Crash course: Social Security is crashing faster than you think.

POLITICIANS of both parties are finally fretting about the danger from soaring entitlement spending. Yet Congress and the Clinton Administration show no willingness to face, let alone act to avert, the coming ruin of the biggest entitlement of all. Without radical reform, Social Security threatens to cause a general fiscal crisis.

Such a warning may seem odd, given the fact that the program has run surpluses every year since the 1983 Social Security tax increases, accumulating large "trust funds" that can be tapped to pay future retirement benefits. As mandated by law, these surpluses are invested in interest-bearing U.S. government debt. As of fiscal 1993, the Old Age and Sickness Insurance (OASI) trust fund had assets of $355.6 billion, and the Disability Insurance (DI) trust fund had $10.3 billion. Hospitalization Insurance (HI), or Medicare A, had a trust-fund balance of $126.1 billion. It would seem that candidate Bill Clinton was right in 1992 when he said of Social Security, "It's solid. It's secure. It's sound."

Yet it's none of these. Social Security can meet today's obligations, but the program is doomed thanks to demographics. When the huge Baby Boom generation was born, fertility rates (number of births per woman) were unusually high. They have fallen steadily since. Thus, when the Baby Boomers begin retiring in about 2010, the beneficiary population will start growing faster than the number of workers paying Social Security taxes. Under conditions that Social Security's Board of Trustees deems most probable, the beneficiary population will increase from 42.7 million in 1994 to 80.3 million in 2030 (up 88.1 per cent), while the worker population will go from 137.2 million to 162.8 million (18.7 per cent). Under more-pessimistic assumptions, beneficiaries will double, from 42.7 million to 85.2 million, while taxpaying workers will rise from 136.9 million to 151.2 million (10.4 per cent).

Put another way, 3.2 workers now support each beneficiary (down from 5.1 in 1960 and 4 in 1965). By 2030, the ratio will be only 2 to 1. Medicare is in the same pickle. The Hospital Insurance worker-beneficiary ratio, now 4 to 1, will be only 2 to 1 by 2050. Social Security and Medicare costs will therefore begin exceeding revenues, and the trust funds will have to be drained to make up the difference. When the trust funds are exhausted, Social Security will be bankrupt.

Moreover, this crisis is approaching faster than most people realize. The annual report of Social Security's Board of Trustees presents an actuarial analysis of the trust funds' performance during the next 75 years under "optimistic," "intermediate" ("most likely"), and "pessimistic" economic and demographic assumptions. The report includes the projected dates by which the trust funds will be exhausted based on those assumptions. Examination of the projected exhaustion dates from the 1990--1994 reports is grimly revealing (see Table 1).

TABLE I: SOCIAL SECURITY'S WORSENING PROSPECTS

Year of   Projected Year of Trust Fund Exhaustion
Report       OASI      DI    OASDI     HI       Assumptions
 1990         (*)      (*)     (*)    2018        Optimistic
             2046     2020    2043    2003      Intermediate
             2027     1998    2023    1999       Pessimistic
 1991         (*)      (*)     (*)    2018        Optimistic
             2045     2015    2041    2005      Intermediate
             2026     1995    2019    2001       Pessimistic
 1992         (*)     2060     (*)    2009        Optimistic
             2042     1997    2036    2002      Intermediate
             2026     1995    2019    2001       Pessimistic
 1993         (*)     1995     (*)    2000        Optimistic
             2044     1995    2036    1999      Intermediate
             2025     1995    2017    1998       Pessimistic
 1994         (*)     1995     (*)    2004        Optimistic
             2036     1995    2029    2001      Intermediate
             2023     1995    2014    2000       Pessimistic

(*)Trust fund not projected to be exhausted within report's 75-years projection period.

Source: Social Security Administration, Office of the Actuary 

As we go forward in time, the projected trust-fund exhaustion dates are creeping back toward us. In 1990, exhaustion of the OASDI (combined OASI and DI) fund under pessimistic assumptions was 33 years away (2023); under intermediate assumptions, it was 53 years off (2043). But OASDI is now projected under pessimistic assumptions to go broke in only twenty years (2014), and under intermediate assumptions in just 35 years (2029)--a grave deterioration in Social Security's outlook in just four years.

This substantial "creepback" in trust-fund exhaustion dates indicates that Social Security's future is worsening rapidly and that we are running out of time to cope with it. If the creepback continues, the Social Security crisis might hit some time in the next decade. As for Medicare, under all sets of assumptions (no matter how they slice it, in other words), the trustees conclude that "the trust fund is projected to become exhausted even before the major demographic shift begins to occur."

