The Future Of Social Security – And What Can Be Done To Save It

On August 5, 2010, the Social Security Board of Trustees released its annual report on the financial health of Social Security. Social Security is the common name for a social insurance program officially called “Old-Age, Survivors, and Disability Insurance” (OASDI), in reference to its three components. (1) (2)

2009

In 2009 the total expenditures paid out by Social Security were $686 billion. Most of this, $675 billion, went to pay benefits to beneficiaries. Another $6.2 billion was used to pay the cost of administering Social Security programs. (Personal comment: This means that it costs less than 1% of benefits paid to administer Social Security. No insurance company in the US can come anywhere near this low administration cost.) The remaining $5.8 billion was used to administer the Supplemental Security Income (SSI) program ($3.6 billion), to provide administrative support to Medicare ($2.1 billion), and to cover the costs of SSA’s Office of the Inspector General ($120 million).

The total income to Social Security from taxes was $689 billion. Of this, $667 billion came from payroll taxes and $22 billion came from taxation of Social Security benefits, leaving a surplus of $3 billion, which was added into Social Security’s assets, referred to as the Social Security Trust Funds. The trust funds also earned $118 billion from interest, increasing their value to about $2.5 trillion. The interest rate earned by the combined trust funds was 4.9%

In 2009, approximately 156 million workers paid into the program and 53 million received benefits. This is a ratio of approximately 2.94 workers for each beneficiary.

So What’s The Problem?

Short Range Projections (2010 through 2019)

The following assumes that there will be no changes to the laws governing Social Security funding.

In 2010, Social Security expenditures are projected to exceed income by $41 billion. This is the first year that this has ever happened, and is seven years earlier than what was projected just a couple of years ago. The cause is the continuing high level of unemployment, which reduces income to Social Security, as less FICA taxes are paid. SSA will need to make up the shortfall by taking money out of the trust funds. In 2011, expenditures are again projected to exceed income, by about $4 billion, which amount will again be made up by withdrawal from the trust funds.

From 2012 through 2014, income is projected to exceed expenditures slightly. The surpluses will be added back into the trust funds.<

Beginning in 2015, expenditures will again exceed income permanently, by an increasing amount each year. This is a year sooner than last year’s report, which also is due to the continuing poor economic conditions. In 2019, the shortfall will be about $70 billion.

The graph below illustrates this.

Graph from reference (2) below.

(Updated 12/29/2010. The 2% “payroll tax holiday” has altered this graph. Please see The Effect of the 2% Cut In FICA Taxes in 2011 for details and a revised graph.)

Long Range Projections (2020 through 2085)

The shortfall will continue to increase every year. Paradoxically, the value of the trust fund will also continue to increase until 2025, because the interest earned on trust fund assets will exceed the amount taken out of the trust fund to cover the shortfall. After 2025, the value of the trust fund will begin to be depleted at an increasing rate until 2037, when it is projected to be exhausted. This is the same as last year’s projection.

After that the only money available to pay benefits will be the payroll tax and tax on benefits, which will be enough to cover about 75% to 78% of benefits payable under current law. Over the 75-year period from 2010 through 2085, the trust fund would require additional revenue equivalent to $5.4 trillion in present value dollars to pay 100% of all scheduled benefits. This $5.8 trillion is referred to as “unfunded liability.”


Graph from reference (2) below.

The causes of the long-range financial problems are principally demographic trends. Large numbers of baby boomers, the first of whom reached age 62 in 2007, will continue reaching retirement age over the next two decades. The longevity of retirees is gradually increasing. (My comment: I’m not sure that this will be a continuing trend. Worsening health care and increasing poverty for many of the elderly are not conducive toward increasing longevity.) Another trend is that birth rates dropped precipitously after the baby boom cohort, and have remained at a lower level ever since. The number of workers for each Social Security beneficiary is expected to fall from 2.9 in 2009 to 2.1 in 2035, then decrease slowly to 1.9 by 2085. (My comment: I am not sure this is valid either. As the percentage of population moves away from a largely white majority to a more multicultural mixture, I believe that the birthrate will increase.)

