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NATIONAL
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CIPA, 777 UN Plaza, Suite 3C, NY, NY 10017
UNCOMMON SENSE
21 November 2005 [Rev.]
#1 OF A SOCIAL SECURITY PACKET
SOCIAL
SECURITY IS NOT IN "CRISIS"
By
Richard B. Du Boff, Professor Emeritus of Economics, Bryn
Mawr College
By any standard, Social Security is the most successful social
program ever enacted in the United States, guaranteeing a measure
of basic security for nearly all workers and their families.
For nearly two-thirds of the elderly, Social Security provides
at least half their total income; for 22 percent of them, it
is the only source of income. Without it, the poverty rate for
the elderly would jump from 10 to 48 percent. Social Security
is not just for retirees: it also provides monthly benefits for
disabled workers and their dependents, and for the dependents
of deceased workers. Together, these two groups comprise 31 percent
of all Social Security recipients.
Since its enactment in 1935, Social Security has also been America's most popular
social program, and surveys show continued support. So why do more than half
of young people think that Social Security will not be there when they retire?
And why do so many people believe that the current Social Security system will
be "bankrupt" when the baby boomers retire?
Despite its record, Social Security has always had opponents, who decry "big
government" programs and have now created a sense of crisis to try to destroy
a successful one. Much of the fear has been stirred up by a stream of scary articles
and editorials in the major media, as well as by loud alarms from politicians,
warning the younger generation that before they retire Social Security will already
be hurtling toward insolvency.
The assumptions of impending Social Security "crisis" purport to be
based on an economic reality--the aging of the population as baby boomers retire
and as all retirees live longer. A falling share of the population who are still
working will have to support growing numbers of elderly, whose retirement benefits
could exhaust the Social Security Trust Fund and leave nothing for generations
that follow. The conclusion appears unavoidable: without huge increases in tax
rates, there will be a ballooning deficit in the fund from which Social Security
payments are made. The only solution, we are told, is to allow workers to channel
their payroll taxes into their own investment accounts, so that they can benefit
from the much higher returns that stocks and bonds will bring them over the long
run.
A serious examination of these assumptions is in order: Will there be too many
elderly for the working-age population to support? Can we afford the retirement
bill? Is privatizing Social Security the answer?
Too Many Elderly for the Working-age Population to Support?
The economic burden of supporting retirees is often estimated by what is called
the "dependency ratio"--the number of elderly compared to the number
of people of working age (20 to 64 years). This ratio is projected to rise
from 20.3 seniors per 100 working-age people in 2005 to 36.8 seniors in 2035,
as Americans
aged 65 and over increase from 37 million to around 75 million--and from 12
to 20 percent of the population. Thus, as the post-World War II baby boom generation
reaches retirement age starting in 2012, it must be supported by the relatively
smaller cohort of workers born during the low birth-rate years of the past
three
to four decades.
The problem here is that the working population supports all those who do not
work--children, including students, as well as the elderly. This "total
dependency ratio" changes the picture radically: the ratio of all dependents
to workers is projected to rise from 66.7 per 100 workers in 2005 to 80.8 by
2035 and 85.9 in 2080. Not only does this represent a much lower rate of dependency
growth than when only the elderly are included; it also reveals that total
dependency at its estimated future peak will still be well below what it was
from 1960 to
1975, when it averaged 89.4 percent of those working and peaked at 94.7 percent
in 1965. No demographic projection for the next 75 years puts the ratio anywhere
near as high as it was in the 1960s; only "a mortality revolution at the
oldest ages" could possibly do that, observes the eminent demographer
Richard Easterlin.
Total dependency ratios are anything but irrelevant. In the United States, the
costs of educating the baby boomers caused large, probably unprecedented, increases
in spending on education following the Second World War. At that time, our economic
productivity was far less than today's. In real (price-corrected) terms, gross
domestic product (GDP) per capita in 1960 was 36 percent of what it was in 2005,
and much less than what it will be in the years to come. This means that one
worker today can produce far more than the same worker did four decades ago,
and less than what his or her successor will be able to produce decades from
now. It seems safe to say that if we could afford to pay for the education of
the baby boomers, we can afford to pay for their retirement.
