In response to tight economic times, many U.S. workers have chosen to stop contributing to their retirement accounts, thus freeing up money to meet current needs. As a short-term strategy, many will argue it makes sense. But what if workers never return to their previous saving habits and join the millions of other Americans who save too little for retirement? Social Security is already providing a larger share of individual retirement income than it was ever designed to handle. Will Social Security be around to meet the growing needs of mature Americans?
Jason J. Fichtner, Ph.D.
Fichtner is the Acting Deputy Commissioner of Social Security. Previously, he was a Senior Economist with the Joint Economic Committee of the United States Congress.
Andrew Biggs, Ph.D.
Biggs is a resident scholar at the American Enterprise Institute in Washington, D.C., where his work focuses on Social Security policy. He held the office of Deputy Commissioner for Policy and principal Deputy Commissioner for Social Security during the Bush administration.
Peter Diamond, Ph.D.
Diamond is one of the world’s leading experts in economics and a professor at M.I.T. He has focused much of his professional career on the analysis of the U.S. Social Security system.
Is Social Security going bankrupt?
Jason J. Fichtner, SSA: Social Security is not going bankrupt. You hear that story all the time: Social Security is going bankrupt, it is going to be insolvent. That is not actually true. There is money right now in the system to pay full scheduled benefits up to 2041*. After that, based on the Trustees Report, payroll taxes would no longer be enough to pay the fully scheduled benefits, so we would pay partial benefits after that time. That is in 2041*. A lot of things can happen until then.
Peter Diamond, M.I.T.: And as long as there’s payroll tax revenue rolling in, there’s money available to pay benefits. So if the scenario plays out according to the projection, in 2041*everybody on the rolls will get a 22 percent benefit cut. So they’ll still have 78 percent of what’s scheduled.
Now that would be a terrible social outcome if we let that happen. That’s why it’s important to crank up and get the thing fixed sooner rather than later. But because we have dedicated revenue for Social Security, it shows that the problem’s really a manageable one.
Andrew Biggs, AEI: The vast majority of economists agree that due to demographic pressures, Social Security is going to face significant financing problems going forward. The real differences come in how we resolve those problems. Should we resolve them by raising taxes, by reducing benefits, or by increasing retirement age? In general, economists will probably favor increasing the retirement age because it will keep people in the job a little bit longer; it will encourage people to save a little bit more. If you delay retirement by two or three years, it doesn’t simply mean a higher benefit at retirement, it also means two or three years in which you can continue to contribute to your IRA or 401(k) rather than drawing Social Security benefits. Even a few years’ delay in retirement can produce big increases in retirement income.
Social Security is facing insolvency, so we know that taxes are going to increase or benefits are going to be reduced. IRAs and 401(k)s don’t have the participation rates that are really required to give everybody retirement savings, and traditional defined benefit pensions are starting to go away as companies drop them. The key, I believe, is to institute a universal retirement savings program giving every American the opportunity and means to easily save for retirement. The important factors here are to make the programs very simple, so that most workers can easily accomplish their savings. The current 401(k) system is complex for many workers. Many workers don’t understand it; they don’t choose to participate.
What could help improve the system?
Andrew Biggs, AEI: If we want to increase Social Security benefits versus what the system can actually afford to pay, we have two options. One is for people to pay more taxes into the traditional system, the other is for people to pay more into accounts that they would own and control themselves. People are very wary of paying taxes into Social Security because they believe these taxes not truly being saved and invested to pay for their future benefits; they are being used to finance deficits elsewhere in the government.
Given the choice between paying more into Social Security and receiving higher Social Security benefits, and paying more into an account they hold themselves, I think a lot of people will choose to hold an account instead of paying higher taxes. The stock market decline has dealt a heavy blow to the idea of Social Security accounts, but when the rubber meets the road, and we face the choices we have to meet in order to fix Social Security, I believe the idea of accounts may look attractive to some people.
Jason J. Fichtner, SSA: There are several ways you can talk about reforming the system. Now, we at Social Security don’t deal with the policy of reform; that is actually the privy of the White House or the Office of the Secretary of the Treasury, and the Treasury is the managing trustee for Social Security trust funds. But there are several options that you can throw around. One is raising the retirement age. Currently, for those born after 1960, the full retirement age is 67.
People are living longer; obviously, when the program was designed people weren’t living as long as they do now, so you can readjust the age of retirement to take into account the difference between mortality and life expectancy. That is one way to do it. We also could raise taxes to cover the shortfall, or you could reduce benefits. You could change the formula so the benefits aren’t the current structure they are now.
Peter Diamond, M.I.T.: Well, first of all, the system is money in and money out. So, if you’re gonna run out of money given the scheduled benefits, what you need to do is either get more money in or less money out. And you can do any kind of mix of having higher taxes or lower benefits, and you can have higher taxes by raising the tax rate or by increasing the maximum earnings that are subject to tax. Or you could change the definition of earnings. When an employer gives you health benefits, those health benefits are not part of the base for Social Security tax.
Each year in the Trustees’ report, the 75-year projection deficit is reported relative to taxable payroll. That says if we had an increase in the payroll tax starting the next January first, that’s how much it would take for a permanent increase to keep things right for 75 years.
But given the way the system is structured, a year later, when you’re doing a new 75-year projection, it’s going out a year further. You would discover that you hadn’t done enough, because the system has a tilt.
The system has a tilt because we expect people to live longer and longer. We expect mortality rates to be declining. And yet the ages in the system, other than the change that was legislated in 1982 — which raised the age for receiving full benefits from age 65 to 66, and in time, it will go up to 67 — apart from that, there are no adjustments for longer lives, for fewer workers.
