Making Social Security Strong and Adequate for the 21st Century
The National Committee to Preserve Social Security and Medicare recently held an event on “Commissions, Cuts and Crisis Calls”. This is the third part; check out the first part here and the second part here.
VIRGINIA RENO: Good morning everyone. It’s great to see an overflowing room to be talking about Social Security. My focus today, I think the problem going third is that sometimes what you have to say has been said before but there’s also value in saying it similar things in a different way. My focus is on 3 aspects of Social Security; its finances, its affordability and its adequacy.
I’m with the National Academy of Social Insurance and our mission is to promote understanding of how social insurance contributes to both economic security and a vibrant economy.
The first thing that’s important to recognize about Social Security and its finances is unlike almost every other Federal program, the short term in Social Security is 10 years; in most other programs that’s the long term but here Social Security’s short term is 10 years. Its long term is 75 years and there is created an expectation that for the system to be in balance it should be a balance both for 10 years and for 75 years; that’s a big task.
Next important thing about Social Security is who pays for it. And it’s important to recognize this is not, it’s easier to think about this as in terms of “people pay, people receive”. It’s not just a government program. Workers and employers pay and they pay equal amounts; 6.2% of earnings up to a tax cap which is this year $106,800. That was the lion share of revenue for Social Security last year; 83% of the money coming in. Another set of payers are upper income beneficiaries who pay income taxes on their Social Security benefit income and part of that money also goes to Social Security; last year it was 3% of revenue. The other important source of revenue is interest on the reserves; the Social Security surpluses that are invested in Treasury securities. That interest income was 14% last year, a non-trivial addition to Social Security income.
In terms of finances, Social Security is now running a surplus and it has been running a surplus on an annual basis for about 20 years. Last year it was projected it was projected in the trustee’s report to have an income of about 820 billion dollars; it’s a big program. The outgo was 623 billion leaving a surplus of 186 billion, and that surplus then, as mentioned, is invested in Treasury securities; it’s available to pay future benefits and it earns interest.
Taking the 75 year outlook for Social Security, and the trustees offer 3 different scenarios for the outlook. This one is their so-called best estimate or middle scenario; Social Security surplus is expected to continue through 2026, from 2009 to 2026; about 27 more years. That is, revenue plus interest on the reserves will exceed what is paid out; the reserves will accumulate to about 5.5 trillion dollars. Again this used to be unfathomable numbers until we had a meltdown, but they’re big numbers because it’s a big program and it serves a lot of people.
After 2026 the reserves will gradually be drawn down to help pay for benefits, because the money coming in plus the interest is not quite enough to continue to pay benefits. By 2041 the reserves will be depleted, then new money coming in would cover only 78% of the cost, according to this best estimate scenario. And under the law, benefits cannot be paid beyond that amount. If nothing happens there would be a ratchet down in benefit payments. But of course a lot can happen between now and then, including a change in the forecast and including action by policy makers to either fix the revenue or reduce the benefit obligations.
Also important to know that this shortfall could happen sooner and it could happen never. Under the trustees’ high cost scenario, reserves will be depleted 10 years earlier in 2031. Under their low cost scenario, the system is adequately financed for 75 years and beyond. This is ultimately an acknowledgment of the sheer unpredictability of the future, but this range of estimates gives us a sense of probabilities about how quickly we need to act and the magnitude of the action that’s needed.
Shifting from finances to the question of affordability; will we be able to afford Social Security when boomers retire? And Henry has alluded to this, as did Mrs. Kennelly. But as boomers retire, there will be a significant growth in the share of the population who are 65 and older; projected to rise from about 13% today to about 20% by 2030.
But how much does that raise the cost of Social Security? Well, the best way to think about that, and this has been mentioned before, is Social Security total benefit payments as a share of the entire economy or gross domestic product, that’s GDP. Today benefits are about 4.3% of the economy, and that is projected to rise to about 6.1% by 2035. That’s a 1.8 percentage point increase in the share of the economy for Social Security. Then according to the best estimate scenario, the system will decline slightly as a share of GDP back to 5.8%, but that increase is 1.8% of the total economy. Is that a big deal? Well, if history is a guide, the answer is probably no. We can afford it. Certainly the increase in spending for national security in just the last 7 years, 2001 through 2008, was 2.0%; that’s just 7 years, not 25 years.
