The Social Security
system, according to its own actuaries, faces a financial crisis of
immense proportions. The Office of the Chief Actuary of the Social
Security Administration (SSA) is projecting that within 15 years,
the system will begin taking in less money than it needs to pay the
benefits promised to participants. Moreover, within 30 years, it
will have only enough money to pay less than 75 cents of every
dollar of benefits it promises. By 2075, using its intermediate
assumptions, Social Security will be running an annual deficit of
$562 billion (in 1999 inflation-adjusted dollars).
Despite these dire predictions, supporters
of the current Social Security system blithely assert that the
problem can be solved by faster economic growth. Without much
evidence, they claim that current economic projections are entirely
too pessimistic and that the financial shortfall will disappear if
the numbers are made more optimistic.
Robert Reich, former Secretary of Labor in
the Clinton Administration, for example, has called the SSA
economic projections "wildly pessimistic." Economist James K.
Galbraith claims that if higher growth rates were substituted for
the SSA's projected rates, "future deficits disappear without any
cuts in benefits or increases in taxes." These assertions
were bolstered by the Department of Commerce's October 1999
adjustment in its economic growth figures, which shows that the
U.S. economy grew at a faster rate from 1959 through 1998 than
previously estimated.
Regrettably, claims that Social Security
can be saved by faster economic growth are wrong. If anything, the
projections underlying the Social Security Administration's
forecasts are likely to be overly optimistic. And even if the SSA
massively underestimates the future rate of economic growth, higher
growth will have little impact on the system's solvency. By some
measures, faster growth could even add to Social Security's
problems.
According to an analysis of Social Security's own
projections, if the inflation-adjusted growth rate of average wages
over the next 75 years increases over the current forecast by 56
percent (or from the SSA's intermediate or "best guess" forecast of
0.9 percent annually to its most optimistic forecast of 1.4
percent), then:
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Social Security's date of insolvency--when
revenues can no longer cover benefits--would be pushed back by a
mere two years, from 2014 to 2016. (See Chart 1.)
-
There would be only a modest decrease
in Social Security's deficit as a share of taxable
payroll.
Under the scenario of faster economic growth, by 2075 Social
Security's annual shortfall would equal 5.12 percent of taxable
wages, compared with 6.54 percent under the SSA's intermediate
scenario.
-
Measured in terms of inflation-adjusted
dollars, faster economic growth would cause an increase in Social
Security's annual shortfall after 2055.
Although economic growth would increase revenues, it would cause
an even larger increase in the system's benefit obligations over
the long term. By 2075, the annual Social Security deficit under
the scenario of rapid economic growth is $629.9 billion
(in 1999 inflation-adjusted dollars), $67.8 billion higher than the
deficit under the SSA's intermediate projections.
In
short, critics of reform are mistaken if they think
faster-than-predicted economic growth will help the Social Security
system avoid its financial crisis. Without fundamental reform that
allows workers to invest their own Social Security taxes, deep
benefit cuts or steep tax increases will be required, regardless of
how rapidly wages grow.
HOW ECONOMIC AND
DEMOGRAPHIC FACTORS AFFECT SOCIAL SECURITY'S FINANCES
The
solvency of Social Security's Old-Age and Survivors Insurance and
Disability Insurance (OASDI) system is determined by three sets of
factors:
-
Economic (economic growth and
inflation);
-
Demographic (fertility,
immigration, and life expectancy); and
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Political (laws passed by Congress
that define the structure of Social Security taxes and
benefits).
However, long-term demographic trends are
the driving force behind the financial crisis that now threatens
the future of the Social Security system. Over the period
1950-1999, the life expectancy at birth of an average worker
increased 8.2 years, from 68.35 to 76.55. During the same period,
the birth rate dropped precipitously. In 1950, American women could
expect to give birth to an average of three children; today, the
average number of children per woman is just two. Social Security
projects these demographic trends to continue. The SSA estimates
that by 2075, life expectancy will have reached 81.85 years and
U.S. women will give birth to an average of 1.9 children each over
their lifetimes.
The
increase in longevity coupled with the declining birth rate is
increasing the number of Social Security recipients relative to the
number of younger workers whose payroll taxes support their
benefits. In 1945, two persons were collecting benefits for every
100 workers paying Social Security tax. By 1999, this number had
increased to 30 beneficiaries for every 100 workers; and the SSA
projects that by 2075, there will be 54 persons receiving Social
Security benefits for every 100 persons paying into the
system--even though all of the baby boomer generation will have
died.
Put
simply, demographic trends threaten the future solvency of the
Social Security system by increasing the ratio of retirees who
receive Social Security benefits to workers who pay Social Security
taxes.
Economic Growth.
The major economic variable that affects the solvency of the
Social Security system is growth. Moreover, because
Social Security taxes are levied only on labor income, the key
relevant measure of economic growth is the real growth rate of
average wages and self-employment income.
