Social Security: How The Trouble Began

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In the past the needs and wishes of the elderly have had little force in shaping federal retirement policy, as Mr. Graebner demonstrates in these pages. But the organized elderly now constitute one of the most effective political pressure groups in America. As such, old people see the long-term general welfare interests of the nation and their own immediate interests as one problem. It follows that they want Congress to act quickly and forcefully to remedy the failures of Social Security funding—failures that go back to three crucial decisions made when the Social Security Act was originally adopted in 1935.

• The first of these was not to include everybody in the insurance scheme. About 10 percent of the population—all federal employees and all who derive the whole of their income from investments—remain outside the system.

• The second decision was to finance Social Security entirely from matching contributions by employees and employers, with no contribution from government. This was a radical departure from the plan adopted in European countries, where generally a third of the contributory payment is made out of general tax revenues: and it has meant that the Social Security tax burden is carried by employees alone, because employers pass their tax portion back to their employees in diminished wages.

• The third decision was for a pay-as-you-go approach whereby current payments to beneficiaries are substantially made out of current collections from payroll taxes—which is to say that those now in the work force pay the pensions of those who have retired. Private pension systems are organized differently: they invest their funds, and the dividends thus earned pay a major portion of the benefit costs.

These three decisions rendered Social Security vulnerable to economic and demographic fluctuations. For many years after the first Social Security checks were issued in 1940, a rising birthrate and an expanding economy helped the program. Payroll taxes more than sufficed to meet benefit payments: indeed, a surplus was accumulated.

All this has now changed. The baby boom of the late 1940s and the 1950s has been succeeded by a long period of declining fertility and increasing longevity. Thus, 9.2 percent of Americans were sixty-five or older in 1960; 12.2 percent will be, it is estimated, in 2000. This means that the number of Social Security beneficiaries now grows much faster than the number of workers whose payroll taxes finance their benefits.

Hence the sharp and successive increases in the payroll tax (eight of them by 1990) mandated by Congress in 1977. The combined employer-employee payroll tax is now 13.4 percent (equally divided) of the employee’s wage up to $35,700 (which is the maximum taxable wage base as of January 1, 1983). By 1990 the tax will rise to 15.3 percent. Meanwhile, Congress has dealt with the immediate cash-flow problem of the Old Age and Survivors Insurance Fund by authorizing transfers to that fund of tax receipts from the disability and Medicare funds—neither of which is currently in financial difficulty. These adjustments, however, are only stopgaps.

The major impact upon the system of demographic change is yet to come. Presumably the birthrate will either remain about as it is or decline, since a long-run decline in fertility is characteristic of advanced industrial nations, while the bulge in the demographic pattern produced by the baby boom moves inexorably toward 2010, when the oldest members of the boom generation will begin to retire. The most “pessimistic” Social Security economists estimate that there will be 68 Social Security beneficiaries for every 100 workers in 2030, and 84 in 2050, as compared with 31 today.

Thus the problem. How may it be solved?

Drastic cutting of benefits is unlikely. More probable are increases in the payroll tax beyond the 15.3 percent already scheduled for 1990—perhaps to 18 percent by 2020, at which point there may be a cutoff on tax increases, the remainder of the funds coming from general tax revenues. Indeed, there seems to be a growing belief that general support of the old-age system is both morally and economically inevitable. The payroll tax is, of course, regressive: as Ben B. Seligman says in his Permanent Poverty: An American Syndrome , Social Security remains “structured in such a manner that the income transfers flow from lower-middle-income groups to lower-income groups, with upper-income groups contributing very little.” If a third of the Social Security benefits were financed out of graduated income tax collections, it would probably be unnecessary to increase the payroll taxes beyond the mandated 1990 level.

Such an increase could also be avoided by raising the retirement age from sixty-five to sixty-eight over a twelve-year period beginning in 2000. This change would dramatically alter Social Security’s fiscal outlook. An estimated $200 billion surplus in the old-age portion of the system would be accumulated in the next seventy-five years, enabling the costly correction of certain gross inequities that now mar the system, notably with regard to working women. At present the Social Security law favors early retirement: a worker who retires at sixty-two, as the law permits, receives a pension only 20 percent less than he (or she) would have received had she (or he) retired at sixty-five—and at present nearly three out of four do opt to retire early.