Another way to think about affordability when we’re talking about the baby boom is, how did things change when they were children? Back in the 1950s, ’60s and ’70s, there was unprecedented demand to increase spending for public education. These baby boomers showed up kind of by surprise at kindergarten saying “Okay where’s my teacher?” Towns, counties, states and the Federal government had to respond quickly, and they did, and spending for public education grew by a total of 2.8 percentage points between 1950 and 1975, that 25 year period when boomers were showing up needing to be educated. Well the fact that there, that was a surprise, that kind of took the country by surprise, this baby boom. But it is not a surprise that these boomers are growing older and the boomers are fully reflected in the long range forecast of Social Security, and have been for a long time.
Shifting from this affordability, to do we need to worry about the adequacy of Social Security, and as Barbara pointed out and as others have said, we haven’t heard much about adequacy of Social Security lately. We hear about the need for entitlement reform, we hear about the need to reign in spending, but it’s also important to think about what is the point of this program. What is its purpose, and is it achieving that purpose of delivering basic adequacy of income to seniors and to families?
Reasons why we might want to think about this are, because Social Security is such an important part of income of elders, the benefits, as others have said are relatively modest, replacement rates are declining, it will be less adequate relative to prior standards of living in the future than it has been in the past, and other sources of income for seniors and families are less secure. We’ll go over each of those briefly.
First as Mrs. Kennelly pointed out the average benefit for a retired worker is about $13,000 a year, that was just last month. While that’s an important amount of income, it’s far from a comfortable level of living, and it’s also important to know that Social Security is a key part of income not just for low income seniors but up through the middle and the upper middle of the income distribution. The next slide has more details on this.
This is showing Social Security has a percent of seniors’ total income when seniors are divided into 5 equal groups based on their income. For the lowest income group, and this is couples and unmarried individuals together, the lowest income group, their income is less than $12,000 a year; Social Security is 82% of the total. For the next lowest income group their income goes up to almost $19,000 a year; Social Security is still almost as large a share: 79% of their total income. You get to the middle income group that is those with incomes between roughly $19,000 and $29,000 a year; Social Security is 2/3 of that. You get to the upper middle income group with incomes between $29,000 and $50,000, Social Security is still the largest simple source of income, it’s nearly half, 45%. Only when we get to the top income group, with incomes over $50,000 dollars a year, is Social Security not the main source, and it’s important to know why it’s not the main source. Most people in this top income group are still working, they’re not retired yet and earnings from work are their largest single source of income. So to the extent, when and if they do retire, their income will be probably at a different level, at a lower level than it currently is.
Moving on, other reasons we talked about the need to focus on adequacy is that as Henry pointed out, replacement rates are modest; they’re modest by international standards and they’re modest in terms of thinking in terms of how retirement advisers talk about retirement income adequacy. Today, a 65 year old receives about 39% of prior earnings after taking out Medicare premiums; that’s for an average earner. But under current law, that will decline to about 32% for those retiring at 2030. And that happens for the two reasons that Henry Aaron talked about; that replacement rates will go down as because the age for receiving full benefits is rising, and because Medicare premiums are taking out a bigger bite of Social Security Benefits. So benefits are relatively modest today, but comparing ourselves to where we’ve been over the last 25 years, replacement rates will not be that good in the future.
Okay, the next reason why it’s important to think about adequacy, and this is not about Social Security, it’s about everything else. All the other sources that people can count on in retirement are taking a hit in the financial crisis. The value of people’s own homes are at risk, 401k plans are declining in value, and employers have often taken a holiday from putting money into 401k plans because the employers themselves are at risk, pensions are being frozen by employers or terminated, savings accounts are subject to the same uncertainty as 401k plans, and jobs, that chance of having a retirement job is also much riskier in today’s economic environment. So in this climate of uncertainty, only Social Security has been able to hold its value for seniors. So that poses the question for us of just how much, how big should this foundational piece of retirement security be.
In terms of how we might improve adequacy, I’m talking about options here that have been suggested. These are not firm recommendations, and we don’t have cost estimates for them here but they’re ideas that have come up in various venues including a recent project of the National Academy of Social Insurance where we were asked to invite scholars to come up with suggestions for improving Social Security for vulnerable groups. One of those was to create a special minimum benefit that guarantees a meaningful standard of adequacy for people who have long work records under Social Security, say 30 years or more.