Consistent with the SSA's own approach, this
analysis attempts to capture the impact of economic growth caused
by many factors (such as new technology, improvements in skills and
training, deregulation, and capital accumulation) to the extent
that this economic growth is reflected in greater worker
productivity and higher wages. An increase in other sources of
income, such as dividends or rent, does not increase Social
Security payroll tax revenues (or benefits).
An
increase in average wages has two effects on the balance between
Social Security expenditures and revenues. First, an increase in
the average earnings of workers and the self-employed increases the
payroll tax base and the amount of payroll tax revenue that is
available to pay benefits. This improves the solvency of the Social
Security system.
However, there is also a second effect.
According to current law, the Social Security benefit to which a
retiree is entitled is calculated as a proportion of the value of
the "Average Wage Index" on the year of retirement. Each year, the
Average Wage Index is calculated by the Social Security
Administration using the average value of wage, salary, and
self-employment income for all workers in the economy. If, in a
certain year, the Average Wage Index increases (due to the faster
growth of wages in the real economy), the Social Security
Administration must pay higher benefits to workers who are retiring
in that year.
While this effect is initially small in the first
year, the impact becomes greater over the long term as successive
cohorts of workers retire, each of whom must be paid higher
benefits as the average amount of wages rises because of this
increase in the Average Wage Index.
In
short, an increase in the average wage earned by workers not only
increases the revenues that the Social Security Administration has
available to pay benefits, but also increases the benefit
obligations that the Social Security trust fund must meet. Over
the long term, the positive revenue impact of wage growth comes
close to being cancelled out by the increase in benefit obligations
that it also generates.
The Projected Effect of Faster Economic
Growth.
The Social Security Administration's "best guess" of future
economic and demographic conditions is represented by the
"Intermediate Assumptions" scenario that SSA publishes each year in
the Annual Report of the Board of Trustees of the Federal
Old-Age and Survivors Insurance and Disability Insurance Trust
Funds. These projections include estimates of future mortality,
fertility, inflation, economic growth, and interest rates that are
used to forecast the expected revenues and expenditures of the
Social Security system over the next 75 years.
The
Social Security Administration also makes projections based on a
pessimistic "High Cost Assumptions" scenario and an optimistic "Low
Cost Assumptions" scenario. These two sets of forecasts represent,
respectively, fiscal outcomes where all of the underlying
demographic and economic conditions are much less favorable and a
scenario in which conditions will be much more favorable than the
Social Security Administration projects.
Charts 2 through 6 show the future fiscal condition
of the Social Security system under a scenario in which wages grow
at the rate projected by the Social Security Administration in its
"Low Cost Assumptions" (or extremely optimistic) scenario, but
where all other economic and demographic variables (fertility, life
expectancy, inflation, and interest rates) occur exactly as
projected in its "Intermediate Cost" (or "best guess") scenario. In
short, the projections hold constant all of the SSA's demographic
and economic projections except for average wages, which the author
of this analysis assumes will grow at the rate projected in the
SSA's most optimistic scenario.
The
projections shown in Charts 2 through 6 assume that average wages
grow at an annual rate of 1.4 percent after inflation over the next
75 years, rather than the 0.9 percent rate projected in the SSA's
"Intermediate Cost" scenario. This 1.4 percent rate of wage growth
was selected because it is the rate used by the Social Security
Administration in its "Low Cost" or optimistic set of projections.
In other words, the scenario reported in these charts assumes that
over the next 75 years, wages grow at a rate that is 56 percent
faster than the rate projected by the Social Security
Administration in its "best guess" about future economic
conditions.
To
give an idea of the magnitude of this difference in growth rates,
consider that if wages grow at the 1.4 percent rate projected in
Social Security's most optimistic scenario, by 2075 the average
wage per worker in the United States would be $83,374 (in terms of
1999 dollars), rather than the $57,438 predicted under the SSA's
"Intermediate Cost" set of projections.
The
degree to which the projection of 1.4 percent annual real growth in
wages is extremely optimistic becomes clear when one considers the
historical rates of growth of wages. According to the Social
Security Administration's 1999 annual trustees' report, "the
average annual rate of change in average real earnings for the
total U.S. economy was an increase of 0.9 percent for the 40 years
1958-97." The report also
states that the average annual real growth in wages during the
decades 1968-1977, 1978-1987, and 1988-1997, respectively, was 0.4
percent, 0.0 percent, and 0.8 percent.
In
other words, under the Social Security Administration's "best
guess" scenario, wages will grow at least 12.5 percent faster than
they actually have in any decade since the 1960s. The optimistic
scenario used in this analysis assumes a 1.4 percent annual real
growth rate in wages that lies more than 56 percent above the
growth rate of U.S. wages in the entire period since the
mid-1950s.
