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Social Security: The Coming Crash

Social Security’s troubles are fundamental. Its financial problems are not minor and temporary, as most politicians, at least in election years, feel compelled to insist. Unless the system is reorganized, these problems will become overwhelming. To put the matter bluntly, Social Security is heading for a crash. We cannot permit this to happen, because it would put the nation itself in very serious jeopardy. Though in effect for only two generations, Social Security has become the defining link between citizen and state in modern America. It has such uniform and reverential support that if the system crashes, so almost certainly will civic harmony and the economy itself. The prospects for Social Security and for general prosperity are now inseparable.

The Social Security system has become a high-risk gamble on economic progress and population growth—a bet by today’s workers that their children and grandchildren will be rich and numerous enough to foot the bill for another round of generous retirement benefits. Should this hope go even mildly awry, today’s workers will retire into a Social Security system running deficits larger than the total benefits it pays out today.

Meanwhile the system—which spent over $190 billion in fiscal 1982—has already grown so colossal as to shape the entire future of the economy. Social Security spending has moved from 1 percent of the entire federal budget in 1950 to 26 percent today. By far the biggest government social program in world history, the system now spends each year more than the combined net investment in plant, equipment, research, and development of all the private companies in the United States.

During the past few years, we have witnessed a revolt against both the burden of rising federal taxes and the binge of spending which has made those taxes necessary. In many ways, Social Security is the prime mover of both. A little-known, but important, fact is that between 1955 and 1980 Social Security taxes more than accounted for the increase in federal revenues as a percent of GNP. The growth in Social Security outlays is responsible for almost all of the increase in federal outlays as a percent of GNP. Thus, were it not for the growth of Social Security, federal revenues as a percent of GNP would have declined and federal outlays would have remained virtually unchanged.1

There is of course more to the Social Security puzzle than economics. It raises questions of ethics as well. Is a “contract” between generations fair when it gives today’s older people a vastly higher return on their contributed taxes than their children and grandchildren can possibly hope to receive? Is a welfare program that gives almost 30 percent of its tax-free benefits to the 20 percent of the elderly population with highest incomes what we want? (Incidentally, that 20 percent of the elderly population has a family income of $30,000 per year or more, and those over sixty-five who are married to nonworking spouses can expect to receive tax-free benefits that will total about fifty times their lifetime payroll tax contributions.)

Still, if Social Security’s financial problems cause the entire economy to fall into perpetual stagnation, robbing our children and grandchildren during their working and retirement years of their rudimentary economic security and indeed of even their Social Security, such ethical dilemmas of the Social Security system will become irrelevant. One of the highest moral obligations facing us is to give our offspring a decent chance at prosperity. If we fail there, the Social Security system itself, and much else, will disappear.

1.

The US economy is suffering from a progressive disease—a spreading paralysis of those activities that raise the standard of living. I am not referring to the current recession. In discussing Social Security and our economy, we must learn to think of decades and generations. Americans, ever impatient, are inclined to mistake short-term cycles for long-term trends. But the economy’s worst problem is not in fact today’s high unemployment or yesterday’s soaring inflation. Rather, it is described in the following comparison:

Annual Productivity Growth Rate2

As these figures show, America’s machinery for creating national wealth is slowing down. The ability of our workers to produce more each year is becoming weaker each year. This slump in the growth of productivity now has little visible effect on daily life. But the cumulative impact will be enormous. Consider the year 2020, when those who are now infants will be at their working prime. If productivity stays roughly the same—if the trend of recent years continues (but does not get worse)—the average worker in 2020 will produce $22,800 in goods and services, just about what he does today.3 The country, for the first time in its history, will have stood still for a span of forty years. (By contrast, the last forty years have seen real income produced per worker rise from $10,000 to $22,000, or about 120 percent.)

If, on the other hand, productivity were now to start growing again at the 2.5 percent rate which prevailed from 1948 to 1967, the average worker in 2020 would produce $57,700 in goods and services, an increase of about 160 percent. In that case, our grandchildren would look back on us as relative paupers, and would by 2020 be enjoying a buoyant prosperity and widening social opportunities in a nation that was a strong force in the world’s economic and political affairs. But we are instead on a course leading to unprecedented stagnation, almost certain social strife, and steadily diminishing international influence.

Why are we heading toward the wrong future? Many managerial and cultural factors are responsible, and their relative importance remains a matter of dispute. But one factor seems prominent in virtually every study that has been made: the productivity of US workers is stagnating largely because they are not being provided with an adequate flow of both new tools—modern plant and equipment, innovative techniques, improved methods of production—and new products.

