Washington College Magazine
Faculty Voices: Dollars and Sense
By Professor Robert G. Lynch
Claims are being made that the Social Security system is in financial crisis and is facing bankruptcy unless significant steps are taken to correct for projected deficits. On December 11, 2004, President George Bush asserted, "In the year 2018, for the first time ever, Social Security will pay out more in benefits than the government collects in payroll taxes. And once that line into the red has been crossed the shortfalls will grow larger with each passing year. By the time today's workers in their mid 20s begin to retire, the system will be bankrupt, unless we act to save it."
Toss off that social insecurity complex. Economic policy analyst Robert Lynch weighs in on the debate over Social Security, and the scales are in our favor.
In addition, the President has argued that the financial exigency confronting Social Security is being driven by a serious, growing, and inexorable demographic problem. As he noted in his State of the Union address of February 2, 2005, "a half century ago, about 16 workers paid into the system for each person drawing benefits," whereas "right now it's only about three workers. And over the next few decades, that number will fall to just two workers per beneficiary." Thus, "with each passing year, fewer workers are paying ever-higher benefits to an ever-larger number of retirees."
The President is probably overstating the case for financial crisis and his assertion of a looming bankruptcy is at least somewhat of an exaggeration. Similarly, the President's implication that demographic forces will inevitably undermine the current Social Security system is inaccurate. Although there may be challenges in the future to its financing, the Social Security program is not likely to face a major crisis. Its potential financial challenges, furthermore, may be resolved with relative ease. Let us review the facts about the soundness of the Social Security system and what could be done to fix its problems.
For the past 20 years Social Security revenues have been greater than the benefits paid so that the system has been running surpluses and amassing savings. In their 2005 report, the trustees of Social Security projected that the program will continue to amass savings by earning more in revenue than it pays out in benefits for the next 13 years. Thus, by 2017 the system will have accumulated over $4.6 trillion in assets, up from about $1.7 trillion in assets in 2004. The assets are held in the Social Security trust fund in the form of U.S. Treasury bonds.
These bonds are currently earning about 6% interest and this interest is reinvested in the trust fund. Starting in 2017, the trustees project that Social Security tax revenues will not be enough to cover all the benefits that have been promised. They estimate that for the next ten years part of the interest earned on the Social Security trust fund will be needed to cover the promised benefits. The rest of the interest will be reinvested in the trust fund so that by 2027 the trust fund holdings will have grown to over $6 trillion. Between 2027 and 2041, the trustees project that promised benefits will exceed Social Security tax collections and interest on the trust fund so that the trust fund itself will have to be gradually liquidated. Once the trust fund is exhausted in 2041, the trustees project that Social Security taxes will be sufficient to pay about 70% of the benefits that have been promised through 2079, the last year of their analysis.
In other words, according to the trustees, the Social Security system is currently in excellent financial health, running surpluses and accumulating assets. They also project that the system will be able to pay all its promised benefits for the next 37 years and after 2041 it will still be able to pay about 70% of promised benefits. Under no circumstances do the trustees foresee 'bankruptcy', as most people understand the word: the system never runs out of money and is always able to pay most of its promised benefits. However, they do expect financial challenges that will eventually undermine the system's ability to pay about 30% of its promised benefits. The trustees summarize these potential financial challenges by estimating that there is likely to be a long-run (75-year) deficit that is equivalent to 1.92 percent of income subject to Social Security taxes.
There are good reasons to believe that the projections of the trustees are wrong because the long-term economic and demographic assumptions they are based upon are probably too pessimistic. Pessimistic projections of future economic and population growth translate into gloomy estimates of the solvency of the Social Security system. Although no one can honestly claim to know with certainty what the economic and demographic outcomes will be over the next 75 years, within the economics profession perhaps the most commonly accepted predictor of future economic performance and trends is past performance and trends. And yet, in a number of critical areas the projections of the trustees for future economic and demographic outcomes fall short of past performance and trends, and far short of what most experts expect.
For example, the Trustees project that long-run real economic growth will be about 1.8% or about half the rate of the historical average. They arrive at this growth rate largely by assuming that productivity will grow about 1.6% and population will grow at only 0.2% a year. However, over the past century productivity has grown over 2% and population has grown over 1%. If future economic, productivity, and population growth rates are similar to their past growth rates, then there will be no deficit in Social Security—instead, there will be large surpluses.
The trustees' assumption about future immigration is probably their single most questionable assumption. Since 1970, immigration has grown about 4 percent a year and immigration experts almost universally agree that immigration to the United States will continue to grow in the future, although many believe that it will do so at a slower rate. And yet, the Social Security trustees assume not just slower growth in the future, but an absolute decline from 1.4 million total immigrants in 2002 to 900,000 new immigrants a year after 2020. If instead of declining, as the Trustees assume, immigration were to grow at a modest 1 percent annually over the next 75 years, then the trustees' projected 75-year deficit would be cut nearly in half.
The Trustees recognize the high degree of uncertainty in their projections although they fail to acknowledge that their assumptions are very pessimistic. In fact they offer three projections: a low cost, a high cost and an intermediate forecast. All of the Trustees' projections provided above refer to their intermediate forecast, which they consider to be their best estimate. It is instructive however, to briefly review their low cost or optimistic projection to get an idea of how easily the financial challenges confronting Social Security could disappear.