What Is The Trust Fund, Anyway?

The Social Security Trust Fund is not a cash account. It’s not cash money kept in a lockbox somewhere. The accumulated surpluses (such as the surplus of $3 billion from 2009) and interest earned have all been borrowed by the U.S. government. This is done by SSA which invests the surpluses in special non-marketable Treasury securities (bonds) issued by the U.S. government. These bonds are then deposited into the Social Security Trust Fund. As I mentioned before, at the end of 2009, the trust fund stood at $2.5 trillion, all in the form of bonds.

The bonds in the trust fund represent money owed by the federal government to SSA. The current amount owed, $2.5 trillion as of the end of 2009, is one component of the U.S. national debt, which stood at $13.3 trillion in August 2009.

These bonds represent the government’s commitment to repay the borrowed cash whenever Social Security needs it, like it does this year. As the bonds are redeemed by SSA, the U.S. government must raise the necessary cash either by raising taxes, increasing publicly held debt, or lowering other expenditures.

By the end of short range period in 2019, the value of the bonds and accumulated interest in the trust fund is projected to be $3.9 trillion. The trust fund is projected to reach a peak value of $4.2 trillion in 2025, and to begin declining thereafter, as Social Security expenditures exceed tax income and interest on the bonds combined. As I said before, if nothing is done, the trust funds will be gone by 2037.

What Can We Do About It?

I agree that something needs to be done. The sooner we solve this problem, as a nation, the less it will hurt.

Nobel Laureate economist Paul Krugman, deriding what he called “the hype about a Social Security crisis”, wrote in 2004 in the New York Times:

“[T]here is a long-run financing problem. But it’s a problem of modest size. The [CBO] report finds that extending the life of the trust fund into the 22nd century, with no change in benefits, would require additional revenues equal to only 0.54 percent of G.D.P. That’s less than 3 percent of federal spending — less than we’re currently spending in Iraq. And it’s only about one-quarter of the revenue lost each year because of President Bush’s tax cuts — roughly equal to the fraction of those cuts that goes to people with incomes over $500,000 a year. Given these numbers, it’s not at all hard to come up with fiscal packages that would secure the retirement program, with no major changes, for generations to come.” (3)

I have listed three different studies of potential solutions to the long term Social Security funding problem. They are from the Congressional Budget Office (CBO), The Urban Institute, and AARP. The chart from the CBO study shows the effect of various changes expressed as percentage of GDP. The goal is to reach 0.6% of GDP. The other two studies results are presented as per cent of “shortfall,” the unfunded liability. The goal is to eliminate the shortfall entirely; in other words to reach 100%.

CBO Study

The Congressional Budget Office (CBO) is a federal agency within the legislative branch of the United States government. It is a government agency that provides economic data to Congress. The CBO was created as an independent nonpartisan agency by the Congressional Budget and Impoundment Control Act of 1974.

The CBO reported in July 2010 (4) the effects of a series of policy options on the “actuarial balance” shortfall, which over the 75 year horizon is approximately 0.6% of GDP. (Notice that it has increased from .54% of GDP in the 6 years since 2004. There is a cost for delay.) On a GDP of $14.5 trillion, this represents approximately $90 billion per year; the dollar amount would grow along with GDP. For example, CBO estimated that raising the payroll tax by two percentage points (from 12.4% to 14.4%) over 20 years would increase annual program revenues by 0.6% of GDP, solving the 75-year shortfall. Half of this increase would be paid by the employer and half by the employee, as it is now. The effects of different policy alternatives are summarized in the CBO chart shown below.