Another indicator of Social Security's growing weakness is the appalling rise in its actuarial deficit, the amount by which future outlays exceed revenue and the value of the trust funds during the next 75 years. In 1990 the combined deficit was projected to be $5.8 trillion under intermediate assumptions. That figure rose to $10.2 trillion in 1993 and $10.4 trillion this year. Significantly, about half the deterioration in Social Security's actuarial position in the last three years has been due to improvements in methods of projecting costs and income. That is, the more accurate a view of its future the actuaries achieve, the worse that future looks.

A. Haeworth Robertson, Social Security's chief actuary from 1975 to 1978, warned us about these actuarial deficits in 1992. "Only the foolhardy would continue to ignore the longer range financial problems projected for the Social Security program," he wrote in Social Security: What Every Taxpayer Should Know, published by the Retirement Policy Institute. "It is not a question of whether future costs will be higher; it is a question of whether they will be so much higher as to be unaffordable. It is a question of whether we are making promises we will not be able to keep."

The Case for Pessimism

ALTHOUGH discussion of Social Security typically uses the intermediate assumptions, there are compelling grounds for using the pessimistic ones instead. Robertson has argued convincingly that the pessimistic assumptions for productivity, fertility, and mortality rates--the variables that "have the greatest impact on long-range projections of future income and outgo"--are more realistic.

Social Security's long-run cost as a share of payroll varies inversely with the fertility rate; the more workers supporting retirees, the lighter each worker's burden and the sounder the program. Surveying the long decline in fertility rates here and throughout the developed world, and their current very low levels (1.6 in Western Europe, 1.8 in Northern Europe, and 1.9 in the U.S. in 1988), Robertson concluded that the 1990 report's intermediate assumption of 1.9 (the same as in the 1994 report) seemed optimistic and that the pessimistic assumption of a future fertility rate of 1.6 births per woman (used in both 1990 and 1994) "is probably quite appropriate to use as an intermediate assumption, and it could even be optimistic."

Brisk productivity growth increases Social Security's tax base faster than outlays by causing wage increases to outstrip benefit cost-of-living adjustments. By the same token, stagnant productivity impairs Social Security's ability to pay its way. The 1990 report assumed future long-term average annual productivity increases of 2.2 per cent (optimistic), 1.7 per cent ("most likely"), and 1.4 per cent (pessimistic). Robertson pointed out that the annual increase for 1968--1988 averaged only about 1.1 per cent; he concluded that the "pessimistic" 1.4 per cent was a suitable intermediate figure, and perhaps even optimistic.

Declining mortality rates mean longer life spans, hence higher Social Security costs. American death rates adjusted for age and sex have fallen steadily with improvements in health care, living standards, diet, and exercise. Death rates fell by an average of 1.2 per cent a year between 1900 and 1991 and by 1.4 per cent a year from 1968 to 1991. Given this trend, the 1994 report's intermediate assumption of a 0.6 per cent average annual decline in the death rate between 1991 and 2068 looks too optimistic, as does even the pessimistic assumption of 1 per cent.

Overall, Robertson argued, the focus on intermediate assumptions imparts an optimistic bias to people's thinking about Social Security. In deciding which set of assumptions to use, the real test is which set most accurately portrays the most likely future and thus best enables Social Security to honor its promises. By that standard, he said, the pessimistic assumptions are "the most appropriate ... and even they may be somewhat optimistic."

In effect conceding that Robertson is right, the Social Security trustees' 1994 report revised some intermediate assumptions toward pessimism. The fertility rate was reduced slightly for the first 15 years, reflecting lower-than-expected birth rates in 1992. Male mortality rates were trimmed to reflect mortality rates in 1992 and 1993, which were below expectations. (These changes were offset by adjusting the projected future beneficiaries for the influx of illegal aliens, presumably less likely to get benefits than legal residents.) Some economic assumptions were also adjusted, which slightly worsened the actuarial deficit; e.g., labor-force participation rates were lowered to reflect increases in the number of workers expected to receive disability benefits. And the new future productivity growth estimates are 1.7 per cent (optimistic), 1.4 per cent (intermediate), and 1.1 per cent (pessimistic)--vindicating Robertson's position.

Furthermore, only the pessimistic projection is realistic enough to assume recessions during the next ten years: in 1995 (real GNP projected to fall by 0.5 per cent) and 1998 (real GNP down 1.7 per cent). This squares well with historical experience: recessions in 1975, 1980, 1982, and 1991.

Finally, the creepback of OASDI trust-fund exhaustion dates even under intermediate assumptions--from 2043 in 1990 to 2036 in 1992 and 2029 in 1994--indicates that pessimism is justified.

