury securities.

The trust fund assets would be exhausted. All the Treasury securities would have been sold. Taxes would be sufficient to pay 73% of the benefits promised under current law (The 2004 OASDI Trustees Report 2004).

Figure 1 below provides a comparison of annual cost with total annual income (including interest) and annual income excluding interest, for the OASDI program using the intermediate assumptions in the 2004 Trustees Report (again, even the SSA cautions that significant uncertainty surrounds the intermediate assumptions). Figure 1 shows that based on these intermediate assumptions, the combined OASDI cost will be payable from (1) current tax income alone through 2017, (2) current tax income plus amounts from the trust funds that are less than annual interest income for years 2018 through 2027, and (3) current tax income plus amounts from the trust funds that are greater than annual interest income for years 2028 through 2041 (i.e., through the year preceding the year of trust fund exhaustion) (The 2004 OASDI Trustees Report 2004).

Figure 1. Estimated OASDI Income and Cost in Constant Dollars, Based on Intermediate Assumptions [in billions] [Source: The 2004 OASDI Trustees Report 2004].

The year-by-year relationship between income and cost rates shown in Figure 2 below illustrates the pattern of cash flow for the OASDI program that is expected to occur during the entire 75-year period. As can be seen in the graph below, the OASDI cost rate is projected to decline slightly between 2004 and 2007 and then increase to the current level within the next 3 years; the cost rate then begins to rise more quickly first exceeds the income rate in year 2018, resulting in cash-flow deficits after that date. "Despite these cash-flow deficits," the trustees say, "beginning in 2018, redemption of trust fund assets will allow continuation of full benefit payments on a timely basis until 2042, when the trust funds will become exhausted" (The 2004 OASDI Trustees Report 3). This redemption process will eventually demand a flow of cash from the General Fund of the Treasury; increasing strains on the federal budget will take place well before 2042.

Like the aforementioned Ponzi scheme struggling to survive by finding still more investors for its doomed approach, the trustees point out that "Even if a trust fund's assets are exhausted, however, tax income will continue to flow into the fund. Present tax rates would be sufficient to pay 73% of scheduled benefits after trust fund exhaustion in 2042 and 68% of scheduled benefits in 2078" (The 2004 OASDI Trustees Report 4). These projections are illustrated in Figure 2 below, but again are based on the spurious intermediate assumptions used by the SSA for demographic changes during these periods; however, as noted above and repeatedly in the literature, these projections do not include some fundamental components required to make them relevant and many suggest that even these fairly grim projections fail to paint an accurate picture of just how bad things are going to be for both active workers and aging retirees in the future.

Figure 2. OASDI Income and Cost Rates under Intermediate Assumptions [As a percentage of taxable payroll] [Source: The 2004 OASDI Trustees Report 2004].

Social Security's cost rate will generally continue to increase rapidly through the year 2030 or so as the majority of the baby-boom generation reaches retirement age; after this point, the trustees report that the cost rate is estimated to increase at a slower rate for about 15 years as the baby boom ages and begins to decrease in size. Based on the intermediate assumptions used in the above analysis, reductions in death rates and relatively low birth rates will continue, resulting in a significant upward shift in the average age of the population. These shifts will drive the cost rate above 19% of taxable payroll by 2078 under the intermediate assumptions.

According to the trustees, "In a pay-as-you-go system such as OASDI, this 19-percent cost rate means the combination of the payroll tax (scheduled to total 12.4%) and proceeds from income taxes on benefits (expected to be 1.0% of taxable payroll in 2078) would have to equal more than 19% of taxable payroll to pay all currently scheduled benefits" (5). The upward shift shown in the average age of the population is also expected to continue, further increasing the gap between OASDI costs and income after 2078 (The 2004 OASDI Trustees Report 2004).

The primary reason that the OASDI cost rate will increase rapidly between 2010 and 2030 is that, as the large baby-boom generation born in the years 1946 through 1964 retires, the number of beneficiaries will increase much more rapidly than the number of workers. The estimated number of workers per beneficiary is shown in Figure 3 below. The figure shows that in 2003, there were about 3.3 workers for every OASDI beneficiary. By 2030, the baby boomers will have mostly retired, and the projected ratio of workers to beneficiaries will have declined to just 2.2 by then. After 2030, the number of workers per beneficiary will slowly decrease, and the OASDI cost rate will continue to rise (The 2004 OASDI Trustees Report 2004).