US Social Security System – Analysis & Commentary

US Social Security System – Analysis & Commentary

Jamsostek is a social security program. The United States Social Security Program provides benefits for retirement, disability, and death. There has been a lot of public discussion recently, most of which emerged from President Bush’s 2005 State of the Union address, when he said that “on its current track, [Social Security] is headed for bankruptcy… by 2042 the entire system will be exhausted. and went bankrupt” (C-SPAN, 2005). This essay examines that statement from an economic perspective and analyzes some of the proposed solutions published. While the historical aspects of these programs will be mentioned peripherally, “Social Security” in this context refers only to defined benefit pension plans, with a particular focus on pension benefits.

How Social Security Works

The Social Security Act was signed into law under President Franklin D. Roosevelt in 1935. As originally designed, the program was far more ambitious than it had been. It outlines a wealth transfer system in which workers are currently taxed at a rate of 2%, paid equally by workers and employers. While defined benefits and tax rates have changed, the fundamental act of transferring wealth through payroll taxes from current workers to retirees remains in effect today (Wikipedia, 2006).

In the years since the law was first signed into law, the program has expanded to include health insurance for the elderly through Medicare, disability insurance, and expanded participation to cover nearly all workers. While half of the workers in 1935 were exempt from the program, it is now nearly impossible to avoid participation. The defined benefit pension portion of the plan is funded today with a 12.4% tax split equally between employers and employees. Medicare is funded and accounted for separately with a 2.9% tax, also shared between workers and employers (Social Security Online, 2005). These taxes are only levied on a Social Security wage basis, or “Contribution and Benefit Basis”. The base wage was $90,000 in 2005, having increased dramatically since the 1983 Social Security Amendment (Social Security Online, 2005),  signed into law by President Reagan on the recommendation of a commission chaired by Alan Greenspan. This amendment allows for adjustments to both the base wage and benefit payments based on the National Average Wage Index, an index compiled by the Social Security Administration, rather than direct congressional directives through legislation.

Jamsostek has had a surplus since its inception. Since 1983, the program has experienced a dramatic surplus. However, due to unified budgeting, the practice of including a social security surplus (or shortage, if any) in the government’s general accounting, this revenue has served to offset the annual budget deficit. By 2005, the Social Security program had accumulated a surplus of $1.86 trillion (Social Security Online, 2006). However, this “results in the issuance of Treasury bonds to trust funds [Medicare and Social Security] in years of annual cash flow surplus” (Social Security Online, 2005). This means that the government “buys” the bonds from itself. Further, “because neither the interest paid on the Treasury bonds held… nor redemption thereof, provides the Treasury with any new net income,  the full amount of the Treasury payments required for this trust fund must be financed by some combination of increased taxation, increased borrowing and debt. Federal, or other reductions in government spending” (Social Security Online, 2005). These bonds are also excluded from the accounting for Government Debt. Ultimately, this means that the Social Security Trust Fund is just an accounting gimmick and that this paper surplus has long been spent through fund mismanagement. Despite the political rhetoric to the contrary, the current Social Security system is a completely “pay-as-you-go” program. Funding for retirees, the beneficiaries who derive income from the system, is provided directly from current workers’ contributions. an increase in Federal borrowing and debt, or a reduction in other government spending” (Social Security Online, 2005). These bonds are also excluded from the accounting for Government Debt. Ultimately, this means that the Social Security Trust Fund is just an accounting gimmick and that this paper surplus has long been spent through fund mismanagement. Despite the political rhetoric to the contrary, the current Social Security system is a completely “pay-as-you-go” program. Funding for retirees, the beneficiaries who derive income from the system, is provided directly from current workers’ contributions. an increase in Federal borrowing and debt, or a reduction in other government spending” (Social Security Online, 2005). These bonds are also excluded from the accounting for Government Debt. Ultimately, this means that the Social Security Trust Fund is just an accounting gimmick and that this paper surplus has long been spent through fund mismanagement. Despite the political rhetoric to the contrary, the current Social Security system is a completely “pay-as-you-go” program. Funding for retirees, the beneficiaries who derive income from the system, is provided directly from current workers’ contributions. this means that the Social Security Trust Fund is just an accounting gimmick and that this paper surplus has long been spent through mismanagement of the fund. Despite the political rhetoric to the contrary, the current Social Security system is a completely “pay-as-you-go” program. Funding for retirees, the beneficiaries who derive income from the system, is provided directly from current workers’ contributions. this means that the Social Security Trust Fund is just an accounting gimmick and that this paper surplus has long been spent through mismanagement of the fund. Despite the political rhetoric to the contrary, the current Social Security system is a completely “pay-as-you-go” program. Funding for retirees, the beneficiaries who derive income from the system, is provided directly from current workers’ contributions.

