7.16.2008

THE FUTURE OF SOCIAL SECURITY

SOCIAL SECURITY AND THE ELDERLY

Since the beginning of time, people have sought economic security to provide for their own well being during the course of their lives. The traditional sources of economic security come in the form of personal assets, labor, family and charity (DeWitt, 2003). The ancient Greeks would keep stocks of olive oil to provide nourishment in times of famine. The feudal governments of medieval Europe provided economic security through an exchange between feudal lords and serfs of labor for physical protection. One of the most significant forms of economic security has come in the form of family support.

The elderly in our modern age have faced many sweeping changes that have affected the traditional forms of economic security. Three “important demographic changes happened in America beginning in the mid 1880’s that rendered the traditional systems of economic security increasingly unworkable (DeWitt, 2003).

1. The Industrial Revolution

America was transformed from an agrarian society to a more urbanized society. Workers on a farm were self employed and relied on their own labor for sustenance. A person’s work on the farm directly related to their own ability to survive. Their well being was thus directly under their own control.

The switch to an industrial society has created a setting were one’s economic security is laid upon forces outside of your control. Such forces include economic recessions, layoffs, and failed business ventures. During this time the American society dramatically shifted in demographics, with a much larger percentage of the population living in cities instead of small rural communities.

2. Family Structure Altered

The agricultural society prior to the 1930’s created a strong core of support for the elderly in the form of an extended family. Families lived in much closer proximity in this era and children were able to care for their parents when they became unable to perform the physical labor found of a farm. The switch to a more urbanized society led to the decline of the extended family to the form of the nuclear family.

3. Increased Life Expectancy

The rapid increase of technology as a result of the industrial revolution had many benefits to the quality of life people enjoyed. Advances in pubic sanitation and medicine led to large increases in life expectancy. The obvious result is a large increase in the elderly population.

HISTORY OF SOCIAL SECURITY

The first programs resembling social security can be found as far back in American history as the Civil War. At the conclusion of the war, there was a large percentage of the population who were disabled, widowed or made orphans. The people in general felt the need to care for these persons through generous pensions. The Civil War pension program began in 1862 and was limited in the fact that it did not extend itself to the general public. This program expanded such that in 1894 military pensions accounted for 37% of the entire federal budget (DeWitt, 2003).
The Civil War pension program provided a model for the future social security program as we know it. “Following the outbreak of the Great Depression, poverty among the elderly grew dramatically” (DeWitt, 2003). At the time it was estimated that in 1934, over half the elderly persons in America lacked sufficient income to provide for themselves. To combat this rising problem, as many as 30 states began limited pension related programs by 1935. Benefits were extremely limited however, and only 3% of the elderly actual received any actual support.
Social Security as we know it today came as a result of the Great Depression. The aforementioned demographic changes coupled with the Great Depression created a large demand amongst the populace of America for a government system to provide for economic security.

HOW IT WAS CREATED

The Social Security Act was created by President Roosevelt and passed by Congress as part of Roosevelt’s New Deal. Roosevelt signed the Act into law on August 14, 1935. “This act provides benefits to retirees and the unemployed, and a lump-sum benefit at death. Payments to current retirees were (and continue to be) financed by a payroll tax on current worker’s wages, half directly as a payroll tax and half paid by the employer” (Social Security Act, 2006). The Act has undergone numerous amendments and changes since its creation.

ORIGINAL PURPOSE

The purpose of Social Security was to address the issues of economic security aforementioned by “creating a work-related, contributory system in which workers would provide for their own future economic security through taxes paid while employed” (DeWitt, 2003). In theory, Social
Security is a government mandated retirement program designed to help the elderly. It is important to note that at its inception, Social Security did not cover the disabled or medical benefits. The sole purpose of Social Security was to provide economic security for the elderly.
There were no major changes to Social Security until 1950. The three person board set to oversee the program was replaced by the Social Security Administration, headed by a Commissioner. Amendments were made to the program to cope with the effects of inflation to those on a fixed income.

Another significant change to Social Security occurred in the early 1980’s. In 1983 Amendments to Social Security signed into law by President Ronald Reagan, a previously enacted increase in the payroll tax was accelerated, additional employees were added to the system, the full benefit retirement age was slowly increased, and up to one-half of the value of the Social Security benefit was made potentially taxable income (Social Security Act, 2006). These actions led to a large surplus of funds which were then invested into a trust fund. The government uses the surplus funds to purchase special bonds from itself for the purpose of increasing the value of the trust through interest payments.

CURRENT STATUS OF SOCIAL SECURITY

Medicare, Medicaid, and Social Security currently account for nearly 10% of the GDP of the United States. In 2002, the cost of these programs amounted to nearly half a trillion dollars.

COMPLIANCE WITH ORIGINAL PURPOSE

The Social Security program has seen numerous changes to its original purpose. In 1954 President Eisenhower added a disability insurance program to “help” the “public with additional coverage during economic insecurity" (DeWitt, 2003). This amended the original Social Security program to provide benefits to disabled workers between the ages of 50 – 64. In 1960 President Eisenhower made further changes to allow disability payments to all disabled workers of any age and to their dependents.