Several other countries have adjustments like that. Sweden has adjustments based exactly on projecting life expectancies and Germany has adjustments that are based on the demography, the ratio of the older to the younger population, retirees relative to workers. We don’t have anything like that.
So the system is projecting benefit costs that rise relative to the revenues. But if you don’t change the age for full benefits, then the system gets more and more costly as people live longer and longer. As far as I know, nobody is suggesting seriously that we should just up the payroll tax as of January first by as much as we need; instead, people are proposing various ways to have more revenue coming in and slowly trimming benefits going out.
Would raising the taxable maximum (or tax cap) make a difference?
Jason J. Fichtner, SSA: Right now, you pay Social Security in payroll taxes up to a certain maximum level of income and above that you don’t pay anything. So for 2009, the cap is $106,800. So for earned income between $1 and $106,800, you pay Social Security payroll taxes. Above that, you don’t.
In 2008, that figure was $102,000, and we adjust it every year based on the average wage growth in the economy. So in 2010, it will be higher and in 2011, it will be higher, etc. So individuals right now are taxed on their earnings up to $106,800 for 2009 — it is called the taxable maximum.
Right now, you don’t pay any payroll taxes above that taxable maximum. One of the reform plans being tossed around is to get rid of that taxable maximum, so any earned income, whether it is $1 or $110,000 or $250,000, is taxed at the payroll tax rate. In the 2008 Trustees Report, for the first time, if we had eliminated the payroll tax maximum, it would have solved the Social Security trust fund end balance over the 75-year horizon, just by doing that alone.
Andrew Biggs, AEI: The Social Security tax has traditionally been levied up to a ceiling or a cap. Today the Social Security tax is 12.4% of your earnings on the first $106,800 that you earn. The program has always had this cap. The rationale behind it was that above that level, people would save and provide for themselves on their own. So there is a purpose for the way that the system was structured. If you were to eliminate the cap, that means that people earning higher amounts will be paying more taxes.
However, with the Social Security program, the benefits you receive are also based on those earnings. So if we were to eliminate the cap, somebody, a very highly paid executive, for example, would be paying more in taxes, but they’d also be receiving very, very high benefits in retirement.
In theory, eliminating the cap could eliminate almost the entire Social Security deficit. The problem, though, is, in the short term, eliminating the cap would produce very, very large surpluses within Social Security. And most people who understand the trust fund understand if those surpluses are truly saved, they would be spent on other things in the future. In the future, however, we would owe more benefits than we do today, because all these high earners would receive more benefits then they would under current law. So we could actually face larger deficits in the future then under current law by doing this.
The key is, if you are going to raise taxes, to make sure those taxes are saved to help benefits in the future. That is something the trust fund doesn’t currently do very well and I think most people realize there might be better ways to do it.
So on the whole, I think raising or eliminating the taxable maximum is out of character with how and why the system was created in 1935 by President Roosevelt. It would have some distortionary effects on the economy by creating disincentives to work and to save and it could undermine public support for the system. That said, it is almost inevitable that some increase in the cap will be considered as Social Security reform is put forward. The question is, will it be a modest increase or will people attempt to eliminate it entirely? I think the latter would probably be a bad step.
What about personal retirement savings accounts?
Andrew Biggs, AEI: Back in 2005, President Bush proposed reforms to Social Security, one part of which would have been the option for workers to voluntarily put part of their Social Security taxes in a personal retirement savings account similar to an IRA or a 401(k). Now the decline in the stock market today has obviously dealt a very heavy political blow to the idea of personal accounts as part of Social Security. At the same time, though, I’ve analyzed how people would have fared had personal accounts been instituted and it shows that as the plans were written, very, very few people would have lost money. The reason for that is the accounts as proposed by President Bush would have had a life-cycle account portfolio in them, meaning they would automatically shift from stocks to bonds as workers neared retirement.
So workers retiring today when a stock market is down would have had very, very little of their money in stocks. Younger workers would have taken significant losses on their Social Security accounts, but they would have two or three decades to make up for those losses before they retire. So the politics are very, very difficult for Social Security accounts right now.
Peter Diamond, M.I.T.: Social Security gets the payroll tax revenue. It also gets some of the income tax revenue from taxing the benefits of retirees and disabled workers; that’s a big part of our ability to go on paying benefits as projected till 2041*.
So if some of that payroll tax revenue doesn’t go into the Social Security trust fund, but instead goes into individual accounts, then there’s less revenue flowing into Social Security and the trust fund runs out of money sooner, because of the individual accounts, rather than later. Under the kinds of proposals that President Bush was looking at for individual accounts, for just the individual account part, the trust fund would hit zero about a decade earlier.
Now the typical plan for Social Security with individual accounts sidesteps that problem by assuming the Treasury will just provide the money to make up that shortfall. And the question of where that money will come from is a key question. Proponents like to pretend that it will come from fraud, waste, and abuse in the federal budget, as if there were a lined item called, “Fraud, Waste, and Abuse.” But most likely, it would come from increases in the public debt. And even before we had the crisis that we have now, which will greatly increase the public debt in these projections, these proposals resulted in significant increases in the amount of debt outstanding; that would potentially have been a financial problem.
*Note: On May 12, 2009, the Obama Administration reported that the Social Security trust fund will be exhausted in 2037, four years earlier than predicted.
These comments were taken from extended interviews conducted in February, 2009.