Social Security is Turning 80
August 14th marks the 80th anniversary of the signing of the Social Security Act by President Franklin Roosevelt in 1935. The program has done much to alleviate poverty among the elderly. Unfortunately, the system itself is showing its age. The Old Age and Survivors Insurance program (OASI, retirement benefits) is now running cash deficits as the baby boomers are retiring. The Disability Insurance program (DI) has been running deficits for several years, and is about to exhaust its trust fund. The recently released Trustees Report shows that only 93% of current OASI costs are covered by 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. revenue, and that when the OASI trust fund runs out in 2034, benefits would have to be cut by more than 20% from projected levels. Longer term, OASI has a funding gap of four percent of payroll, meaning that would require more than a four percentage point rise in the payroll tax to close the funding gap over the next 75 years, or benefits would have to be reduced below promised levels by 27% by 2090.
The system’s ills have been driven in part by demographics, as the number of workers per retiree has been falling for decades. When the system was young, there were many workers paying into the system for each person drawing benefits. For example, there were 16.5 workers per OASDI beneficiary (retired and disabled workers combined) in 1950, as if each suburban block was supporting one retiree. Today, there are only 2.8 workers per OASDI beneficiary. By 2060, the ratio will be only 2 to 1, as if every two worker couple will be supporting someone’s grandmother in their attic.
The demographic challenge would be manageable except for the System’s formula for paying benefits. Currently, a worker’s lifetime earnings are averaged, after adjusting for wage growth, and a benefit formula is applied. The benefit formula, which sets the benefit a worker gets upon retirement, keeps benefits growing without limit over time in line with average wages (wage indexing). Over time, wages generally rise in real terms, that is, faster than prices. Under the current formula, benefits will rise in real terms too, to ever higher real levels. As workers earn more over the decades, but there are relatively fewer of them, it will impossible for the system to make ends meet. The benefit formula has put benefits on autopilot, with a course set for a collision with the demographic mountain range ahead.
The Consequences of Wage Indexing for Future Benefits
| Benefits for Future Retirees at Normal Retirement Age | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Annual Numbers (dollar amounts in real 2015 dollars) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Attaining Age 65 | Age at Retirement | Scaled Very Low Earnings | Scaled Low Earnings | Scaled Medium Earnings | Scaled High Earnings | Scaled Maximum Earnings | National Average Wage Index | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2015 | 66 | $8,868 | $11,602 | $19,115 | $25,342 | $30,834 | $47,820 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2030 | 67 | $11,219 | $14,680 | $24,199 | $32,057 | $39,504 | $60,082 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2040 | 67 | $12,613 | $16,507 | $27,211 | $36,051 | $44,418 | $67,481 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2050 | 67 | $14,181 | $18,556 | $30,590 | $40,521 | $49,884 | $75,965 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2060 | 67 | $15,936 | $20,851 | $34,368 | $45,530 | $55,864 | $85,130 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2070 | 67 | $17,820 | $23,316 | $38,432 | $50,911 | $62,472 | $94,960 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2080 | 67 | $19,860 | $25,985 | $42,828 | $56,736 | $69,638 | $105,883 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2090 | 67 | $22,161 | $28,996 | $47,792 | $63,311 | $77,722 | $118,315 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Table 1, excerpted from a table in the Social Security 2015 OASDI Trustees Report, shows the projected growth in real retirement benefits under current law. These numbers are after inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . Wage indexing of the benefit formula, coupled with a projected increase in average real wages by 2090, will send real benefits soaring by about 150 percent, to 2.5 times their current levels. The benefits would be fifty percent more for married couples getting a spousal benefit, and twice the benefit for a two-worker married couple each earning the illustrated levels.
Thus, in 2090, a single average income earner would receive the equivalent of $47,927 in annual benefits in 2015 dollars, a median income couple with the 50% spousal benefit would receive $71,668 ($47,927 with an extra 50% spousal benefit), and a two worker median income couple would receive $95,584 ($47,927 each). Upper income couples with two workers could be getting annual benefits equal to $155,444 ($77,722 each) in 2015 dollars. Surely, some trimming of benefit growth could be done without injuring future cohorts.
In the absence of reform, funding these expanding benefits will require a significant increase in 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. rate by 4.28 percentage points for OASI by 2090, or by 4.69 percentage points to cover DI as well (over and above the 12.4 percent already charged today for the retirement and disability programs), which would be a major blow to low income workers.