As a fraction of GDP, spending by state and local governments on education
grew from 1.5 percent in 1946 to 5.6 percent in 1975--which understates the
actual
increase in educational expenditures because it excludes outlays by households
on private education (independent and parochial schools and private colleges
and universities). This increase of
4.1 percentage points of the GDP, in 29 years, was nearly twice as large as
the projected increase for Social Security over the next 75 years (4.3 to 6.4
percent
of GDP). Now education spending is on the rise again, as children of the baby
boomers and immigrants pack America's schools. In 1997 enrollment at secondary
school level surpassed its 1971 baby-boom peak, reached a record 53 million
students by 2000, and, unlike the fall in school enrollment in the 1970s when
the baby
boom ended, is expected to grow without letup through the rest of the 21st
century. Already public school systems face spiraling costs because of teacher
shortages
and aging, inadequate school buildings and equipment. Why are the doomsday
prophets of Social Security silent on this matter?
Can We Afford the Retirement Bill?
Ultimately, our ability to support the dependent population hinges on two issues:
Will our economy be able to produce the goods and services those people require?
And will the government be able to finance its pension and other commitments?
When the Social Security Act was passed in 1935, Congress specified that
it was to be financed by a special payroll tax (now called FICA) on workers
and their employers. This was done to muster political support; it was not
an economic necessity. President Franklin Roosevelt favored such a payroll
tax because he felt it would assure Americans that they had "earned" their
benefits and had a right to them, and "with those taxes in there, no
damn politician can ever scrap my Social Security program."
The economic fact is that no matter how pensions are financed, the goods
and services to be consumed by retirees cannot be stored up in advance but
must
be produced at the time: the bread eaten in the future will be baked then,
and the doctors and nurses who provide medical care must be available then.
These goods and services will come from the nation's economic output, not from
the money in the Social Security Trust Fund. If our economy fails to grow,
future consumption by retirees will cut more deeply into the goods and services
available to the working population, whether that population is taxed to pay
the retirement benefits or those benefits are paid from some accumulated trust
fund, public or private.
Social Security is simply another claim on society's resources and production.
Its future viability depends on how large the labor force will be, what fraction
is employed, and how high the productivity of its workers will be--in other
words, on how fast the
output
of goods and services grows in future decades.
The "Crisis" Projections: How Reliable?
To estimate the future condition of the Social Security Trust Fund over periods
ranging up to 75 years, as they are required to do, the Social Security Trustees
must make assumptions about the growth of the economy (GDP), labor productivity,
wage income, unemployment, fertility, net immigration, mortality, marriage,
divorce, disability incidence, and retirement patterns. It can readily be seen
how each of these variables affects either the number of people working and
the amount of FICA taxes they are paying, or the number of retirees and disabled
and the amount of benefits they are receiving, or both (wage income and unemployment,
for example, determine FICA revenues flowing into the Trust Fund and also the
credits earned by current workers toward their future retirement benefits.)
Because of the uncertainties associated with all these variables, the Trustees
offer three "alternative" projections, based on three sets of economic
and demographic assumptions, to show the range of possible outcomes--the "low-cost" or
optimistic projection, the "high-cost" projection, and the "intermediate" alternative
that the Trustees call their "best estimate of the future."
