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The Salvation of Social Security

Social Security remains sacred in American politics while it threatens the entire economy. In the recent election campaign, practically all the candidates promised to “preserve Social Security,” to “resist any cuts in benefits,” and to “protect the elderly poor.” No one dared to say that without major reforms—including “cuts”—the Social Security system will run huge deficits, that these deficits will push our children into a situation of economic stagnation and social conflict and create a potentially disastrous situation for the elderly of the future.1

Politicians cannot hide a truth this important. When a recent national survey asked workers whether they felt they would end up receiving their Social Security benefits, 84 percent between the ages of eighteen and forty-four said no. Evidently many people sense that Social Security is in very serious trouble. Why do so many politicians pretend otherwise? They do so because they fear that the voters will punish messengers of bad news, and the future of Social Security is particularly bad news.

The elderly are bound to feel threatened, betrayed, and angry if politicians speak of taking away the one thing that has sustained many of them. At the same time, younger generations tend to see the elderly as far sicker and poorer, far more disabled and homeless than they really are. Younger people also believe the elderly are more dependent on their children than they are—or think they are. A recent survey, for example, found that people below the age of sixty-five estimated that about 30 percent of the aged receive income from their children. But in fact only 1 percent of old people—possibly fewer—receive their principal support from children or relatives; fewer than 5 percent receive any help that could be considered income; and the elderly are twice as likely to be providing financial help to children as to be receiving it.2

Social Security benefits are obviously of special importance to the elderly poor. Reforms must be carefully structured to avoid harsh consequences for those who depend on the system. But most retirement benefits do not go to those below the poverty level. Social Security is in many ways a middle- and upper-income program; it has become a political sacred cow not because of a humane concern for the poor but because of a political reluctance to impose fiscal restraint on middle- and upper-income voters. Still, if such reforms are carried out soon, they need only involve a gradual reduction in the rate of increase of Social Security benefits, giving the current working population time to adjust, and providing—through expanded private savings and private pensions—the savings people need for their retirement and the savings the economy needs for its long-term health.

1.

The Myths of Social Security

If Social Security is to be saved, the obfuscation that has served to hide the true problems of the system must give way to informed debate. Understanding is now blocked by a set of myths—fantasies, really—about how Social Security works, whom it benefits, and how it will fare over the next decades. That the system is riddled with flaws—financial, ethical, and ultimately political—may come as a surprise to most citizens.

Myth One: The problems are not serious. Events are rapidly undermining the myth that Social Security’s financial troubles are minor and temporary. In November the retirement fund had to borrow from the disability fund—the first such borrowing in the history of Social Security. By late 1983, the disability fund will run out of money to lend and then will itself face certain bankruptcy. Like two drowning swimmers, both funds will have no choice but to reach out to grasp the third fund, the Hospital Insurance fund (HI, Medicare “Part A”), which is itself sinking fast. Unless the economy undergoes a truly miraculous recovery, providing a vast infusion of new payroll tax revenue, all three funds—the entire Social Security system—will run out of money sometime in 1984 or 1985.

Yet the myth that the Social Security system is fundamentally sound persists. According to the myth, Social Security will be saved by payroll tax increases between now and 1990, which have already been legislated, and by the fact that by the end of the 1980s the last of the postwar baby-boom generation will become taxpayers while the less numerous prewar generation will retire. Meanwhile, we are not to worry if all three funds happen to go broke before this. During the 1990s all the funds will be running in the black—so the myth goes—and can easily repay any interim borrowings from the Treasury. As for the long term, even the myth makers concede that gradually deepening deficits will begin in 2000 or soon thereafter, but we are admonished only to “monitor” the situation and to avoid “rash” solutions.

Nearly everything is wrong with this picture. As long as retired people continue to receive benefits wildly out of proportion (currently, three to five times as large) to their lifetime payroll tax contributions, plus interest, the system will remain fundamentally out of balance. In a chain-letter scheme in which everyone makes payments to someone else, not everyone can win the jackpot—unless there is an impossible acceleration in growth of the number or wealth of new players. It would take momentous economic good luck for the system to achieve a temporary balance in the late 1980s and 1990s. When the baby-boom generation retires early in the next century, the system will disintegrate.

Let us examine the future in detail. The Social Security trustees regularly publish projections of the future financial condition of the trust funds—the so-called “optimistic,” “intermediate,” and “pessimistic” projections. Our estimate of the imminence and severity of the collapse of Social Security as we know it depends on which of the projections we believe. As I argued in the first part of this article, the so-called “pessimistic” assumptions are not merely plausible, but, to me, are the most probable of the three possibilities. On the record of the last decade or so, the “pessimistic” assumptions look, indeed, optimistic.3 Table I, on the opposite page, shows what we have in store on the basis of these “pessimistic” assumptions.