Change The Taxation Of Earnings

Policy Option % GDP
Option 1. Increase the Payroll Tax Rate by 1 percent(a) in 2012 0.3%
Option 2. Increase the Payroll Tax Rate by 2 percent over 20 years 0.6%
Option 3. Increase the Payroll Tax Rate by 3 percent over 60 years 0.5%
Option 4. Eliminate the Taxable Maximum 0.6%
Option 5. Raise the Taxable Maximum to Cover 90% of Earnings(b) 0.2%
Option 6. Tax (At Current Rates) All Covered Earnings Above the Taxable Maximum; Do Not Increase Benefits 0.9%
Option 7. Tax Covered Earnings Up To $250.000 at 4%; Do Not Increase Benefits 0.5%
Option 8. Tax All Earnings Above The Taxable Maximum At 4%; Do Not Increase Benefits 0.3%
Option 9. Tax All Earnings Above $250,000 at 4%; Do Not Increase Benefits(c) 0.1%

The effects of these changes was calculated based on revenue increases taking place in or beginning in 2012.

(a) 0.5% for employees and 0.5% for employers.

(b) An increase from $106,800, where it is now, to about $156,000 in 2012. The rate would stay at 90% thereafter.

(c) Earnings above the Taxable Maximum but below $250,000 would not be taxed.

Change The Benefit Formula

Policy Option % GDP
Option 10. Raise from 35 to 38 the Number of Year of Earnings Included in the AIME(a) 0.1%
Option 11. Index Earnings in the AIME Formula to Prices 0.2%
Option 12. Reduce All PIA (b) Factors by 15% 0.5%
Option 13. Reduce the Top Two PIA Factors by Roughly One Third 0.7%
Option 14. Reduce the Top PIA Factor by One-Third 0.1%
Option 15. Reduce All PIA Factors by 0.5% Annually(d) 0.4%
Option 16. Index Initial Benefits to Changes in Longevity 0.5%
Option 17. Reduce PIA Factors to Index Initial Benefits to Prices Rather Than Earnings 1.0%
Option 18. Lower Initial Benefits for the Top 70% of Earners 0.5%
Option 19. Lower Initial Benefits for the Top 50% of Earners 0.4%
Option 20. Index the Bend Points in the PIA Formula to Prices 0.5%
Option 21. Index Earnings in the AIME and Bend Points (c) in the PIA Formula to Prices 0.6%
Option 22. Replace the Current PIA Formula with a New Two-Part Formula 0.2%

The effects of these changes was calculated based on benefit cuts taking place in or beginning in 2017.

(a) The AIME for a retired worker who reaches age 62 after 1990 is calculated on the highest 35 years of earnings on which that worker paid Social Security taxes (up to the taxable maximum, $106,800 in 2010). Earnings before age 60 are indexed to compensate for inflation and for real (inflation-adjusted) growth in wages; earnings after age 59 enter the computations at nominal values. Dividing total earnings by 420 (35 years times 12 months) yields the AIME.

(b) The PIA is the monthly payment to a worker who begins receiving retirement benefits at the full retirement age or to a disabled worker who has never received a retirement benefit reduced for age. For workers who turn 62, become disabled, or die in 2010 (for calculation of survivor benefits), the PIA formula is 90 percent of the first $761 of the AIME plus 32 percent of the AIME between $761 and $4,586 plus 15 percent of the AIME over $4,586. Those percentages constitute the PIA factors.

(c) Bendpoint is another word for PIA factor.

(d) By 2080, the PIA factors would be 65 percent, 23 percent, and 11 percent, equal to about three quarters of what they are now. In 2048, this option would match the reduction in initial benefits provided by Option 12 (which would cut benefits by 15 percent in 2017), but it would provide for smaller cuts in earlier years and larger reductions in later years.