On July 30, 1965, President Lyndon Johnson signed into law the most significant changes to the Social Security program with the creation of the Medicare bill. This law gave the Social Security Administration (SSA, 2006) the responsibility to administer a new government medical insurance program. Medicare extends health coverage to nearly all Americans aged 65 or older.

RESULTS OF DEVIATION

The added amendments to the Social Security program demonstrate a deviation from the programs original purpose. Beginning in 1972, the public began to become aware that Social Security was facing serious financing problems due to the added programs. Social Security was
facing a funding shortfall due to the increased costs associated with the amendments, changing demographics associated with the baby boom generation, and a bad economy during the late 1970’s. The SSA reported in 1975 that “the Trust Funds would be exhausted by 1979” (DeWitt,
2003).

The financing shortfall was addressed in the 1977 Social Security Amendments, which raised payroll taxes and increased the wage base to a much larger percentage of Americans. These fixes were temporary band aids, as their effect was estimated to only balance the program for the next 50 years. Appendix A demonstrates the growth of the Social Security program through 1937 until 2002.

FUTURE OF SOCIAL SECURITY

Since the 1983 Amendments to Social Security, total revenue into the program has exceeded total expenses. In 2004, total revenue exceeded expenditures by more than $150 billion (OASDI, 2005). If there are no changes in current law regarding taxes, benefits, and the retirement age in
Social Security, it is anticipated that expenditures will exceed revenue beginning in 2018. The surplus revenue generated up until 2018 will be completely exhausted according to most estimates between 2041 or 2052 (SSA, 2006). The most significant change resulting in these results is due to the retiring “baby boomer” generation. Through shifting demographics, the percentage of people receiving benefits will be greater than the amount of people contributing to fund those benefits.

IF THINGS DO NOT CHANGE

According to the Government Office of Accountability (GAO, 2006), the status of Social Security in future years is not promising. By 2080 Medicare, Medicaid, and Social Security will account for 25% of the GDP. The future of the Social Security Program is best summarized by a report issued by the GAO: “GAO’s simulations lead to an overarching conclusion: current fiscal policy is unsustainable over the long term.

Absent reform of the federal retirement and health programs for the elderly -- including Social Security, Medicare, and Medicaid – federal budgetary flexibility will become increasingly constrained. Assuming no changes to projected benefits or revenues, spending on these entitlements will drive increasingly large, persistent, and ultimately unsustainable federal deficits and debt as the baby boom generation retires” (GAO, 2006).

FUTURE IMPLICATIONS

Nearly everyone is in agreement that Social Security will face issues in the future that will need to be resolved. Funding for the system will become a serious problem in the near future, and actions must be taken to continue offering benefits promised by the program. In recent years, there has been increased debate on dealing with these issues. Politicians regard Social Security as the third rail of politics. President Bush attempted to offer reform to the Social Security program after his 2nd term election as did President Clinton before him. The Congress and people of the United States did not agree with the changes he proposed to the system, the most notable change being Privatization accounts. People who receive benefits to from the system represent a large voting bloc of the United States. Indeed, the largest and most powerful political action group is the American Association of Retired Persons (AARP, 2005).

There are many different proposals to amend the Social Security program. Only two will be discussed here. The two proposals are that of taxation and privatization.

RAISE TAXES

In order to meet the expected revenue shortfall that is projected to occur around 2020, revenue will have to be increased in the form of taxes to fund the program. Thomas N. Benthell, noted economist advances the following nine ways to keep the system solvent:

1. Raise the cap to 90% of taxable earnings. (This essentially taxes higher income workers).
2. Increase payroll tax rate. (This would affect lower-wage workers adversely).
3. Raise taxes on benefits.
4. Preserve tax on estates over $3.5 million.
5. Extend coverage to newly hired state and local government employees.
6. Invest a portion of the trust funds.
7. Adjust the Cost of Living Allowance.
8. Increase Nominal retirement age to 70.
9. Index benefits to prices, not wages. (Benthell, 2005).

A few of these changes could cover the expected shortfall alone, while a combination of two or more would have the same effect. These changes can be summarized into the concepts of raising taxes, reducing benefits paid, and increasing the retirement age. These are the only means available to those who oppose any structural changes to Social Security to keep the system afloat in the future. All people who support these aforementioned proposals are generally opposed to privatization of Social Security.

REASONS AGAINST PRIVATIZATION

Opponents to privatization of Social Security are numerous. One opposition group who is generally more famous for their skilled argumentation against privatization is the Social Security Network also known as the Century Foundation. The arguments of this group are extensive and each of the following points is exhaustively backed with supporting data. Only a brief summary of the groups 12 points will be listed:

1. Today’s insurance to protect workers and their families against death and disability would be threatened.
2. Creating private accounts would make Social Security’s financing problem worse, not better.
3. Creating private accounts could dampen economic growth, which would further weaken Social Security’s future finances.
4. Privatization has been a disappointment elsewhere.
5. The odds are against individuals investing successfully.
6. What you get will depend on whether you retire when the market is up or down.
7. Wall Street would reap windfalls from your taxes.
8. Private accounts would require a new government bureaucracy.
9. Young people would be worse off.
10. Woman stand to loose the most.
11. African Americans and Latin Americans also would become more vulnerable under privatization.
12. Retirees will not be protected against inflation (Anrig, 2004).