TABLE I

The “pessimistic” assumptions themselves need to be examined. For the next two decades, demographics will hold very few surprises since almost every new worker by the year 2000 has already been born and can be counted.4 What counts is our assumptions regarding economic performance, and of these, two statistics have special significance: the future unemployment rate and the future rate of real-wage growth. The former tells us how many workers are paying taxes into the system; the latter tells us how quickly each worker’s tax payments are rising or falling relative to the Consumer Price Index (i.e., relative to each retired person’s indexed benefits). Table II, on the opposite page, shows both rates under the “pessimistic” projection.

TABLE II

The single most important variable for the near-term Social Security outlook is real-wage growth. Higher real wages immediately translate into higher total payroll tax collections. The striking point about Table II is that compared with the past five, ten, or even fifteen years, the “pessimistic” assumption about real-wage growth looks rosy. If real wages between now and the year 2000 were to perform as they did during the past fifteen years (that is, to decline by 0.2 percent per year), then the Social Security deficits would be truly appalling—more than double the already unacceptable “pessimistic” figures of Table I.

We may reasonably hope that new investment and the maturing of new entrants into the labor force will make it possible to improve on the labor productivity record of the past and thus allow us at least to match the pessimistic projection. But working against this will be the fact that the era of cheap energy and “costless” pollution is over.

The near-term outlook for Social Security is much less affected by changes in the unemployment rate than by changes in real-wage growth. Looking at the projected unemployment rates in Table II, most people will, I think, conclude that the estimates, although unpleasant, are highly plausible. In recent years, most economists have come to agree that the so-called “natural rate” of unemployment (that is, the unemployment rate consistent with a rate of inflation that is not accelerating) will be substantially higher in the foreseeable future than it was in the late 1950s and throughout the 1960s (when between 4.0 and 4.5 percent seemed about the norm). Young people today are taking much longer to decide on careers. Moreover, the number of families with several earners has been rising dramatically. Wives, husbands, or grown children tolerate being unemployed more frequently, and for longer periods, when their families enjoy other sources of steady income. The “pessimistic” projection of 7.25 percent unemployment for the period between 1982 and 2000 looks favorable when compared with the current rate of 10.4 percent and the projections of most economic forecasters that the rate is unlikely to fall below 9 percent until 1984 or 1985.

Any realistic—let alone prudent—assessment of our economy’s potential should take the “pessimistic” economic projection, or something close to it, as a guide for the next two decades. Further into the future the forces of demography impinge on any calculations. The central demographic question is really quite simple: as the twenty-first century wears on, how many retired (or disabled) beneficiaries will there be for every tax-paying worker? The answer to this question will depend almost entirely on the future fertility rate and on future life expectancy. More children, of course, means more tax-paying workers, which means more Social Security tax revenues for the same number of beneficiaries. Longer life spans, on the other hand, will tend to increase the number of retired people to whom benefits must be paid.

These future variables are inherently unknowable. They will be strongly influenced by the subtlest cultural trends (such as the social acceptability of having one as opposed to five children) and the most recondite medical discoveries (such as the production of cancer-fighting antibodies). Yet their influence on the future of Social Security is profound. By the year 2050, the projected “optimistic” and “pessimistic” deficits diverge sharply: an optimistic deficit of 0.7 percent of the GNP versus a pessimistic one of 10.9 percent of GNP. Over two-thirds of this difference is due to the cumulative effect of differing demographic assumptions.

According to the “pessimistic” projection, women in future decades will have only slightly fewer children than they are having now (about 1.70 versus 1.85 per lifetime). At least two current trends may actually reduce fertility rates below this “pessimistic” projection: the widespread availability of family planning and contraceptives, and the rapidly growing female participation in the labor force. Because fertility rates and economic growth have always been closely correlated, we may eventually fall into a curious sort of vicious cycle. Sustained low birthrates will put a greater burden on our system of retirement entitlements, which may in turn ensure that our economic growth remains very low.

  1. 1

    These economic consequences were discussed in the first part of this article in the New York Review, December 2, 1982.

  2. 2

    See Stephen Crystal’s America’s Old Age Crisis: Public Policy and the Two Worlds of Aging (Basic Books, 1982), which contains a great deal of useful information on the elderly and on attitudes toward them. I have also found most informative the statements and speeches of Robert Beck, chairman of the Prudential Insurance Company of America.

  3. 3

    Throughout the 1970s almost every “intermediate” projection for Social Security has, in the light of actual subsequent experience, turned out to be overly optimistic. I find today’s widely used “intermediate” assumptions optimistic and the “optimistic” assumptions sheer fantasies.

  4. 4

    One exception to the rule of “no surprises” may be immigration. Projections of the work force (and, therefore, aggregate earnings and the receipts of the Social Security system) are based on the premise that current immigration laws can and will be enforced. Either a flood of illegal immigrants or a substantial loosening of immigration restrictions could therefore significantly increase Social Security receipts by offsetting low birthrates (while avoiding the costs of child-rearing). Yet such an expansion of the work force would intensify the problem of insufficient capital formation—on which I have earlier laid considerable stress.

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