Increase Benefits For Low Earners

Policy Option % GDP
Option 23. Modify the Special Minimum Benefit and Index It to Growth in Earnings -0.5%
Option 24. Introduce a New Poverty-Related Minimum Benefit -0.05%
Option 25. Enhance Low-Earners’ Benefits on the Basis of Years Worked -0.3%

Raise The Full Retirement Age

Policy Option % GDP
Option 26. Raise the FRA to 68 0.1%
Option 27. Raise the FRA to 70 0.3%
Option 28. Index the FRA to Changes in Longevity 0.2%

Reduce Cost of Living Adjustments (COLAs)

Policy Option % GDP
Option 29. Reduce COLAs by 0.5 Percentage Points 0.3%
Option 30. Base COLAs on the Chained CPI-U 0.2%

Urban Institute Study

The Urban Institute estimated the effects of five alternative solutions during May 2010, along with an estimated reduction of the shortfall:

1. Reducing the COLA by one percentage point: 75% (My comment: This is a bad idea. This would compound over time, like interest left in a bank account. It would have a major impact on current beneficiaries and those approaching retirement age.  The same argument applies to CBO Options 29 and 30.)

2. Increasing the full retirement age to 68: 30%

3. Indexing the COLA to prices rather than wages, except for bottom one-third of income earners: 65% (My comment: This one is a bad idea. It came from President Bush’s White House. It would increase the payment to lower paid workers and decrease the payment to higher paid workers. But, over time the difference would flatten out. Ultimately, everyone would get the same amount regardless of how much their covered earnings had been. See (6).

4. Raising the payroll tax cap (currently at $106,800) to cover 90% instead of 84% of earnings: 35% (My comment: I agree with this one. Why not 95% of earnings?)

5. Raising the payroll tax rate by one percentage point: 50%. (My comment: I agree with this one also.)

AARP Study

AARP conducted a study on this issue in 2008. The list below has been compiled from their report by Wikipedia. The Wikipedia article is titled [b][url=http://en.wikipedia.org/wiki/Social_Security_debate_%28United_States%29]Social Security debate (United States)[/url][/b]. It is actually a quite good presentation of the major issues of this debate. (7)

Revenue raisers

1. Raise the cap from about 83% of taxible earnings (where it is now) to 90% of taxable earnings (This would be an increase from about $108,000 to
to about $170,000 (in today’s dollars) phased in over 10 years): 39%
* PRO: Affects only 6% of taxpayers or top 15% of income. Can be phased in gradually. Not a new tax, restores prior policy.
* CON: It’s a tax increase for higher earners.

2. Increase payroll tax rate: Each 0.5% tax rate increase addresses 23% of shortfall.
* PRO: A gradual increase would maintain 75-year solvency.
* CON: A regressive tax increase that adversely affect workers. (My comment: Social Security is a program meant to replace worker’s wages which are lost due to age, disability, or death. It was always intended to be funded by workers.)

3. Raise taxes on benefits: 10%
This amounts to a reduction in the benefit to high wage earners so the pros and cons are purely subjective.

4. Preserve tax on estates over $3.5 million: 27%
* PRO: Improves tax progressivity, affects only 1/2 of 1% of all estates.
* CON: Would alter the President Bush’s tax-cutting plans. (My comment: So what?)

5. Extend coverage to newly hired state and local government employees: 10%
* PRO: Makes Social Security universal, with all sharing obligations and benefits.
* CON: State and local governments employees might get less retirement benefits. (My comment: This may have been true in the past, but states and cities are beginning to look into cutting their retirement benefits because they cannot afford them. What might happen on the local level is what happened to Federal employees in 1984; a hybrid system consisting of Social Security and a much smaller Federal pension.)

6. Invest 15% of the trust funds in stock and bond index funds: 10%
* PRO: In the most optimistic scenario, the trust would earn higher returns on its investment.
* CON: Since the US government has a debt, this amounts to borrowing money in bonds to invest in the stock market, or margin trading.  Cost of transition between $600 billion – $3 trillion. Less likely scenarios involve lower or negative returns. (My comment: Not so
unlikely, as we’ve all seen.)

Cost trimmers

1. Adjust the COLA: 18%
* PRO: Saves money.
* CON: This would set the standard of living afforded by Social Security to the level the individual could achieve at their date of initial benefit.  The current plan allows for an increased standard of living based on productivity increases made in the US economy. (My comment: I still think this is a bad idea.)