New tools and ideas are provided by investment—by adding to the stock of capital, physical and intellectual, that will generate income in the future. We have been underinvesting in the future. A comparison with Japan during the Seventies is instructive, and sobering:

—Japan invested nearly three times as much in new corporate plant and equipment (9.8 percent of GDP vs. 3.4 percent in the US).4

—Japan invested over seven times as much in public “infrastructure” such as roads and waterways (5.0 percent vs. 0.7 percent).

—Japan invested 20 percent more in civilian research and development, exclusive of R & D for space and defense (1.9 percent vs. 1.6 percent).

—The differences between Japanese investment in scientific education for the young and that of the US are huge, if not as precisely measurable.

Instead of investing adequately in such productive activities, we have, to a dangerous extent, been creating huge debts for other purposes, notably private consumption, and particularly Social Security and public pensions. The true levels of national debt are different from what most people assume; the public believes that the federal debt consists of the loudly announced sum of $1 trillion. In fact, the Social Security system has an “unfunded” liability (i.e., the amount by which expected benefits to current participants exceed their scheduled future taxes) of over $6 trillion. The unfunded liabilities of the federal and military pension system approach another trillion dollars. Nothing could be more salutary for the prospects of long-term productive investment and indeed the global financial system than the news that these grotesquely large obligations to pay public retirement benefits were being reduced and brought under control.

Investment requires savings. One reason we are investing too little is that we are using up every year, in current and often imaginative consumption, far too much of the income we are producing. The national pool of savings available for investment is shallow. This is because the flow of personal and business savings into the pool has been inadequate and the federal government’s burgeoning deficits have become an enormous drain on the pool. Compared to those of all other industrial countries, savings from individuals and families in the US have been a mere trickle. Between 1970 and 1979, for instance, the household sector of the economy saved on average only five cents of each dollar earned. The comparable figure for Japan was about fifteen cents of each dollar earned.

The chief explanation for this difference is very straightforward. The Japanese have consciously designed their entire system of economic incentives to reward savings and investment. We have largely rewarded borrowing and consumption. For example, no other major industrial country permits unlimited tax deductions for interest. In Japan, moreover, personal income derived from capital—i.e., from savings—is taxed either lightly or not at all. In the US, such “unearned income” suffered especially high taxes until recently, and still enjoys relatively small tax incentives.

In Japan, buying houses and durable consumer goods on credit is difficult and requires big down payments. In America, the tax laws and the banking system are heavily skewed toward financed consumption—i.e., toward keeping savings at the lowest possible level.

Pensions in Japan—both public and private—are meager, forcing workers to save for their retirement. Social Security in America now seeks to provide every eligible retired person, regardless of need, with a stipend sufficient to cover all or at least most of the basic necessities of life. The need to save is accordingly weakened. As for American corporations, while their flow of savings (so-called “retained earnings”) has traditionally been considerable, a sustained binge of corporate borrowing has been dangerously eroding that tradition.5

We have thus become a nation of spendthrifts and Japan a nation of savers. But it is an illusion to think that we could quickly or simply change our laws, institutions, habits, and culture so that they will more closely resemble those of Japan. The recent changes in the tax structure to encourage more saving by households and businesses will prove helpful, but further changes in the tax system, though necessary, will require a long and hard effort, and the amount of additional savings they might provide remains uncertain.

2.

Of necessity, we must turn to a surer and more direct strategy for enlarging the pool of savings available for investment: namely to stop the government from draining the savings pool. The government finances its deficits by using up—literally extinguishing—the savings generated by the country’s citizens and corporations. This government “dissaving” has taken on new and frightening dimensions over the last several years, and the problem is getting worse.

The recent rhetoric about the evils of deficit spending and the debate over the balanced-budget amendment have partly hidden a distressing reality. The US now faces federal deficits so large, so longterm, and so unprecedented that if or when an economic recovery occurs our shallow pool of savings would be substantially depleted. There would be little left to sustain the indispensable levels of investment we need to restore economic growth and international competitiveness.

  1. 1

    Between 1955 and 1980, federal outlays rose from 18.0 to 22.4 percent of GNP while Social Security outlays grew from 1.2 to 5.3 percent of GNP. Social Security payroll taxes rose from 1.3 to 5.4 percent of GNP, more than accounting for the increase in federal revenues from 17.2 to 20.1 percent of GNP.

  2. 2

    Productivity” refers to real domestic income per employed person.

  3. 3

    All sums are computed in constant 1980 dollars.

  4. 4

    GDP (Gross Domestic Product) differs from GNP only by attributing all production to the country where it is located (i.e., ignoring international income flows). All investment is measured net of depreciation.

  5. 5

    Some facts on debt-heavy corporate balance sheets are set forth with admirable clarity in an article by Felix Rohatyn in The New York Review of Books, November 4, 1982.

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