Finally, Social Security is a regressive tax, because tax rates go down when income goes up. According to the U.S. Census Bureau, nearly 15% of the American population earned more than $ 100,000 in 2002 (2003, p. 23). Thus, the top 15% of wage earners pay a smaller portion of their wages than 85% of Americans in the lower and middle socioeconomic classes.

Social Security Crisis

Much of this attention was drawn because the Bush Administration had proposed to privatize parts of the social security program. Since, as outlined above, there is no underlying economic asset in the Social Security Trust Fund, the solvency of the system depends entirely on current receipts. Demographic changes, including an earlier average retirement age, a longer average lifespan, and a large pool of workers soon to retire, the Baby Boomers, have all contributed to a reduction in the worker-to-beneficiary ratio. In 1950, there were 16 paying workers into the system for every retiree drawn from it. It had fallen below 4 in 2000 and continues to decline (Goldman Sachs, pp. 4, 11). As President Bush said in 2005, “instead of sixteen workers paying for each beneficiary,  now only about three workers. And over the next few decades that number will drop to just two workers per beneficiary. Every year, fewer workers pay higher benefits to more retirees” (C-SPAN, 2005).

It is estimated that the first shortfall will occur in 2018 (C-SPAN, 2005), “the day of reckoning, [when] pensioner benefits will exceed payroll tax receipts” (Washington Post, 2005). In addition, because the current surplus is included in the unified budget, the declining surplus contributes to the increase in the current deficit. The deficit must be paid for through reduced spending, increased taxes, or additional debt, all of which will have a contractual effect on gross domestic product in the medium to long term.

Proposed Solution

President Bush has outlined a solution centered around the establishment of a Personal Retirement Account. This is an opt-in program that will allow young workers to allocate a portion of their payroll taxes to a private retirement account. These accounts will be strictly regulated and offer limited flexibility to workers, but will in any case be segregated from the general social security fund and thus unavailable for the unified budget. As a young worker myself, this sounds like a positive idea at first glance. However, from an economic perspective, this does not solve the fundamental problem, the fact that the ratio of workers to beneficiaries is decreasing. Privatization only makes the problem worse.

Another point of controversy is the way in which benefits increase. They currently increase automatically based on the National Average Wage Index, as described above. This index tracks wages, not inflation, and as such should cause Social Security benefits to echo an overall increase in the nation’s standard of living. Due to expansive economic growth, each next generation must be better than its predecessor. This means that, with a consistent ratio of workers to beneficiaries, it should be possible and reasonable to extend social security benefits indefinitely. Switching to a price indexing model effectively maintains a standard of living in times of transition. While this may seem trivial, it fundamentally changes the philosophy behind the Social Security program from a pension plan,  in which retirees receive benefits similar to the amount they pay into the program, a form of welfare, which only guarantees a basic level of support as determined. at the time of transition. For example, if current benefits had been price indexed at 1990 price levels, then basic services would not include improvements in living standards since 1990, such as wireless communication or access to the internet. “Pricing indexing will keep the purchasing power of Social Security benefits [at current levels], but these benefits will represent a steadily declining percentage of income before retirement” (Munnell & Soto, 2005, p.1). if current benefits had been price indexed at 1990 price levels, then basic services would not include improvements in living standards since 1990, such as wireless communication or access to the internet. “Pricing indexing will keep the purchasing power of Social Security benefits [at current levels], but these benefits will represent a steadily declining percentage of income before retirement” (Munnell & Soto, 2005, p.1). if current benefits had been price indexed at 1990 price levels, then basic services would not include improvements in living standards since 1990, such as wireless communication or access to the internet. “Pricing indexing will keep the purchasing power of Social Security benefits [at current levels], but these benefits will represent a steadily declining percentage of income before retirement” (Munnell & Soto, 2005, p.1).

