The Coming Crisis.
Whatever America finally does about Social Security, its coming financial crisis will create one of the most dangerous and fateful political problems in our nation's history. Once seen as a sure source of security in old age, the federal government's program of Old-Age, Survivors, and Disability Insurance (OASDI), or Social Security, is now widely perceived as heading for bankruptcy. Many younger Americans have lost faith in Social Security and believe that it will be unable to pay them benefits when they retire.
A crisis is indeed coming, with serious consequences not only for Social Security but for the budget, the economy, and our politics. Given OASDI's importance in our national life, an understanding of that crisis and its causes is vital.
Social Security seeks to replace income loss from retirement, death, or disability by paying to retired workers, survivors of deceased workers, and disabled workers monthly benefits that are financed by taxes on the labor incomes of employees and the self-employed. Any surplus revenue above benefit and operating costs is used to purchase Treasury bonds, which are issued to Social Security's Treasury accounts, commonly known as the Old-Age, Survivors, and Disability Insurance Trust Fund. Interest on these bonds, and taxes on benefits, furnish additional income to Social Security.
Since 1983, Social Security has run surpluses and accumulated Treasury bonds in its "trust funds." In the next century, however, Social Security will run deficits, and its actuaries project that, under their "intermediate" or "most likely" actuarial assumptions, in 2034 the trust fund will be exhausted and Social Security will be unable to pay full benefits on time. Under their "high cost" assumptions--which some experts, such as former Social Security chief actuary Haeworth Robertson, believe are more accurate--"trust fund" exhaustion will occur sooner, in 2024.
The 'trust fund': a red herring
Many Americans believe that Congress has been robbing Social Security's "trust fund" to finance other spending and help cover federal budget deficits, and that this is the major cause of Social Security's future financial weakness. In July 1998, Carolyn Lukensmeyer, director of the Americans Discuss Social Security Project, testified before the Senate Special Committee on Aging about her findings from polling 17,000 Americans and discussing Social Security with 3,700 persons in 15 states.
"The government's borrowing of excess payroll contributions to pay for other programs, unrelated to Social Security, is the real focus of the public's concern," Lukensmeyer reported. Specifically, 79 percent of respondents identified government spending of Social Security's reserves on unrelated programs as one reason why Social Security might face financial trouble, and 45 percent said this is the main reason.
In fact, it is not. For one thing, Congress is doing nothing nefarious. Use of surplus Social Security revenues to purchase Treasury debt was explicitly required by the original Social Security Act of 1935. The only other alternatives are for Social Security either to hold idle cash balances or to invest in private securities, and these options were rejected in the thirties--quite understandably--as being, respectively, inane and socialistic.
Moreover, despite their name, the "trust funds" are Treasury accounts that do not receive or hold money. The Treasury collects Social Security taxes, which go into the Treasury's general fund, not into the "trust funds." Social Security benefits are paid by the Treasury out of its general fund, not from the "trust funds."
Given all this, accusing Congress of looting Social Security's nest egg is nonsense. As for this operation harming Social Security's prospects, mere conversion of surplus revenue into an equivalent value of Treasuries is not harming future finances, since the bonds serve as claims against the Treasury, which the federal government is obligated to honor.
No, raiding the "trust fund" is not causing Social Security's coming crisis. The problem lies elsewhere.
Demographics of doom
In 1946--1964, the American fertility rate (average number of children born to a woman over her lifetime) was high, 3.03 in 1950 and 3.61 in 1960, resulting in the huge baby boom generation. The baby boomers will start retiring in 2010, and Social Security's "intermediate" actuarial analysis projects that from 1995 to 2030, when the last boomers retire, the population aged 65 and over will nearly double, from 34.3 million to 68.4 million. The "high cost" assumptions project growth to 72 million, an increase of 110 percent.
Moreover, thanks to modern medicine and nutrition, Americans' life spans have greatly increased. In 1940, male life expectancy at birth was 61.4 years, and life expectancy at age 65 was 11.9 years. By 1995, these figures were 72.4 years and 15.3 years, respectively. Longevity is expected to keep improving; under Social Security's "intermediate" actuarial assumptions, a man turning 65 in 2010, when the baby boomers begin to retire, will have an average life expectancy of 16.3 more years. This means that these numerous retirees will enjoy unprecedentedly long retirements, so they will be collecting benefits for many years, increasing the pressure on Social Security's finances.
Unfortunately, demographic changes after the baby boom make it virtually certain that without major changes in the program, Social Security will be unable to bear the burden. After 1964, the fertility rate collapsed to 2.88, and in 1975 to just 1.77, well below the replacement rate (that needed to replace the existing population) of 2.1. Since 1988, it has been just above 2.0--better, but still below the replacement rate.
Those who will be paying the boomers' benefits, the generation born after 1965, will thus grow much more slowly than the beneficiary population: under "intermediate" assumptions, from 159.8 million in 1995 to 193.3 million in 2030, or just 21 percent; and under "high cost" assumptions, to 188.1 million, a mere 17.7 percent.
The burden of supporting each beneficiary will therefore be spread over fewer and fewer taxpayers. In 1945, 42 taxpayers paid into Social Security for each beneficiary taking money out. Today, 3.4 taxpayers support each beneficiary; under "intermediate" assumptions this ratio falls to 3.1 in 2010 and just 2.1 in 2030. Under "high cost" assumptions, the ratio is 2.9 in 2010 and 1.9 in 2030.