In recent years the Trustees' "best estimate" or intermediate
alternative has been based on pessimistic assumptions about the
most important variable for the future of Social Security--the
rate of economic growth, which is the major determinant of employment
and unemployment, and taxable wage income. The low-cost or "optimistic" alternative
is only slightly less pessimistic. Both assume that in years
to come real GDP will grow much more slowly than it has over
the past century or more, when it has averaged around 3.2 percent
per year. In the intermediate alternative, growth rates over
the next decade are projected to average 2.5 percent per year,
and only 1.8 percent per year from 2016 to 2080. If the economy
grows as much as 2.6 percent a year over the next 30 to 75 years,
as the Trustees' "optimistic" alternative assumes,
the Social Security deficit will disappear. Yet even the relatively
sluggish economy of 1973-1996 produced an annual growth rate
of 2.8 percent. Just eight years of faster growth and lower unemployment
from 1997 through 2004 increased FICA tax revenues enough, according
to the intermediate alternative, to push back the date by which
the Social Security Trust Funds are predicted to be exhausted,
from 2029 to 2041. At that time it is estimated that annual payroll
tax revenues will still be sufficient to cover 74 percent of
benefits due under the current benefit structure, and from 2042
to 2080 an average of 70 percent of benefits due could be covered
by payroll taxes.
If we nonetheless accept the Trustees' intermediate alternative, how large
are the deficits for Social Security, which are predicted to start in 2015?
The Trustees measure them by calculating the immediate and permanent increase
in the Social Security payroll tax needed to eliminate the deficits and establish "actuarial
balance" for the Trust Fund over the next 75 years. As of 2005, the FICA
tax of 12.4 percent would have to be raised to 14.32 percent--or by slightly
less than 1 percentage point on both workers and employers, who each pay 6.2
percent on the first $90,000 of earned income (so that a worker's FICA tax
would be raised from 6.2 to 7.16 percent).
This tax increase hardly seems onerous for a rich nation whose taxes take the
smallest share of GDP of any high-income country. Nor is it necessary to increase
the tax for lower-wage workers. More than half of the actuarial gap could be
closed by removing the income ceiling on the amount of earnings subject to
the payroll tax ($90,000 in 2005, $94,200 in 2006) and imposing the tax on
all incomes with no upper limit. This has much to recommend it, in view of
the rising inequality of income in the United States since the 1970s that has
lifted a greater share of wages above the taxable maximum. The point has not
been lost on the Social Security Trustees: they have consistently reported
since 1984 that the ratio of taxable earnings to total earnings in covered
employment has been declining "due to the increasing proportion of total
covered wages earned by very high wage earners." An even better approach
would be to restore more progressivity to the personal income tax and use it
to help Social Security. The editors of Business Week, who have called the
Trustees' intermediate estimate of future GDP growth "a ridiculously low
number," also suggest that "using future general revenues to finance
Social Security solves most of the 'crisis'" (February 1, 1999).
Under the Trustees' low-cost, or optimistic, alternative, Social Security will
have increasing surpluses in the future, so no tax changes
are needed. This holds true, it should be noted, even under the optimistic
assumption that from
2005
to
2080 the economy will grow 2.6 percent per year, well below its long-term historical
rate of 3.2 percent, and that population will grow at the annual rate of 0.7
percent--less than it did during the Depression years 1929 to 1941. If, as
seems likely, population, and numbers of workers contributing to Social Security,
grow faster than this scenario would have it, there could be even larger surpluses
in the Trust Fund--one more reason to dismiss talk of a Social Security "crisis."
Is Privatizing Social Security the Answer?
Those who recommend privatizing Social Security would redirect workers' payroll
taxes into personal retirement accounts to be invested in financial markets.
For corporate stocks in particular, they claim, returns are historically higher
than any eventual rate of return on the FICA taxes paid in by workers during
their income-earning years. The fact, however, is that compared to Social Security,
private investments expose their owners to higher administrative expenses and
far less insurance coverage, along with fluctuations in financial markets and
volatility in rates of return.
The annual costs of running Social Security amount to less than 1 percent of
its benefit payments. The life insurance industry has costs that average 12
to 14 percent of benefits, an indication of what would lie in store for a privatized
Social Security system entailing tens of millions of small accounts, placed
with scores of competing financial institutions marketing diverse products
and trying to maintain high profit margins. Furthermore, a government-run system
is universal: it includes all workers rich and poor, well and unwell, and spreads
risk across income classes and generations. Social Security covers major contingencies
of life, is portable from one job to the next, and is financed by contributions
that are not directly related to benefits. Because it is weighted in favor
of workers with lower lifetime earnings, it keeps millions of elderly out of
poverty. It is also an inflation-adjusted, lifetime benefit, guaranteeing that
recipients will not outlive their savings.