One popular proposal among politicians from the Democratic Party is to actually use the Jamsostek Trust Fund. If it were possible to recover the nearly two trillion dollars currently owed to the Trust Fund from the general federal budget, this would delay any shortfall until 2042 according to Social Security trustees, or 2052 according to the Congressional Budget Office (Washington Post, 2005). It represents a general federal budget arrangement and generates a surplus each year to pay debts to the trust fund. This is very positive advice that will have many positive side effects. Increasing the national saving rate will tend to lower the interest rate, giving rise to further business investment, raising the aggregate supply curve. Improved growth also tends to delay calculation day 2042, as the forecast includes a relatively anemic annual growth in gross domestic product of only 1.8% (Washington Post, 2005). This will certainly reduce the crisis in the short term. However, the underlying problem of decreasing the worker-to-beneficiary ratio will remain.

Conclusion

The 1983 Social Security Amendment was incorrect. The solvency of the Social Security system was not in serious jeopardy and the payroll tax increase was used to hide the lack of fiscal responsibility in the general federal budget at the time. “In 1983, Congress knew that the new revenue would be used to reduce the budget deficit, not saved to fund future liabilities. But when the time came to pay back Social Security, it was understood that the burden would be shared by taxpayers and the government at large” (Washington Post, 2005).

I believe that social security is a valuable institution that does relatively well and needs little updating. The simple and hard truth is that the worker to beneficiary ratio needs to be raised back to a manageable level. From 1950 to 1997, the average life expectancy at birth for both sexes was 68.1. The same figure in 1997 was 76.5, an increase over more than eight years (Moody, 2006). This would imply that a similar increase in the retirement age over time is appropriate. In 1950, the worker-to-beneficiary ratio was 16 to 1, and the payroll tax was 3%. Benefits, such as provisions for early retirement and disability benefits, were added throughout the 1950s, and taxes continued to increase to 6% in 1961 (Wikipedia, 2006).

Leaving aside the political difficulties of implementation, I propose the following changes. First, the unified budget must be dissolved. Lawmakers must not be allowed to raid the coffers of our national pension system to cover their inability to manage the budget. In return, the federal government had to be pardoned the nearly two trillion dollars they had stolen from pension funds. The Americans were lied to in 1983, but that’s the water under the bridge at this point, and there’s a fair amount of fiscal trouble that would be created by removing the Social Security surplus from the budget as it is.

Second, the retirement age should be shifted upwards to increase the ratio of workers to beneficiaries. It’s politically difficult, but it tackles the problem head-on and definitively. A sliding scale retirement age, with an appropriate definition of benefits for early retirees, should be applied. Including the number of years worked in this formula also seems a fair provision which will partially replace the regressive nature of payroll taxes. For example, a worker with low education who starts working and contributes to the system at the age of 16 is certainly entitled to withdraw benefits earlier than a highly educated, privileged citizen who delays entering the workforce until the age of 30. Not only lower-skilled workers have a shorter life expectancy,

Finally, payroll taxes must be lowered to match the reduced benefit liability. This will provide a stimulus to the economy and boost spending. Basic Trust Fund reserves must be established immediately through the issuance of bonds. Payroll taxes must then be reduced to breakeven, including interest and simple payments on these new bonds. A reduction in payroll taxes will immediately provide an economic stimulus. Savings given to workers will result in additional consumption and raise the aggregate demand curve. Savings provided to employers will result in additional investment, increasing the aggregate supply curve (Tucker, 2004, pp. 284-293).

Both Keynesian and supply-side ideologues should be pleased with this proposal. Additional growth will also help reduce the impact of removing social security surplus receipts on the general budget.

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