As
can be seen from both Chart 2 and Chart 3, the faster growth in
wages pushes back the date of insolvency by a mere two years, from
2014 to 2016. By 2035, the annual deficit is equal to 3.85 percent
of taxable payroll under the scenario of rapid economic growth,
only 1.19 percentage points below the deficit of 5.04 percent of
taxable payroll that occurs under the Social Security
Administration's baseline assumptions. By 2075, Social Security's
annual shortfall as a percent of payroll is equal to 5.12 percent
under the assumption of faster wage growth, compared with 6.54
percent under the SSA's intermediate projections.
Chart 2 shows the annual expenditures and
revenues of the Social Security system as a percent of taxable
payroll under two sets of assumptions: the Social Security
Administration's "Intermediate Cost" (or "best guess") assumptions
and a scenario in which wages grow at an annual rate that is 56
percent faster than under the SSA's "Intermediate Cost"
assumptions. Chart 3 reports Social Security's annual deficit or
surplus as a percent of taxable payroll in each of these two
scenarios. Expressing Social Security's revenues and expenditures
as a percent of taxable payroll enables us to examine the surplus
or deficit relative to the tax base that is potentially available
to fund the system's needs.
The implications of the projections shown in Chart
4 can be expressed in terms of the increase in payroll taxes needed
to balance the Social Security system under each set of
assumptions.By 2040, even under the scenario in which wages grow at
a rate that is 56 percent faster than is currently projected, the
Social Security OASDI tax rate would have to be raised by 30
percent (or 3.76 percentage points) over the current rate of 12.4
percent to pay promised benefits. By 2075, OASDI payroll tax rates
would need to be increased by 5.12 percentage points above the
current level of 12.4 percent to 17.52 percent in order to generate
sufficient revenues to pay the benefits promised under current
law.
Social Security's financial position also
can be measured in terms of inflation-adjusted dollars. While the
system's deficit or surplus as a percent of taxable payroll is a
good measure of the balance of the system relative to the potential
tax base, expressing the balance in terms of inflation-adjusted
dollars gives a very good sense of the absolute financial burden of
any imbalance.
Chart 4 shows the effect on Social
Security revenues and expenditures (in terms of 1999
inflation-adjusted dollars) of a 56 percent increase in the growth
rate in real wages above the rate projected in the SSA's
"Intermediate Assumptions" scenario. As Chart 4 shows, the increase
in economic growth causes an increase in both Social Security
benefits and taxes over the next 75 years.
As
can be seen in Chart 5, an increase in the rate of wage growth has
little impact on Social Security's financial health, measured in
1999 inflation-adjusted dollars. If the economic growth rate is
raised by 56 percent, the Social Security system's insolvency
date--when revenues can no longer cover benefits--is pushed back by
a mere two years (from 2014 under the "Intermediate Assumptions"
scenario to 2016).
In
fact, increases in economic growth lead to increases in Social
Security deficits during the years after 2055. Under the scenario
of a 56 percent jump in the growth rate of wages, by 2075 Social
Security's annual deficit is $629.9 billion (in 1999
inflation-adjusted dollars), an amount that is $67.8 billion higher
than the $562.1 billion deficit existing under the SSA's "best
guess" assumptions. This hike in the deficit occurs because faster
economic growth eventually results in larger dollar increases in
benefits than in revenues.
CONCLUSION
According to projections made by the
Social Security Administration's own Office of the Chief Actuary,
even a massive 56 percent increase in the rate of economic growth
above projected levels will do little to solve Social Security's
financial crisis. If the average annual growth rate of wages over
the next 75 years is increased from 0.9 percent to 1.4 percent, by
2035 the Social Security system will still be able to pay out only
77 cents for every dollar of promised benefits. In that year,
benefits must be cut by 23 percent, or payroll taxes increased by
30 percent from the levels promised in current law, if the system
is to remain in balance.
In
fact, by some measures, the projections from the Office of the
Chief Actuary suggest that faster economic growth actually may hurt
rather than help the system's long-term financial health. According
to the Social Security Administration's projections, if wages grow
at an annual real rate of 1.4 percent, by 2075 the OASDI program
will be running annual deficits of about $630 billion (in
inflation-adjusted 1999 dollars). By comparison, the program's
annual operating deficit will be "only" $562.1 billion by 2075 if
wages grow at only 0.9 percent per annum.
The
long-term financial crisis facing Social Security is very real and
cannot simply be wished away by assuming future rates of economic
growth that are higher than any figure that is justified by the
evidence. Even if wages grow for the next 75 years at a rate 56
percent above the actual growth rate achieved in the period since
World War II, Social Security will continue to face dire financial
problems. Under the current pay-as-you-go structure, these problems
can be solved only by drastic cuts in benefits or by massive hikes
in payroll taxes, which would hurt current and future generations
and drive down their rates of return from the program.
The
real solution to both the solvency crisis and the rate of return
crisis confronting Social Security is to create a system that
allows workers to fund their retirement by investing their own
payroll taxes rather than relying on the payroll taxes paid by
younger generations.
Gareth G. Davis is a
former Policy Analyst in the Center for Data Analysis at The
Heritage Foundation.