Under the low cost scenario the 75-year actuarial balance is assumed to be a positive 0.38 percent of taxable income and the trust fund in 2079, instead of being depleted is assumed to hold assets that amount to about five times the value of the benefits promised in 2079. In other words, under the low cost scenario Social Security is more than fully funded and, without undermining the solvency of the system, we could afford to immediately and permanently reduce Social Security taxes, from 12.4 percent to 12.02 percent.
What are some of the main differences between the assumptions underlying the pessimistic intermediate forecast and the rosy low-cost forecast? Productivity in the low-cost forecast is assumed to be 1.9 percent, still below the historical average, instead of 1.6 percent as in the intermediate projection. Real wage growth in the low cost projection is pegged at 1.6 percent, about the historical average, instead of at 1.1 percent as in the intermediate forecast. And immigration is projected at 1.3 million, probably considerably less than what we should expect, instead of 900,000 as in the intermediate projection. To wit, relatively minor and reasonable adjustments in the basic economic and demographic assumptions eliminate the projected financing problems of the Social Security system. Thus, Social Security may not be facing any financial challenges and, if it is, we can grow our way out of them.
The excessively pessimistic nature of the trustees' intermediate forecast can be illustrated by comparing their population forecast with the population projections widely considered the most authoritative - those of the US Census Bureau. Incredibly, the trustees of Social Security assume that the US population will include 36 million fewer people in 2050 than what the US Census Bureau projects. As noted earlier, a larger population will ease the financial challenges of sustaining Social Security.
But what if the predictions of the intermediate forecast are in fact correct? Are we not then threatened by a serious crisis? No, not really.
First, even if we do nothing future Social Security recipients will get more in benefits than do current retirees. If the best estimates of the Trustees are correct and Social Security is able to pay only 70% of promised benefits after 2041, the real purchasing power of the benefits of future retirees will be greater in today's dollars than what current retirees receive. For example, the non-partisan Congressional Budget Office has projected that if we do nothing the average retiree in 2065 would receive benefits (in 2004 dollars) of $18,300 compared to just $13,300 for the average retiree in 2005. This means that in the midst of a so-called "crisis" future retirees can expect to receive 38% more in benefits than retirees do today.
But what about the demographic time bomb? How can relatively fewer workers afford to pay ever-higher benefits to an ever-larger number of retirees? How will two workers be able to support each Social Security beneficiary in the future when we have three workers to support each beneficiary today?
First, consider that if demography were destiny, Americans would have starved to death long ago. Seventy-five years ago, each farmer had to feed only about 8 Americans. Today, each farmer must support well over 100 Americans.
But, more pertinently, the President has misstated the challenge of supporting retirees in the future. The challenge is not how many workers we have, and will have, per beneficiary anymore than the food challenge is how many farmers we have per American.
Instead, the challenge is a function of two interrelated factors, one demographic and one related to productivity. The demographic factor is how many workers we have, and will have, relative to the population that must be supported.
The second factor is how productive these workers are and will be. Today there are 1.9 people who live off the output of each worker paying into the system. Using the pessimistic demographic assumptions of the Social Security trustees, by 2080 there will be 2.03 people supported by each worker paying into the system, a ratio that will be only about 7% higher than what it is at present. More importantly, each worker today generates an average of $41,000 in goods and services for each of the 1.9 people that he or she must support. But, using the gloomy economic assumptions of the trustees, each worker in 2080 will produce an average of $128,000 (in today's dollars) in goods and services for each person they will need to sustain. In other words, the relatively fewer workers of the future will produce so much more than today's workers that it will be much easier for the coming workforce to support the population of the future than it is for current workers to support the population of today.
Even if the trustees are right, the magnitude of the Social Security "crisis" is small and pales in comparison to other fiscal challenges faced by the government. For example, the trustees estimate that the present value of Social Security's long-term financial shortfall is $4 trillion. By comparison, the Medicare trustees have estimated that the present value of the 75-year shortfall in just Medicare's prescription drug program alone is more than twice as large at $8.1 trillion. So, while there may not be any serious threat to the retirement security of our senior citizens there is certainly a very serious danger to the health security of our seniors. Likewise, the Center on Budget and Policy Priorities has calculated that the present value of the 75-year cost of permanently extending President Bush's 2001 and 2003 tax cuts is nearly three times as large at $11.6 trillion.
If Social Security is "in crisis" then what words would it be appropriate to use to describe the financial condition of Medicare or the fiscal consequences of President Bush's proposal to make permanent his tax cuts?
Given the relatively small size of the deficit in Social Security projected by its trustees, the projected deficit can be corrected by fairly small adjustments. For example, to eliminate the deficit Social Security taxes could be raised 1.92 percentage points from their current rate of 12.4% to 14.32%. This is a small tax increase relative to the tax cuts that were enacted in 2001 and 2003 and would leave Americans paying less in total federal taxes in 2005 than they were in 2000.
Raising payroll taxes is not the only way to increase the revenue for Social Security. An alternative is to raise the ceiling on taxable wages. Currently, no Social Security taxes are paid on income earned above $90,000 in any given year. If we made all wages above $90,000 subject to Social Security taxes as are all wages below that level, then the deficit projected by the trustees of Social Security would be eliminated without cutting benefits for anyone or raising taxes on the bottom 94% of taxpayers.
The bottom line is that too much is being alleged about threats to our retirement security system. Social Security is not now in crisis, nor is it likely to be so in the foreseeable future. w
Robert Lynch is professor and chair of the department of economics. This essay is adapted from his chapter in a forthcoming book The Baby Bust: Who Will Do the Work? Who Will Pay the Taxes? (Rowman and Littlefield, 2006).
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