Making Social Security Work
By Jeff Faux
December 1, 1998

Statement to the National Conference on Social Security

Making Social Security Work

Statement by Jeff Faux, President, Economic Policy Institute to the White House Conference on Social Security, December 8, 1998, Washington, D.C.

What's the Problem? There is enough money in the Social Security Trust Fund to cover all benefits through the year 2032. After that, the 75-year projections of the trustees show that 65 to 75 percent of benefits will be covered.

This projected shortfall is not a result of fewer workers having to support more retirees. (Projected worker incomes from rising productivity will more than offset the decline in the worker/retiree ratio.) Roughly two-thirds of the projected shortfall is a result of people living longer. About one-third is a result of the pessimistic assumption that economic growth over the next 75 years will slow down by half.

How Big Is the Shortfall? The increased cost of Social Security over the next 75 years will amount to about 2.5 percent of GDP. This is not an extraordinary economic burden. In comparison, increased education spending between 1946 and 1966 cost almost 3 percent of GDP. And increases in Social Security taxes between 1960 and 1995 amounted to roughly 2.5 percent of GDP. Throughout this period, economic growth continued, living standards rose, and we were able to finance the Cold War.

From 2020 to 2030, the trust fund will have to cash roughly $2.8 trillion of the Treasury bonds that make up its surplus. If not prepared for ahead of time, this could create a problem for the Treasury. But given the fact that the nation's GDP will have risen from $8 trillion in 1997 to $24 trillion in 2020 and to $38 trillion in 2030, we will surely have the resources to handle it. In any event, the Social Security system is no more responsible for the national debt than were private investors who bought Treasury bonds and now want to cash them in to finance their retirement.

The Solution. One hundred percent of the shortfall can be covered as follows:

• Applying to the Social Security projections technical improvements in the forecasting of prices that have already been made by the Bureau of Labor Statistics but that have not yet been incorporated into the projections. (13 percent)
  
• Raising the "cap" on taxable wages back to the level, relative to all wages, at which it stood in the early 1980s - $97,000 in today's dollars. This would also entail raising the cap on benefit payments. (25 percent)
  
• A small increase in the payroll tax, indexed to the increase in longevity. The increase needed would be 0.02 percent annually for both the employer and employee contribution. (64 percent)

Why Index the Payroll Tax? That Americans will be living longer is good news. But it will mean spending more years on Social Security, which will cost more. The choice is cutting benefits or paying a little more in taxes. Cutting benefits would mean living longer at a lower living standard, and would be particularly hard for the 42 percent of the elderly whom Social Security lifts out of poverty. Even in the trustees' pessimistic projections, real wages will rise 1.1 percent per year, making a tax increase of 0.02 percent a tiny price to pay to assure workers full benefits while they are living longer.

The Privatization Illusion. Citing annual stock market gains of 7 percent over the last 75 years, many claim that workers could get much higher returns than the system now provides by investing their Social Security contributions themselves. This is wrong, for the following reasons:

If the projected growth rate of the economy declines by half, as the Social Security trustees assume, the projected returns from the stock market must also decline. A stock market consistent with the Social Security projections would generate a return of about 3.5 percent. But stocks are highly risky. A typical investment portfolio is therefore more likely to have a 50/50 split between stocks and bonds. Even if we assume a 4 percent return from stocks, a balanced portfolio would return about 3.5 percent. The management fees for administering private accounts are estimated by the President's Advisory Council on Social Security to come to 1 percent of the accounts' value, bringing us to a typical return for a privatized account of about 2.5 percent.

Current contributions support current retirees. If contributions are diverted to private investment accounts, taxes will have to be raised or other government benefits cut in order to pay for current benefits. This would cost taxpayers the equivalent of another 1 percent of the Social Security contributions, putting the net returns from a privatized system even lower than the 2 to 3.5 percent return (exact returns depend on marital status and average earnings) that most workers get from the Social Security system, including the value of disability and survivors insurance. (See Dean Baker, The Full Value of Social Security, Economic Policy Institute and Century Foundation, 1998.)

Investing in the stock market is risky, and many workers would not see average returns. In addition, there is a potential for fraud and abuse, as well as the added costs of a new bureaucracy to administer a system, involving tens of millions of small accounts.

The Social Security system is not in crisis, and does not need radical surgery. Like any other program, it needs to be modified to adjust to changing conditions. The responsible approach is to tell the American people the truth, and to trust their common sense. Future retirees will have the great fortune to live longer than their parents. This will require a modest increase in current contributions in order to assure a decent level of benefits during their longer retirement.

-Jeff Faux, EPI President