The failures of the private insurance market are all the more striking when
the full range of insurance provided by the Social Security system is taken
into account--something that privatizers stubbornly refuse to acknowledge.
Social Security provides not only retirement benefits, but also disability
coverage and benefits to survivors of workers who die before retirement. For
workers, the chances of becoming disabled or dying before age 65 are four in
ten. The only disability insurance for three-quarters of all workers comes
from Social Security. In a typical example, for a 27-year-old couple working
at average wages, with two small children, disability protection is estimated
to be equivalent to a $240,000 policy in the private sector. A comparable survivor
policy is worth $355,000. Disabled workers and their dependents account for
17 percent of total Social Security benefits paid out, with the average monthly
benefit (as of mid-2005) worth $959.
Another compelling reason to preserve Social Security as a government
enterprise is the failure of the private pension system itself
as one of the three "legs" of the retirement stool
for Americans (with personal savings and Social Security). Only
one-third of private-sector retirees receive monthly pensions,
and fewer than one in three have ever received a cost-of-living
increase. In growing numbers of pension plans for current workers,
retirement incomes are not guaranteed in advance ("defined
benefit") but depend upon the investment skills of individuals
and the performance of financial markets, as well as lifetime
earnings ("defined contribution," or 401[k]-type plans).
The New York Federal Reserve Bank reported in 1998 that 35 percent
of workers do not participate in any 401(k) plans, and that nearly
half of all workers who had a 401(k) in a previous job took a
lump sum distribution before retirement age; only 28 percent
rolled their 401(k) over into another tax-qualified plan. Only
ten percent of the total income of the elderly comes from private
pensions; 21 percent comes from earnings by those who continue
working, and 30 percent from government employee pensions and
income from personal assets. Social Security provides 39 percent
of all elderly income; the average monthly benefit (mid-2005)
is $959, and for retirees with an aged spouse, $1,578.
Privatization advocates claim that over the past century the
inflation-adjusted rate of return to stocks has averaged around
7 percent per year, and that for most future retirees the return
on their FICA contributions may be less than half as much. But
it is also an axiom of economics that higher returns are attached
to investments with greater risks. Thus, the returns to Social
Security should be lower because it is essentially a riskless
security in a taxpayer's portfolio. Two analysts (Olivia Mitchell
of the Wharton School, University of Pennsylvania and Stephen
Zeldes of Columbia University) have concluded that claims that
individual accounts will produce higher returns on Social Security
contributions are "inaccurate and misleading . . . .it is
unlikely that a privatized system's risk-adjusted rate of return,
net of other new taxes [to compensate current Social Security
participants for loss of promised benefits], would exceed that
promised under the current Social Security system” (American
Economic Review, May 1996).
And with respect to stocks, the risks for individual investors
cannot be evaluated by looking at returns that average 7 percent
over the “long-run”--the past 100 years or more.
Over the past century returns to stocks have not only followed
long waves up and down, with bull markets peaking in 1901, 1929,
1966, and 2000 and in each instance giving way to decline and
prolonged stagnation; returns have also varied widely from one
year to the next, in many years doing better than the 7 percent
average, but often worse. From 1926 through 2003 (78 years),
investors fared better than the average slightly more than half
the time (41 of those years) and matched the average in six of
those years, but they made less than the average in seven years
(9 percent of the time) or lost money in 24 years (31 percent
of the time). Another historical analysis of stock returns, based
on Standard and Poor’s Security Price Index Record, shows
that for 1872 through 2002 investors lost money 37 percent of
the time (during 48 of 131 years).
In the face of volatility of this order, investors are subject
to stock market swings that can erode, even wipe out, a lifetime’s
worth of savings just when they are needed to live on: someone
might buy stocks in years when prices are bullish and have to
sell in later years when the market is down, sometimes way down.