Another innovative proposal is to improve benefits for widowed spouses of low earning dual earner couples. Social Security now does a pretty good job of easing the transition from couple to widowhood for couples in which one was a primary earner and one was a secondary earner. But for couples in which both were almost equal earning earners, the benefits are not as adequate for the survivor, but there are ways to improve that if we wanted to do so. A third kind of change that people have talked about was very kind of simple, but simply ratchet up benefits after a certain age, say 85, because people beyond a certain age, these other sources of income are much less secure. Savings may have been depleted or spent on a spouse’s final illness, pensions for those lucky enough to have them, rarely keep up with inflation, so they decline in value over time, earnings from work are much less likely to be an option at the age of 85, and even Social Security will have that bigger bite from Medicare taken out each year as those premiums go up faster than Social Security benefits. So one suggestion that people have made is simply ratchet up benefits, a pay increase for people over 85.
A fourth idea that people have suggested, and this really draws on the intergenerational nature of Social Security, is to continue benefits for children of disabled or deceased workers if that child is attending school, either college or vocational school, to continue those benefits up to the age of 22. Social Security used to pay benefits to the children up through age 22 in those circumstances, and as one looks today at the cost of higher education, and the prospects for young families to support their children in higher education, without the income of a parent because of death or disability. I think the cases had, it’s time to revisit that question, is that something that a role we want Social Security to again resume?
Turning now to how might we pay for what we want, and I recognize that people in Washington don’t like to pay, talk about paying for what we want, because it’s about taxes. But after all the business of Washington is to tax and to spend, and the business of Social Security is to remain fiscally responsible by both taxing and spending. So, I think it’s useful to at least think about some ideas for how one could pay for both the benefits that are promised under current law, and any improvement that policy makers want to seriously consider. First, it’s important to recognize Social Security does not need more money now, but policy makers could plan now for what’s needed later.
Among options to improve or to raise revenue are first to keep the estate tax, preserve it and devote it to Social Security. Bob Ball, whom I think Mrs. Kennelly mentioned, has recommended that idea. It was also discussed by a pair of economists, Peter Orszag and Peter Diamond, in a book they wrote on Social Security a few years ago. And if one can develop a clear rationale for using that tax for that purpose. Another proposal is to gradually restore the tax cap, that $106,800 below which people pay Social Security taxes, to cover 90% of aggregate wages. That would cover about a third of the shortfall if it were done very, very gradually. If it were done more quickly, it will cover about half of the shortfall.
A third idea that has been bounced around is a legacy tax, that is a smaller tax on earnings or income above some high threshold with the idea that those who had benefited so richly from the economy and the society could help cover some of the common good cost of the system, like Social Security. And the fourth idea is to schedule Social Security tax rate increases; that is the FICA rate. But do it off in the future. The rate doesn’t need to be higher now. But raising that rate, say from 6.8% to 7% in 2021 to 7.8% in 2051, that’s 12 years from now and, what, 42 years from now. That will eliminate all of the shortfall, and I use that because it’s been costed up by the Social Security actuaries. Now, I think there’s a sense that, nobody wants to pay higher Social Security payroll tax rates, but economists have also looked at the long range projections and say “Well, under the projections, wages of workers are projected to grow in real terms. They will grow faster than the cost of living.” So, workers in theory at least, could share part of that increase in their standard of living to make sure that elders keep up. Again, none of these are easy, but it’s important to at least get them on the table, and to have people think about it rather than shy away from, what do we want in terms of adequacy and how might we pay for it if we want greater adequacy.
To wrap up, we’ve talked about finances, we’ve talked about affordability, and we’ve talked about adequacy. I think one of the important features of Social Security, it is designed to be fiscally responsible, and is remarkably so, and it is transparently a tax and a benefit. It’s very efficient if we want to guarantee economic security, this is by far the most efficient way of doing it. It spends less than 1% on administration, and no other system of pension or savings is that efficient, and it holds its value during meltdowns. So, many options are available to make the system strong and adequate for families and seniors in the 21st century. It’s really just a matter of choices. Thank you.
Comments
Leave a Reply
Settle Tax Debt Fast!
Get Foreclosure Help