2. Increase normal retirement age to 70: 36%
* PRO: Links retirement more closely to life expectancy and increased worker health since program inception. (My comment: I disagree that these assumptions will continue at present rates.)
* CON: Reduces benefits.  Unfair to those forced to retire early but not otherwise eligible for other Social Security benefits.

3. Progressive Indexing – Index benefits to prices, not wages: 100%
* PRO: Could eliminate shortfall.
* CON: Reduces the growth in scheduled benefits over time. (My comment: This is the same solution as #3 on the Urban Institute’s study.)

There are a few more options shown on the first page of the AARP report. (7)

A Few Ideas Of My Own

I have a couple of suggestions of my own, which have not been mentioned in the reports above, but which bear consideration. They are:

1. Put a needs-test on Social Security benefits. A Beneficiary whose total income exceeds some level (perhaps $100,000) would perhaps lose $1 of benefits for every $2 or $3 above $100,000 he was paid from all sources, not including Social Security.

2. Pay FICA taxes on other types of compensation (other than wages) paid to workers, generally corporate officers, such as profit sharing, stocks or stock options, the value of in-kind compensation, etc. This would be separate from the capped FICA amount paid on wages, and would not be added into the earnings record (in other words, it would not result in higher Social Security benefits for these workers.

3. Collect taxes taxes on certain, easily identifiable items. Examples of this could be 1% on all gambling winnings over a certain amount (perhaps over $5,000), 1% of the amount received or spent in large stock trades (perhaps over 5,000 shares), or a 1% tax on purchases of luxury items, such as aircraft, expensive multiple homes (too expensive for middle class folks to afford), cars costing over $50,000, yachts, and collectible art items worth over $25,000.

If anyone here has additional suggestions, please post them. I am thinking of putting up a poll on this topic a little later; I think the results would be very interesting.

Editorial

As I have said many times before before, society has a responsibility to provide food, housing, and medical care to each and every member which belongs to it. This is the main purpose of society. It is the job of the society’s government to see to it these basic needs are met. These basic needs take priority over every other thing that government pays for. Social Security and Medicare are the methods by which this society has chosen to provide these basic needs for its elderly and disabled, as well as the needs of minor children, their surviving parent, and the widows of deceased workers. Therefore, Social Security is a basic priority. Society includes everyone who lives here, including the rich. Those who have been the most richly rewarded have arguably benefited the most, and owe the most to keep the society healthy and able to care for everyone else. It’s past time that we start [u]demanding[/u] of the rich that they live up to their responsibility to the society that made them rich.

As FDR put it in his 1941 State Of The Union Speech (the famous “Four Freedoms” speech) everyone, not only in the US but in the world, was entitled to four basic freedoms: Freedom of speech and expression; Freedom of worship; Freedom from want; and Freedom from fear. Everyone, and I do mean every single person, is entitled to these freedoms, and it is the responsibility of everyone to do his fair share to see to it that this happens.

End of Editorial

There is a lot more to this issue, but these are the basics. Most of the proposed solutions have their pros and cons, and the reports cited above provide a lot of detail. I am not confident that, given the political climate in Washington, much will get done soon to fix Social Security’s funding problem, which will become worse the longer we wait. But sooner or later, the issue will have to be confronted.

References

(1) Social Security Board of Trustees: Long-Range Financing Outlook Remains Unchanged (Aug 2010)

(2) American Academy of Actuaries Issue Brief: An Actuarial Perspective on the 2010 Social Security Trustees’ Report

(3) New York Time Op/Ed “Inventing A Crisis” by Paul Krugman (Dec 2004)

(4) CBO Report “Social Security Policy Options” (Jul 2010)

(5) Urban Institute Fact Sheet on Retirement Policy “Distributional Effects of Alternative Social Security Reforms: Details Matter”

(6) Joint Economic Committee Democrats Report “What If President Bush’s Plan For Cuts In Social Security Benefits Were Already In Place?” May 2005

(7) AARP Public Policy Institute Report titled Reform Options For Social Security (2008)

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