Busting the Budget

WHEN a Social Security trust fund's revenues can't meet outlays, it cashes in some of its Treasury bonds. The drain of the Disability Insurance fund began in 1992. If the pessimistic assumptions come true, the OASI fund will start redeeming its bonds in 2002. Even under the intermediate assumptions, Medicare's Hospital Insurance trust fund will start running down in 1996. To get the money for the bonds, the Treasury will have to cut other spending, raise taxes, or borrow from the public. Given Congress's record on spending reduction and the public's dislike of tax increases, the last option, meaning higher budget deficits, is the likeliest.

The commonly used deficit figures combine the onbudget deficit and the Social Security surplus. When Social Security's surpluses become deficits, budget deficits widen accordingly. If the Treasury pays off the bonds entirely by new borrowing, the resulting addition to the deficit will be catastrophic: $70 billion just five years from now, rising to $130 billion in 2002 and $180 billion in 2004. Adjusted for the three-month difference between calendar and fiscal years, this yields total deficits of $296 billion in 1999, $443 billion in 2002, and $571 billion in 2004.

These projections assume that after HI goes bankrupt, it will be authorized to borrow from OASDI to keep afloat, which will drain OASDI's fund, and increase the deficits that much more. If this occurs, the merged trust funds are projected to run out in 2015 under intermediate assumptions and in 2005 under pessimistic ones. Precedent amply justifies this assumption: the dwindling OASDI fund borrowed from HI before the 1983 "rescue," and Congress authorized borrowing among the OASI, DI, and HI trust funds through 1987.

Thus, even before the trust funds are exhausted--that is, in 10 to 15 years--Social Security's weakness will create simultaneous fiscal crisis and economic calamity. Financing such mammoth deficits out of domestic credit would inflict credit starvation on the private sector. Overseas creditors would refuse to keep lending to a government so manifestly incapable of paying its way and honoring its obligations. If Americans spurn severe spending reductions or piratical tax increases (and they have so far), the only option left would be banana-republic finance: debt monetization, risking hyperinflation.

To avoid further woe after the trust funds go broke, Social Security will have to cut benefits deeply, raise taxes substantially, or both. Paying all benefits promised under current law will require huge tax increases to close the gap between revenues and expenditures (see Table 2). One need not be a supply-sider to predict what such taxes will do to incentives, employment, and economic activity. Even rates considerably lower--say, 20 per cent in 2015 and 30 per cent in 2035--would be crippling. And so burdened, an economy could hardly carry the enormous debt from liquidating the trust funds.

TABLE 2: TAX RATES NEEDED TO PAY SOCIAL SECURITY AND MEDICARE BENEFITS

AFTER TRUST FUND EXHAUSTION, PESSIMISTIC ASSUMPTIONS (as percentage of taxable payroll)

Calendar   OASDHI Cost Rate   Minus Benefit Tax   Equals Required
  Year       (pessimistic)          Rate             Tax Rate
  2015           23.64              .53               23.11
  2020           27.62              .65               26.97
  2025           32.00              .78               31.22
  2030           35.99              .88               35.11
  2035           38.93              .97               37.96
  2040           40.70             1.02               39.68
  2045           41.98             1.07               40.91
  2050           43.39             1.14               42.25
  2055           45.15             1.22               43.93
  2060          47.13              1.30               45.83
  2065           49.01             1.37               47.64
  2070           50.77             1.43               49.34

Source: 1994 OASDI Annual Report

In short, if we continue as we are, there will be unshirted hell to pay--sooner rather than later. To avert this, mere tinkering--e.g., higher benefit taxation or increasing the retirement age--simply won't do.

Taxing benefits gave OASDI only a pitiful $6.2 billion in fiscal 1993. Under the 1993 deficit-reduction law, beginning this year, up to 85 per cent of OASDI benefits for single retirees with incomes above $34,000 and for married couples with incomes above $44,000 are taxable. Revenue from taxes on the first 50 per cent of benefits goes to OASDI (the rest is shunted to Medicare). People below those thresholds will continue to have 50 per cent of their benefits taxed. This taxation is projected to raise only $10.8 billion in fiscal 2003. And this level of benefit taxation is already factored into the deficit and payroll-tax projections described above. Even with a huge future retiree population, squeezing this turnip harder is unlikely to extract sufficient blood.

Deficit foe Peter Peterson calls for raising the Social Security retirement age beginning in 1995, to 68 by 2006. This change, he calculates, will save $16 billion in 2000 and $36 billion in 2004. But with the drainage of the trust funds adding $86 billion to the deficit in 2000 and $180 billion in 2004, this measure isn't remotely adequate. And the retirement age can go only so high.

