January 19, 2005

January 19, 2005 | WebMemo on Social Security

Rising Benefit Levels Drive Social Security's Fiscal Crisis

Social Security outlays currently consume 4.28 percent of the economy as measured by gross domestic product (GDP) and will climb to nearly 6 percent of GDP within 20 years.[1] In that 20-year time period, Social Security spending will increase by about 100 percent-and that is after adjusting for inflation.[2] Social Security's unfunded long-term obligations (the gap between promised benefits and projected payroll taxes) are like a giant mortgage, but one that grows over time and is never paid off. Social Security's total deficit over just the next 75 years is projected to be a staggering $27 trillion in inflation-adjusted dollars, or a $100,000 liability for every working household over that period.

 

This projected spending increase threatens America's economy, particularly when combined with higher spending for other entitlement programs. The experience of European nations is a warning to the United States: larger government inevitably hinders economic performance and reduces living standards. That is why-regardless of the outcome of the effort to create personal retirement accounts-policymakers should take sensible steps today to control Social Security spending tomorrow.

 

There are two main reasons for the upcoming Social Security spending crisis:

  • Demographic changes. Today, there are fewer than 48 million Social Security beneficiaries. By 2030, the number of recipients will climb to nearly 84 million. This dramatic increase in the number of people getting benefits will not be matched by an increase in those paying the bill. In 1950, there was only 1 Social Security recipient for every 16 workers. Now there is 1 recipient for every 3.3 workers, and there will be 1 beneficiary per 2.2 workers by 2030.[3] This significant demographic shift is due to the baby-boom generation, of course, and also due to changes in life expectancy. In 1935, the average 65-year-old could expect to live about 12.6 more years. Today, people who reach age 65 can expect to live for another 17 years. And by 2040, a 65-year-old will be expected to live at least 19 more years.[4]
     
  • Benefit increases. Higher spending also results from benefit levels that grow much faster than inflation. Someone retiring this year with average earnings will get an initial benefit of less than $15,000 each year. Future retirees, however, will get higher levels of initial benefits-even after adjusting for inflation. For instance, a worker with average earnings retiring in 2030 will get an annual benefit (in inflation-adjusted 2004 dollars) of more than $19,000. And by 2055, that same average worker retiring in 2055 will get an annual benefit of more than $25,000 (in inflation-adjusted 2004 dollars).[5] In other words, future retirees are being promised much higher living standards than today's retirees even though Social Security is actuarially bankrupt.

It would be fiscally imprudent and economically risky to allow Social Security spending to increase as promised by current law. The program faces huge long-term deficits, but this is not the only reason to rein in costs. Even if money magically materialized to cover Social Security's deficit, it would still be wrong to let the burden of government climb to higher levels. Nations such as France and Germany suffer from economic stagnation and double-digit unemployment in large part because their governments consume too much of national economic output. It is the burden of spending in these countries-not how it is financed-that has caused their economic malaise.

 

America is heading in the same direction. Social Security's long-term cash-flow deficit is a burden on future generations. Unless policy is changed to control the growth of spending, our children and grandchildren will deal with the economic consequences: higher taxes, higher borrowing, or a combination of the two. And this is not a trivial problem. There are two primary ways to measure the burden future generations face:

  • Inflation-adjusted Cash-Flow Deficit. If the shortfall is measured in "constant" dollars so that a future dollar has the same value as a dollar today, Social Security's cumulative 2018-2080 shortfall is more than $27 trillion.[6]
     
  • Present value deficit. If Social Security's shortfall is measured using "present value" (how much money would have to be invested today to offset future liabilities), its deficit ranges from $5.2 trillion[7] to $11.2 trillion,[8] depending on whether actuaries assume the program is "open-ended" or "closed-ended."[9] These numbers are sensitive to changes in initial assumptions. The Congressional Budget Office, for instance, has a different set of estimates.[10] In any event, present-value calculations presumably understate the problem because it is safe to say that the federal government is not going to collect an extra $5.2-$11.2 trillion today and put it in a mutual fund in order to pay future benefits.

Fortunately, policymakers can lighten the burden on future generations by making changes to the way future retirement benefits are calculated. Making these changes now will allow workers to better plan for the future, but this will be more difficult if policymakers postpone needed reform. Current retirees and those close to retirement, perhaps age 55 and above, should receive every cent that they are promised. This is because they fulfilled their obligations and it would be unfair to suddenly change their benefit levels-particularly since retirees and older workers would have very limited ability to build private savings and develop alternative sources of income for retirement.

 

It is both fair and reasonable, however, to adjust benefit levels for younger workers. The best solution would be to slow the growth of younger workers' retirement benefits. There is no reason why future retirees should get substantially more income-after adjusting for inflation-than current retirees. And since this reform would only apply to workers who are at least 10 years from retirement, they would have ample time to plan for the change.

 

Many other nations already have implemented similar reforms, including Sweden, Germany, and the United Kingdom. In every case, lawmakers understood that promised benefits were too costly and that future taxpayers would face an onerous burden. A central tenet of these international reform efforts was to slow the growth of future benefits to a more sustainable level.

 

Reining in unsustainable benefit growth is desirable and necessary. It should happen whether or not policymakers otherwise reform the Social Security system.

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




[1] Social Security Administration, 2004 Social Security Trustees Report, Table VI.F5, "OASDI and HI Annual and Summarized Income, Cost, and Balance as a Percentage of GDP, Calendar Years 2004-80," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/VI_OASDHI_GDP.html#wp118436.

[2] Social Security Administration, 2004 Social Security Trustees Report, Table VI.F8, "Operations of the Combined OASI and DI Trust Funds, in Constant 2004 Dollars, Calendar Years 2004-8," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/VI_OASDHI_dollars.html#wp93785.

[3] Social Security Administration, 2004 Social Security Trustees Report, Table IV.B2,"Covered Workers and Beneficiaries, Calendar Years 1945-2080," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/IV_LRest.html#wp178448.

[4]Social Security Administration, 2004 Social Security Trustees Report, Table V.A4, "Cohort Life Expectancies," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/V_demographic.html#wp151333.

[5] Social Security Administration, 2004 Social Security Trustees Report, Table VI.F11, "Estimated Annual Scheduled Benefit Amounts for Retired Workers With Various Pre-Retirement Earnings Patterns Based on Intermediate Assumptions, Calendar Years 2004-80," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/VI_OASDHI_dollars.html#wp119381.

[6] Social Security Administration, 2004 Social Security Trustees Report, Table VI.F8, "Operations of the Combined OASI and DI Trust Funds, in Constant 2004 Dollars, Calendar Years 2004-8," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/VI_OASDHI_dollars.html#wp93785.

[7] Social Security Administration, 2004 Social Security Trustees Report, Table IV.B7, "Unfunded OASDI Obligations for 1935 (Program Inception) Through the Infinite Horizon," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/IV_LRest.html#wp267528.

[8] Social Security Administration, 2004 Social Security Trustees Report, Table IV.B8, "Present Values of OASDI Cost Less Tax Revenue and Unfunded Obligations for Program Participants," March 23, 2004, at http://www.ssa.gov/OACT/TR/TR04/IV_LRest.html#wp267012.

[9] The "closed-ended" estimate assumes no future workers join the system. The "open-ended" estimate assumes future workers do participate in the system. For more information, see http://www.ssa.gov/OACT/NOTES/ran1/an2004-1.html.

[10] Congressional Budget Office, The Outlook for Social Security, June 2004, at http://www.cbo.gov/showdoc.cfm?index=5530&sequence=0.

About the Author

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