But with the number of taxpayers supporting each beneficiary declining, Social Security's projected tax revenues from tax rates set by current law will eventually be unable to cover projected benefit costs mandated under current law. As the boomers retire, therefore, Social Security's costs will begin exceeding revenues, and it will start running cash deficits, beginning in 2014 under "intermediate" assumptions, and in 2009 under "high cost" assumptions.
Income from interest on the bonds will help defray costs, but Social Security's "intermediate" actuarial analysis projects that in 2022 benefit costs will exceed not only the tax revenue but the interest income as well, and the "trust fund" will then have to start liquidating its Treasury bonds to cover the shortfall. Under the "high cost" assumptions, Social Security's bond liquidation will commence in 2016.
As more and more baby boomers retire, benefit outlays will increasingly outrun revenues, Social Security's cash deficits will soar, and the "trust funds" liquidation will accelerate until they are exhausted. At that point, Social Security will be unable to meet its obligations and will go bankrupt.
Thus, an aging population--not the lightfingered Congress of popular misunderstanding--is the true culprit in Social Security's coming crisis.
Economic and political consequences
Well before the actual "trust fund" exhaustion date, then, Social Security will be unable to pay its own way and will start running cash deficits. These cash deficits will be covered at first by interest payments by the Treasury on Social Security's bonds, then by interest payments plus money obtained by presenting some of those bonds to the Treasury for redemption. In other words, Social Security's cash deficits represent its claims on the Treasury.
These claims indicate how much money the Treasury will have to raise in those years to make good its obligations to Social Security. In 2025, for example, the Treasury will have to pay Social Security an estimated $420 billion under "intermediate" assumptions, or $764 billion under "high cost" assumptions.
From the time the cash deficits start until the "trust funds" run out, the Treasury will have to raise trillions of dollars. Where will it get all that money? Cutting other federal spending would free up money for this, but it is unrealistic to expect any Congress will make trillions of dollars' worth of spending cuts over about two decades. Raising taxes by such amounts will be equally unrealistic. Most or all of the money will most likely be raised by borrowing from the public.
But this necessarily means that as Social Security's "trust funds" drain, federal budget deficits will explode, by amounts roughly similar to Social Security's cash deficits. Meanwhile, the huge elderly population will also make heavy financial demands on Medicare and other retirement programs. Hence, annual federal budget deficits of $500 billion to $700 billion by 2025, and even larger ones later, are all but certain.
Such huge deficits would, of course, enormously increase spending for interest on the debt, which in turn would drive federal spending higher, creating still larger deficits, meaning still higher interest costs. The budget would thus be caught in a vicious circle.
Indeed, three interacting vicious circles would operate: for Social Security, the budget, and the economy. Financing mammoth deficits with domestic credit would necessarily cause what economists call "crowding out": The federal government would be using credit that would otherwise be available for private business and consumers. With the modern economy enormously credit-dependent, economic activity and employment suffer accordingly. The resulting stagnation would depress tax revenues, meaning deficits would grow from the revenue side as well as the spending side.
This, of course, would lower Social Security tax revenues along with all the rest, driving the program still deeper into the red, which in turn would worsen the burden on the budget. It would also increase federal borrowing, meaning still more crowding out and still higher interest outlays, swelling both budgets and deficits. Investment, employment, and productivity growth would decline accordingly, driving Social Security, the budget, and the economy still further on a downward spiral.
Thus, even before the "trust funds" are exhausted, Social Security's financial weakness will create simultaneous fiscal crisis and economic calamity. Since this is seldom grasped, it bears repeating: The true danger in the Social Security crisis is not the bankruptcy of Social Security itself but the wreckage of our public finance and our economy.
This outcome does not require Social Security's total bankruptcy. Mere substantial partial liquidation of the "trust fund" will suffice. Under "intermediate" assumptions, Social Security's assets will shrink from $4.46 trillion in 2022 to $2.37 trillion in 2030, meaning liquidation of $2.09 trillion in just eight years. So large an addition to publicly held national debt so quickly cannot fail to be disastrous.
The foregoing is based on what Social Security's own actuaries say is likely to happen if Social Security continues in its present form. Averting its collapse and associated budgetary and economic damage will require deep benefit cuts, massive Social Security tax increases, a mixture of both, or far-reaching revision of the program's basic nature.
All of these alternatives carry serious political risks. Since about 96 percent of the labor force now participates in Social Security, the program's fate affects virtually everybody. The political stakes, in other words, are enormous. If nothing is done, Social Security's collapse will strain, perhaps destroy, Americans' faith in their government.
A large increase in Social Security taxes risks alienating the young taxpayers; deep benefit cuts risk enraging the formidable elderly lobby; a mix of large tax increases and benefit cuts will likely be unpopular with both groups, particularly if enacted in a crisis atmosphere after congressional procrastination. Means testing, "privatization," or other major revision of Social Security will drastically alter the allocation of advantages and disadvantages between the generations and hence carry political risks of its own.
John Attarian is a freelance writer in Ann Arbor, Michigan. Under a grant from the Earhart Foundation, he has completed a book on Social Security, from which this article is adapted.