For most people, the bulk of saving for retirement is done in
the last two decades of their working lives--if that long. Thus,
someone who invests in stocks during a 15 to 20 year period,
or less, then retires during two or three bad years stands a
good chance of ending up with meager gains or losses. Between
1900 and 1998, there were 22 twenty-year periods during which
annual returns to stocks came in at less than 2.5 percent--the
return on U.S. government bonds over the same period. For example,
someone who purchased a representative group of stocks in 1929
and held them for 20 years would have had annual returns averaging —0.2
percent by 1949; for someone holding stocks from 1965 to 1985,
returns would have averaged 0.7 percent. Others lucky enough
to be holding stocks when they peaked well above the long-term
average could have had annual gains as great as 10 percent, which
was true for nine twenty-year periods between 1900 and 1998.
All these returns were calculated on the assumption that management
fees averaged 1 percent per year; any higher fees would have
lowered returns and made this historical record look less robust.
Even over earning-and-saving periods longer than 20 years the
same risks are present. For the period 1871 to 1997, Brookings
Institution economist Gary Burtless calculated returns for workers
who began to work at age 22 and retired at 62. Each worker saved
6 percent of his wages annually, invested it in a "total
stock market index" fund, and at retirement converted the
balance into an annuity. Burtless found that the amounts that
workers could expect at retirement differed dramatically--timing
was nearly everything. A worker who retired in 1969 would have
been able to convert his proceeds into an annuity providing 104
percent of his former annual earnings; a worker retiring just
six years later would have replaced only 39 percent of his prior
earnings.
Another insight into the risks of owning stocks over anything
less than the long run--whatever that might turn out to be--comes
from the period 1966 to 1981, which brought an unrelenting bear
market and negative returns to most stockholders. The Dow Jones
index reached 995 in February 1966, spent most of the next 15
years below that level, and never surpassed 1052 until November
1982, while the inflation rate was escalating dramatically during
these years. The only reason stocks have moved back toward their
7 percent average return is nothing less than the subsequent
bull market, the greatest in history. Wharton School Professor
Jeremy Siegel, author of Stocks for the Long Run (third ed.,
2002), notes that "the superior equity returns" of
the 1980s and 1990s “have barely compensated investors
for the dreadful stock returns realized in the preceding 15 years,
from 1966 through 1981, when the real rate of return was —0.4
percent. In fact, during the 15-year period that preceded the
current bull market [that ended in 2000], stock returns were
more below their historical average than they have been above
their average during the 1982-1999 great bull market run.”
Those who predict continued, higher long-term returns to stocks
as a reason for privatization have another problem to grapple
with. Can anyone believe that if future returns to Social Security
are adversely affected by slower economic growth, returns to
financial assets would not be? If the Social Security system
runs higher deficits because of the slower economic growth that
the Trustees' intermediate alternative assumes, it is illusory
to think that returns to stocks will fare any better. Stocks
have produced real returns of 7 percent per year over the past
century when the economy averaged 3.2 percent annual growth.
If the intermediate-range projections for GDP growth hold true,
the rate of return on capital will be less too. If the economy
grows at a faster rate, the stock market will rise at a healthy
pace--but Social Security will also have the funds it needs to
keep solvent throughout the retirement of the baby boom generation.
Privatizers assure us that we are now a nation of savvy investors.
But public opinion surveys consistently bring out what Securities
and Exchange Commission Chairman Arthur Levitt Jr. in 1998 called
a "knowledge gap.” More than half of all Americans
do not know the difference between a stock and a bond and only
16 percent say they have a clear understanding of what an Individual
Retirement Account is. A 2000 survey of households with incomes
from $25,000 to $75,000--then covering 48 percent of all households--showed
that only 20 percent felt confident about choosing appropriate
investments, 25 percent felt knowledgeable about mutual funds,
and 34 percent admitted they didn't know anything about funds.
Of those owning life insurance, 25 percent didn't know whether
they had term or cash-value insurance. A 2001 survey, taken in
the midst of the longest stock market decline since the 1930s,
found that only one person in five knew that there is no insurance
for stock market losses.