We have made two payroll-tax-based rescues already, in 1977 and 1983. To be adequate to save Social Security, a third such rescue would, as we saw, cripple our economy.

Nor is financing out of general revenue an answer. Payroll taxes and general revenue both ultimately come from individual incomes. General-revenue financing would entail a tax increase of the same magnitude as the payroll-tax hikes. Based on the pessimistic assumptions, liquidating the trust funds' actuarial deficit would require extracting an additional $23.2 trillion from the private sector (assuming no benefit cuts), and this will be devastating, either way.

Means testing sounds attractive, but it's problematic. It would have to be extremely rigorous, denying all or most benefits to perhaps even the lower middle class; otherwise, retiring Baby Boomers could still swamp Social Security by sheer numbers. The more rigorous a means test would be, the more unpopular it would be, and hence the more unlikely to be enacted. Also, as Robertson warned, means testing would encourage concealment of other income. "Such a government-induced change in citizen behavior would be extremely damaging to the character of our nation," he wrote. And it is cynical and perfidious to force people to pay all their lives into an unsound system, string them along (as the government does even now) with mendacious assurances that "Social Security will be there when you need it," and then stiff them with a means test.

Radical Reform

THE BEST solution is the most radical: to abandon the idea that "social insurance" is a proper government function and privatize Social Security and Medicare, as policy analysts such as Robert Genetski and Peter Ferrara have proposed. Genetski suggests following Chile's example of letting workers opt out of their social-security program and put at least 10 per cent of retirement income into private investment accounts. Ferrara proposes guaranteeing benefits to today's elderly while giving workers the option of gradually replacing Social Security with "super IRAs" that could be used to purchase life, disability, and retirement health insurance. As he observed in the November 1993 issue of The Freeman, "Social Security's financial problems ... can ultimately be solved only by shifting to a fully funded system of private savings and investment."

It's time to think the unthinkable and do the undoable. The other answers are no answers. And inaction means we will soon have no good options left.

Outrage over radical reform is predictable, but it has no moral or empirical basis. Most "thinking" about Social Security is a tissue of myths such as:

1) Social Security is a retirement insurance program. It's a redistribution from taxpayers to beneficiaries; the insurance terminology--"beneficiary," "insurance," "trust fund," "contributions," etc.--is misleading.

2) You just get back what you paid in. Your taxes went to previous retirees; in any case, beneficiaries get many times what they paid.

3) Social Security is a contract between generations. No such contract exists.

4) I have an earned right to my benefits; that money belongs to me. In the 1960 case Flemming v. Nestor, the U.S. Supreme Court ruled that paying into Social Security confers no property rights to benefits.

5) Social Security has a big surplus, so it's sound. Not so, as we have seen.

6) We had a surplus, but the politicians stole it. There never was any money in the "trust funds," only government debt, by design. And my generation (I will be 67 in 2023, when OASI is projected to go broke under pessimistic assumptions) has no moral right to put such crushing burdens on the young coming up behind us.

So far, politicians of both parties have turned blind eyes to this onrushing menace. They have ignored repeated warnings from Social Security's trustees. Beginning in 1985 (nine years ago), the trustees' annual reports have voiced concern that the rapid increase in disability beneficiaries could exhaust the Disability Insurance trust fund. The trustees have repeatedly asked Congress to reallocate tax rates between the OASI and DI trust funds to divert money to Disability Insurance. Their 1994 report noted that "it is even more urgent now that such action be taken." Similarly, Medicare's trustees have repeatedly described HI as "severely out of financial balance" and stressed that "prompt, effective, and decisive action is necessary."

Yet our politicians refuse to act. In his 1992 State of the Union address, George Bush said, "I will not tamper with Social Security." He repeatedly exempted the program from proposed entitlement caps. Last year Jack Kemp, the former HUD secretary and aspiring GOP presidential candidate, proposed limiting entitlement growth to beneficiary-population growth plus inflation. But he, too, exempted Social Security. Candidate Clinton promised that "we're not going to fool with Social Security." Characteristically, he fibbed, but his benefit tax hike is, as we saw, more pesky than helpful. Representative John Kasich (R., Ohio), author of the House Republican alternative to Clinton's deficit plan, wrote later that "Social Security was off limits. Republicans believe that Social Security represents a fundamental agreement between the Federal Government and the American people--an agreement that must be preserved.... Republicans would achieve their deficit reduction without cutting benefits that American senior citizens have come to consider a sacred trust."

This bi-partisan fatuity perpetuates dangerous myths and fosters a climate of opinion that makes necessary action all but impossible. Our feckless politicians are fiscal Micawbers, assuming that something will turn up. I wouldn't bet my future on it. But unless we start getting the leadership we pay for, we haven't much choice.