May 4, 1998

May 4, 1998 | Backgrounder on Social Security

Social Security Trust Fund Report Shows Need For Reform

The 1998 Social Security Trustees Report, released April 28, 1998, reveals that the retirement program is actuarially bankrupt.1 The retirement program's real unfunded liability has expanded to $17.9 trillion, more than 6 percent higher than reported last year. Moreover, because the Social Security Administration's long-term life expectancy figures are flawed (the Bureau of the Census calculates that Americans will live nearly two years longer than under the figures used by Social Security), the actual long-term deficit is significantly higher.

Opponents of Social Security reform say the report is good news because the bankruptcy date for the Trust Fund is 2032, three years later than predicted last year. But even if the figures in the Trust Fund Report are accepted as accurate, the prognosis for the program is grim. According to the six members of the Board of Trustees of the Social Security Trust Fund (which includes three members of President Bill Clinton's Cabinet):

  • Social Security benefits will exceed projected payroll tax collections in 2013. This annual deficit will explode quickly thereafter, climbing from $49 billion in 2015 to $684 billion in 2030.

  • The total unfunded liability of Social Security, adjusted for inflation, is now $17.9 trillion --four times greater than the national debt.

  • Because surplus payroll taxes have been spent on other government
    programs, the Trust Fund contains nothing but IOUs.
    To make good on those IOUs, politicians in the future will have to raise taxes or issue debt.

  • Even if these IOUs are redeemed, the Trust Fund will go bankrupt in 2032. This is 4 years earlier than projected only five years ago and 16 years earlier than projected ten years ago.

  • In order to keep the system solvent when the Trust Fund runs dry in 2032, payroll tax rates would need to increase by one-third or benefits would have to be cut by 25 percent.

  • Social Security's crisis is driven by demographics. Today, there are 3.4 workers for every beneficiary. The Trust Fund report predicts that, because of longer life spans and lower birth rates, there will be only 2 workers for every beneficiary by 2030. As recently as 1960, there were more than 5 workers per beneficiary.

The Trust Fund Report confirms that Social Security is in crisis and cannot be sustained in its present form. The trustees now indicate that the program's finances are in even worse shape than previously thought. Any efforts to close this funding gap, however, simply will drive Social Security's poor rate of return even lower.2

The only solution is to give workers the freedom to set up private accounts. These accounts would reduce Social Security's unfunded liability because workers in the private system would agree to forego some benefits from the government in order to reap the benefits of higher returns on their
private investment.

WHAT THE TRUST FUND REPORT REVEALS

The annual report published by the Board of Trustees of the Social Security Trust Fund contains a wealth of data on the program's finances. The trustees use three different sets of assumptions about the economy and demographic trends when analyzing the program: optimistic, intermediate, and pessimistic. Almost all analyses of Social Security rely on the intermediate data, and those numbers are used here. Based on these numbers:

  1. Social Security will begin to run large deficits when the baby-boom generation retires. Right now, the program is collecting more in taxes than it needs to fund current benefits. As Chart 1 shows, however, these modest surpluses disappear in 2013. At that point, deficits will grow rapidly, reaching nearly $700 billion by 2030.

Even after adjusting for inflation, Social Security's unfunded liability is huge. Chart 2 shows that total outlays exceed projected revenues by an astounding $17.9 trillion, or roughly $66,250 for every man, woman, and child in the United States.

Defenders of the program claim that a portion of this unfunded liability can be offset by the Trust Fund. The Trust Fund, however, contains nothing but IOUs. All surplus payroll tax revenues have been spent on other government programs (see Chart 3). When the IOUs come due in the future, they can be redeemed only with revenues from taxes or borrowing.

Even assuming that the government can raise the money to redeem the Trust Fund's IOUs, Social Security still will go broke in 2032. After the 1983 bailout, the Trust Fund was believed to be solvent. Chart 4 shows that, as recently as 1988, the IOUs were expected to last until 2048.

Once the IOUs in the Trust Fund are exhausted, the gap between payroll tax collections and benefit payments will be immense. The deficit in 2040, for example, will be more than $1 trillion. To keep the system solvent, payroll tax rates will have to climb to about 18 percent. An alternative is to cut benefits by more than 25 percent. (See Chart 5.)

Demographic trends are accelerating the collapse of Social Security. The number of workers per beneficiary has fallen dramatically. As Chart 6 shows, 3.4 workers support each beneficiary today. By 2030, there will be only 2.0 workers per beneficiary, and, by 2065, there will be only 1.8 workers per beneficiary.

Social Security will provide future retirees with very meager retirement benefits compared with the amount of taxes they are required to pay into the system (see Chart 7). Certain groups, such as African-Americans and working women, suffer particularly low returns.3

WHY REAL REFORM AND PRIVATE ACCOUNTS ARE NEEDED

Those who oppose reforming the Social Security system face an insoluble Catch-22 dilemma. Conventional policies to close Social Security's unfunded liability will worsen the rate-of-return crisis faced by working Americans who must contemplate their future retirement. Specifically, payroll tax increases, reductions in benefits, higher retirement ages, and cuts in the cost-of-living adjustment mean that workers will pay more and get less during retirement. Yet conventional changes to improve Social Security's payout (payroll tax cuts and/or benefit increases) would drive the program into bankruptcy even sooner.

The only solution is to allow workers to divert a portion of their payroll taxes to private accounts. The funds in these professionally managed accounts would be invested in a diversified port-folio of stocks, bonds, and other income-producing assets. Holders of private accounts would benefit from the compounding that results from continual reinvestment of income. By the time they retired, workers who had chosen private accounts could build up a nest egg capable of generating an income much greater than they are promised by Social Security. In addition, workers who chose to divert part of their payroll taxes to private accounts would forego the corresponding proportion of their Social Security retirement income benefits. Thus, the long-term liability of the program would decline.

The Trustees Report underscores the need to act now on prudent and resolute reform rather than wait until bankruptcy is imminent before doing anything effective. Modernizing Social Security by permitting individual accounts and private investment is being adopted in country after
country.4 It is time for the United States to embark on that same path of reform.5

Daniel J. Mitchell is McKenna Senior Fellow in Political Economy at The Heritage Foundation.

Gareth G. Davis is a former Research Assistant at The Heritage Foundation

Endnotes

1. 1998 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (Washington, DC: U.S. Government Printing Office, 1998); available at http://www.ssa.gov/oact/tr/tr98/index.html.

2. William W. Beach and Gareth G. Davis, "Social Security's Rate of Return," Heritage Foundation Center for Data Analysis Report No. CDA-98-01, January 15, 1998.

3. Ibid.

4. For a discussion of successful privatization efforts in Chile, Australia, Britain, and Singapore, see William W. Beach, Daniel J. Mitchell, Gareth G. Davis, and Stuart M. Butler, "Social Security: Improving Retirement Income for All Americans," in Stuart M. Butler and Kim R. Holmes, eds., Issues '98: The Candidate's Briefing Book (Washington, DC: The Heritage Foundation, 1998), pp. 111-117; available at http://www.heritage.org/heritage/issues/.

5. For a discussion of a strategy to reform the Social Security system, see Stuart M. Butler and John S. Barry, "Solving the Problem of Middle-Class Entitlements," in Stuart M. Butler and Kim R. Holmes, eds., Mandate for Leadership IV: Turning Ideas Into Actions (Washington, DC: The Heritage Foundation, 1997), pp. 289-300.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy