April 16, 1999 | Backgrounder on Social Security
The 1999 Annual Report of the Board of
of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds--the 1999 Social Security Trustees' Report--released March 30, 1999,1 reveals that the retirement program is actuarially bankrupt and falling deeper into debt with each passing year. After adjusting for inflation, Social Security's unfunded liability between now and 2075 has risen to $19.8 trillion.
Opponents of Social Security reform say the report is good news because the bankruptcy date for the Social Security trust fund now is 2034, two years later than last year's prediction.2 But this estimate assumes that the trust fund contains real assets. In reality, the fund is nothing more than a bookkeeping entry. It is composed of government bonds--IOUs representing nothing more than a promise to tax future workers. And the Trustees' Report shows that this obligation on future generations is increasing.
The economy's recent performance does help Social Security. The program is collecting more in taxes than had been previously predicted, boosting the short-term surplus of tax revenue over benefit outlays. Moreover, the program has gained an additional year--2014 instead of 2013--before its surpluses will switch to deficits.
Unfortunately, Social Security's long-run numbers are not nearly as cheerful. Higher spending levels eventually will offset the increased revenues. The new Trustees' Report now projects that the program will experience larger annual deficits every year between 2022 and 2075.
Although the following numbers explain the continued deterioration of Social Security's finances, it is important to stress that reformers should not focus on "fixing" or "balancing" the program's deficit. These numbers certainly make clear that the current system is unsustainable, but raising taxes or cutting benefits would serve only to compound Social Security's other crisis--poor and declining returns for taxes paid--by making the program an even worse deal for workers. Instead, these numbers should provide further evidence of the need to transform Social Security into a system of personally owned retirement savings accounts.
Social Security benefits will
exceed projected Social Security tax collections in
This annual deficit will explode quickly thereafter, climbing to $200 billion in 2021 and $1.5 trillion in 2048.
Even after adjusting for
inflation, the shortfall is staggering.
In today's dollars, the annual deficit will reach $100 billion in 2020, $200 billion in 2026, $300 billion in 2037, $400 billion in 2057, and $500 billion in 2068.
The cumulative unfunded liability of Social Security between 1999 and 2075, after adjusting for inflation, now is estimated to be $19.8 trillion --five times larger than today's national debt.
The 75-year projection will
continue to get worse because, with each passing year, a surplus
year is lost on the front end and a deficit year is added on the
For the period 2000-2074, the projected $19.2 trillion shortfall, for example, is 7.9 percent higher than last year's $17.8 billion for 1999-2073 (both in 1999 dollars).
Even when comparing similar
years, the program's finances are deteriorating.
After adjusting for inflation, the cumulative 1999-2075 deficit in this year's report is 5.1 percent larger than the cumulative 1999-2075 deficit in last year's report.
The outlook actually is even
worse than these numbers indicate because the Trustees count the
payroll taxes of federal government employees as a real revenue
In reality, no money changes hands; the government simply creates an accounting entry within Social Security that is offset by accounting debits across the federal workforce. If these phantom revenues are omitted, the long-run, inflation-adjusted shortfall rises to about $22 trillion.3
The existence of the trust fund
will not make paying promised benefits easier because it contains
As the Clinton Administration stated in this year's budget submission,
These [trust fund] balances are available to finance future benefit payments and other trust fund expenditures--but only in a bookkeeping sense.... They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.4
If policymakers do not reform
the Social Security program, balancing the system eventually will
require a 53 percent increase in the payroll tax rate, a 33 percent
reduction in benefits, or a combination of the two.
Such policies, however, would create hardship on workers and retirees. Moreover, they would make Social Security's already meager rate of return (which compares what people get out of the system with what they put in) even worse.
Social Security's crisis is
driven by demographics.
Today, there are 3.4 workers for every beneficiary. The Trustees' 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 Trustees' Report confirms that the Social Security program is in crisis and cannot be sustained in its present form. And as the Trustees now indicate, the program's finances are in even worse shape than previously had been thought. Any efforts to close the funding gap, however, simply would drive Social Security's poor rate of return even lower.5
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.
The Trustees' Report contains a wealth of data on Social Security's finances. Generally, the Trustees use three different sets of assumptions about the economic and demographic trends to analyze the program: optimistic, intermediate, and pessimistic. Almost all analyses of Social Security rely on the intermediate data, and those numbers are used here.
Once the trust fund's IOUs are
exhausted, the gap between payroll tax collections and benefit
payments will become immense.
The deficit in 2040, for example, will be more than $1 trillion ($300 billion in 1999 dollars). 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.
Demographic trends are
accelerating the collapse of Social Security.
The number of workers per beneficiary has fallen dramatically. Chart 3 shows that 3.4 workers support each beneficiary today. By 2030, there will be only 2 workers per beneficiary, and, by 2065, just 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 4).
Certain groups, such as African-Americans and working women, suffer particularly low returns.6
Those who oppose reforming the Social Security system face an insoluble dilemma. Conventional policies to close Social Security's unfunded liability would worsen the rate-of-return crisis faced by working Americans who must contemplate retirement. Specifically, payroll tax increases, reductions in benefits, higher retirement ages, and cuts in the cost-of-living adjustment would mean workers would have to pay more but get less during their retirement years. 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 to this dilemma is to allow workers to divert a portion of their payroll taxes into private accounts. Funds in these professionally managed accounts would be invested in a diversified portfolio 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 have built 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 into private accounts would forego the corresponding proportion of their Social Security retirement income benefits. This would enable the long-term liability of the program to decline.
The Trustees' Report underscores the need to make prudent and resolute reforms now, instead of waiting until the program's bankruptcy is imminent before doing anything effective. Modernizing Social Security by permitting individual accounts and private investment is being adopted in country after country around the world.7 It is time for the United States to embark on this path toward reform.
Daniel J. Mitchell, Ph.D. is McKenna Senior Fellow in Political Economy at The Heritage Foundation.
1. The 1999 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, at http://www.ssa.gov/OACT/TR/TR99/index.html.
3. The preceding summary of what the Trustees' Report shows contains calculations made by Heritage Foundation analysts. Descriptions of these calculations are available upon request. For greater detail on the issue of federal government employee payroll taxes, see Daniel J. Mitchell, "Social Security's $20 Trillion Shortfall: Why Reform Is Needed," Heritage Foundation Backgrounder No. 1194, June 22, 1998.
7. For a discussion of successful privatization efforts in Australia, Great Britain, Chile, and Singapore, see William W. Beach, Daniel J. Mitchell, Gareth G. Davis, and Stuart M. Butler, Ph.D., "Social Security: Improving Retirement Income for All Americans,"in Stuart M. Butler, Ph.D., and Kim R. Holmes, Ph.D., eds., Issues '98: The Candidate's Briefing Book (Washington, D.C.: The Heritage Foundation, 1998), pp. 111-117, also available at http://www.heritage.org.