The September 1998 collapse of the Long Term Capital Management
hedge fund inflicted heavy losses on its investors, which included
some of the savviest of all--Merrill Lynch, Bear Stearns, PaineWebber,
Dresdner Bank AG, the Bank of Italy, Union Bank of Switzerland,
St. John's University (New York). On LTCM's payroll were 25 PhDs,
two of them Nobel Laureates for their pathbreaking work in financial
economics (Myron Scholes and Robert Merton). Widespread surprise,
and worry, followed the stock market slide of 2000-2002 as trillions
of dollars of household wealth vanished, with serious impact
on 401(k) retirement funds now tying millions of households to
the fickle fortunes of Wall Street. By October 2002 the composite
index for the NASDAQ, where the hot high-tech and dot.com stocks
were traded, had dropped 78 percent from its all-time high in
March 2000.
Americans might recall that Britain allowed workers to opt out
of the public pension system and invest in private accounts in
1988, in an arrangement similar to the privatization scheme promoted
in the United States. The new accounts proved costly to set up;
some charged 25 percent of the account value in commissions and
administrative fees. Even before the stock market crash of 2000,
there were widespread complaints about bad financial advice,
high fees, and outright deceptions--a public “mis-selling” scandal.
By 2005 the financial services industry was forced to shell out
$28 billion in restitution payments, the average public pension
had fallen to $150 per week, and many Britons were calling for
a return to system much like U.S. Social Security. In Chile a
military dictatorship privatized the public pension system in
1981 by having people pay 10 percent of their salaries to investment
accounts they controlled. From the start, fees and commissions
absorbed 20 percent of contributions; on retirement another fee
of 9 percent was charged to convert the account to an annuity.
Twenty years on the system was doing so poorly that the government
began asking some workers to delay their retirements. Even middle-class
workers who contributed regularly were finding that their private
accounts, hit with fees that had eaten away a third of their
original investment, were failing to deliver as much in benefits
as they would have received from the old system. Many Chileans
are now trying to create institutions to deal with this “pension
damage” (New York Times, January 27, 2005).
Social Security's "Bottom Line"
"Rate of return" calculations for Social Security
and projections of possible "bankruptcy" inappropriately
apply free market criteria to a nonmarket institution, in this
case the most successful one in our history. Comparing returns
on FICA contributions for one generation of Social Security beneficiaries
against another, or calculating "unfunded liabilities" that
the present generation will allegedly pass on to the next, is
irrelevant, unless it is assumed that succeeding generations
will live in an economy less productive, and poorer, than today's--an
unlikely prospect. Pooling resources so that everyone shares
the major risks of life is the essence of social insurance, allowing
people to make transfer payments to themselves at appropriate
stages of the life cycle. Social Security is part of this public-sector
process, which private enterprise cannot, nor should be expected
to, carry out.
The way to preserve the health of Social Security is jobs for
all at decent pay--the prime goal of national economic policy
advocated by the National Jobs for All Coalition. As the late
Robert Eisner put it, "to bolster Social Security, the best
way is to increase economic growth rates and increase the wages
that finance Social Security."
REFERENCES
Dean Baker and M. Weisbrot, Social Security: the Phony Crisis (Chicago: University of Chicago Press, 1999)
Board of Trustees, Federal Old-Age and Survivors Insurance and
Disability Trust Funds, The 2005 Annual Report
Peter Diamond and P. R. Orzag, Saving Social Security (Washington:
Brookings Institution, 2005).
R. B. Du Boff, "The Welfare State, Pensions, Privatization:
Social Security in the United States," International
Journal of Health Services, no. 1, 1997.
Robert Eisner, Social Security. More, Not Less (New York: The
Century Foundation Press, 1998)
John Mueller, "The Stock Market Won't Beat Social Security," Challenge,
March-April 1998.
_____________________________________________________
Editors:
June Zaccone, Economics (Emer.), Hofstra University and Helen
Lachs Ginsburg, Economics (Emer.), Brooklyn College, City
University of New York
The
National Jobs for All Coalition is a project of the Council
on International and Public Affairs. |
