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In the Crosshairs

Sense about Social Security

“The financial health of Medicare and Social Security is deteriorating faster than expected,” so says the Financial Times, my own favorite paper of record, reporting on the newly issued annual Trustees Report. But is it true, and even if it is, what is the underlying cause?

Three sets of numbers, buried deep in Appendix F, are key to putting the rest of the report in perspective.

Everyone knows that slowdown in population growth plus increased longevity is posing a big demographic challenge to retirement security—the ratio of the old (65 and over) to the working age (20-64) is projected to double from 2011 to 2085 (Table V.A2, p. 88).

So is quite astonishing to find that the fraction of GDP paid out in OASDI benefits is projected to rise only from 4.85% in 2011 to 6.01% in 2085 (Table VI.F4, p. 187), nowhere near double. (This is the first key set of numbers.)

Even so the financial health of the program is in jeopardy, and the reason is that the fraction of GDP being paid into the OASDI program from all sources is projected to rise only from 4.55% in 2011 to 4.55% in 2085 (same table, same page), which is to say not at all!

In plain words, Social Security is not being asked to shoulder very much of the burden of the demographic challenge ahead of us, and it is not being allocated the resources to do even that much.

The biggest cause of the problem is a deterioration in the tax base that supports the program, a deterioration that has been substantial over the last decades and is projected to continue on into the future. One reason is rising inequality, which means that an increasing share of wage income is paid to workers earning more than the taxable earnings cap ($106,800 in 2010). The other reason is the rising cost of health care which means that more and more of total compensation is in a form not reached by the Social Security tax.

We tend to think of the tax as very broad based, since everyone pays it, but really it isn’t. In 2011, taxable payroll is only 36.3% of GDP, and that fraction is projected to decrease to 34.2% by 2085 (Table VI.F5, p. 189). We are trying to support a rising burden on a shrinking tax base—that is the fundamental problem.

Further, we tend to think of the Trustee’s Report for Social Security as analogous to the reports required under the 1974 ERISA legislation for private pensions, but really it isn’t. The main asset of Social Security is the present value of its current claim to 10.6% of the taxable wage bill, an asset that has no observable market price that can be compared to the present value of accrued benefits. It follows that what the Report calls the “unfunded balance” is not really the same thing as a private unfunded pension liability.

Once upon a time, I thought it might be possible to talk sense about Social Security by explaining how it is a kind of Social Mutual Fund, a mechanism for making claims on future wages available to fund retirement in much the same way that regular mutual funds make claims on future profits available to fund retirement. That way of thinking would, I thought, make clear how fantastical were proposals to “privatize” Social Security, for the simple reason that they would place the entire demographic burden on one set of claims, rather than spreading it more widely.

The larger point is that Social Security is only one of the mechanisms that currently channel income to the elderly.

The larger retirement system includes also private pensions, individual savings, and home ownership. These three parts of the U.S. retirement system appear to be of approximately equal importance in the aggregate, though Social Security is relatively more important to lower income groups, and private pensions and saving are more important to higher income groups. (About 80% of households over 65 own their own homes.)

The point to emphasize is that the projected aging of the population is putting pressure on all the mechanisms through which non-workers gain access to current income, not just Social Security. The economic (and political) question is how that pressure should be spread among the various component parts of the retirement system.

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