The Solution: Price Indexing of the Earnings and the Benefit Formula
| Benefits for Future Retirees at Normal Retirement Age | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Annual Numbers (dollar amounts in real 2015 dollars) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Attaining Age 65 | Age at Retirement | Scaled Very Low Earnings | Scaled Low Earnings | Scaled Medium Earnings | Scaled High Earnings | Scaled Maximum Earnings | National Average Wage Index | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2015 | 66 | $8,868 | $11,602 | $19,115 | $25,342 | $30,834 | $47,820 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2030 | 67 | $11,208 | $14,518 | $24,027 | $31,877 | $39,051 | $60,082 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2040 | 67 | $12,279 | $15,163 | $25,601 | $34,221 | $40,725 | $67,481 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2050 | 67 | $12,557 | $15,625 | $26,726 | $34,984 | $41,882 | $75,965 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2060 | 67 | $12,688 | $15,841 | $27,248 | $35,351 | $42,282 | $85,130 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2070 | 67 | $13,075 | $16,484 | $28,816 | $36,443 | $43,939 | $94,960 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2080 | 67 | $13,667 | $17,467 | $32,791 | $38,110 | $46,481 | $105,883 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2090 | 67 | $14,334 | $18,575 | $34,057 | $39,992 | $49,346 | $118,315 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
An alternative to raising the payroll tax or finding other sources of federal funding for the system is to trim the expansion of future benefits. As the table indicates, there is substantial room to trim benefit growth while still allowing for a large rise in future retirees’ incomes. If phased in gradually, slowing the growth in promised benefits is the best outcome for people who must work and retire over the next three generations.
One convenient, gradual method is to switch to price indexing the adjustable elements of the benefit formula and the earnings records of future retirees. Under wage indexing, the formula for calculating initial retirement amount is adjusted each year in line with the increase in average wages. Under price indexing, it would be adjusted according to the rise in the consumer price index. A worker’s earnings history, currently adjusted for wage growth from the date earned to age 60, would continue to be indexed for wage growth up to the date of conversion to the new method, and would be adjusted for prices thereafter. In the tables, I assume an effective switch in 2023.
Normally, wages rise faster than prices, at least over extended periods. Under price indexing of the benefit formula, real benefits would still grow as real wages increased, but a bit more slowly than wages, as shown in Table 2, attached. Real benefits in 2090 would be between 58% and 78% higher than benefits of corresponding workers today, instead of 150% higher. The savings would be about 34% of currently promised benefits, a bit more than needed to bring the system into long run balance.
Under price indexing, in 2090, a single average income earner would receive the equivalent of $34,057 in annual benefits in 2015 dollars, a median income couple with the 50% spousal benefit would receive $51,086 ($34,057 plus an extra 50% spousal benefit), and a two worker median income couple would receive $68,114 ($34,057 each). Upper income couples with two workers could be getting annual benefits equal to $98,962 ($49,346 each) in 2015 dollars.
Long-Term Changes Still Require Short-Term Adjustments
The shift to price indexing would handle the OASI long run deficit, but the savings would take time to build. Taxes would catch up with benefits by about 2055. Meanwhile, some transitory near term deficits would remain as the baby boom retires. The gap would largely be covered by using general revenues to redeem the trust funds, which would be drawn down more slowly than under current law, but additional funding might be required for a few years. If so, the best solution might be to bite the bullet and provide the system with a temporary loan from general revenues.
Why is it Better to Trim Benefits Than Raise Taxes?
Because less of a bad deal is better than more of a bad deal. Social Security offers a poor return on the “contributions” it exacts via the payroll tax. The benefits represent a very low “yield” on the tax payments, about 1.5–2.0 percent over the long term. Real rates of return over long periods of time on personal saving in pensions, IRAs, and other retirement savings plans invested in a diversified stock and bond portfolio can be expected to yield 7 percent or more, before taxes, which is three or four times the rate of return as the tax transfer system. Consequently, future workers would be better off with current tax rates and less growth in future benefits than with higher tax rates and currently promised increases in benefits.
The Cost of Delay
Back in 1976, when the new benefit formula adjustment methods were first being considered, a distinguished panel of experts was appointed by the Senate Finance Committee to weigh in on the issue of how to index the benefit formula. Chaired by Professor William Hsiao, the panel’s report warned that wage indexing would be a mistake, due to the projected demographic changes. It recommended price indexing. Instead, Congress adopted wage indexing in the 1977 Social Security Amendments. The Greenspan Commission in 1983 has another chance to recommend price indexing before the 1983 Social Security Amendments, but failed to do so.
Had Congress chosen price indexing in 1977 or 1983, and added the rise in the normal retirement age that was enacted in 1983, the OASI system would be living within its means today. The system’s formula would have been reigned in before the surge in retirement related to the baby boom generation, saving about $3 trillion in promised outlays (valued as of 1983 by Treasury staff). We would now be in a situation where the payroll tax could be cut, or some of it transferred to cover a portion of the Medicare program, which is projected to run heavy deficits in the years ahead, requiring large premium increases.
We have paid a stiff penalty by waiting nearly 40 years to adopt price indexing. The baby boomers have begun to retire, and the OASI system is already in deficit. Nonetheless, the projected OASI deficits would be brought down to manageable size with price indexing. Without price indexing or some other trimming of the growth of benefits, there can be no permanent fix to the program without substantial loss of jobs and income. Let us not wait another 40 years to do the right thing.
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