PROPONENTS PREDICTIONS

Opponents to privatization feel that there are less costly and easier methods to reform Social Security than through privatization. Such persons are not ignorant to the fact of Social Securities impending problems, only they do not feel privatization is the answer.

LET’S PRIVATIZE SOCIAL SECURITY

Privatization gives individuals the ability to set up retirement accounts in privatized or non government systems. This method potentially gives individuals the means to earn much higher rates of return than offered under Social Security. Workers would choose on their own which securities or other investments their accounts would be entrusted in. In addition, the amount of money placed into the retirement account could be passed down and inherited by the workers’ heirs. Sweden, the United Kingdom and Chile are examples of nations which have a privatized system and are cited by proponents of privatization to bolster their argument.

PROPONENTS

Privatization gives people the ability to invest their money in the way they feel is best. Proponents feel that individuals are the best decision makers about how much risk they should take when investing their monies. Proponents have also lamented over the fact that Social Security has always offered much lower rates of return than is available through other investments. It should be noted that most proponents of privatization do not favor 100% removal from the current Social Security system. The most popular proposal put forth is a combination of the two systems.

REASONS FOR PRIVATIZATION

Numerous calculations have been made regarding the benefits of privatization. One notable think tank has made an exhaustive investigation into the benefits of privatization and came up with the following scenario: “The Heritage Foundation calculates that a 40 year old male with an income of just under $60,000, will contribute $284,360 in payroll taxes to the Trust Fund over his working life, and can expect to receive $2,208 per month under the current program. They claim that the same 40 year old male, investing the same $284,360 equally weighted into treasuries and high-grade corporate bonds over his working life, would own a PRA at retirement worth $904,982 and paying an annuity of up to $7,373 per month” (The Heritage Foundation, 2006). It should also be noted that with the increased amount of funds available to retirees, their spending would increase, thus boosting economic conditions.

PROPONENTS PREDICTIONS

Proponents feel that Social Security does not offer retirees the amount of money they should have underneath privatization. “Too many Americans reach retirement age without a nest egg adequate to meet their need. Social Security, pensions, and retirement accounts should work
together to help Americans amass the assets necessary to provide income security in retirement, without burdening future generations” (The Heritage Foundation, 2006). Furthermore, proponents feel that if privatization does not occur, Social Security funding issues in the future will become much more extreme. For example, the choice will need to be made in the future to raise taxes, decrease benefits, or raise the retirement age in order to fund Social Security. All of these choices will be very hard for politicians to implement.

CONCLUSION

The privatization program has the benefit of not raising taxes to fund Social Security. This point is the proponent’s main emphasis for supporting privatization. In supporting the privatization of Social Security, President Bush has also used this point as a reason to support privatization. This benefit is exactly offset however, because the President has not promised a reduction in government spending to pay for the reform. Therefore, whatever the benefits there are from tax dollars being diverted to the private sector are thwarted from the increased government borrowing. Reforming Social Security in the manner put forth by privatization will take a lot of money. The money put into the reformation will not be less than the money saved through private accounts. A numerical analogy written by Robert Murphy can be found in Appendix B and illustrates this point well.

As we have seen, Social Security has strayed from its original purpose. Whether it should exist or not is not part this current argument. All persons who have paid into Social Security or are currently receiving benefits have been cheated by their government. For the last several decades people have in good faith been paying a substantial part of their incomes into Social Security with the original idea that it was solely for the benefit of the retirement. By adding other persons and programs to the fund, it took away from the surplus of those who paid in. As the surplus decreased to pay for those who had not contributed, taxes had to be raised on current contributors to make up the difference.

The government has so entirely squandered the fund, that the surplus is gone, and those who are justly receiving the monies they paid in, are being paid by current workers. This is the textbook definition of a Ponzi scheme. I believe that all people who paid into the system have a right to receive the monies they paid in. One possible exit from this system is through a sunset policy. All persons who are born after XX/XX/XXXX will not pay Social Security Taxes nor receive benefits, it will be a cutoff age to ensure a smooth transition. To cutoff benefits to those who justly paid into the system in good faith would result in chaos. Needless to say, this is a complex issue, and one that the Federal government should never have become involved in.

APPENDIX A


APPENDIX B

At the risk of boring the reader, let's go over a hypothetical example (with nice round numbers) to illustrate my point. Suppose that initially the government of a large country takes in $600 billion in regular tax revenues, and another $200 billion in Social Security contributions (from both employers and employees). At the same time, this government spends $100 billion in Social Security benefits, while it spends $750 billion on everything else (such as education, defense, welfare, etc.). Thus the Social Security system has an annual surplus of $100 billion ($200 billion minus $100 billion), while the Treasury has a deficit of $150 billion ($600 billion in regular tax revenues and $750 billion in non-Social Security expenditures).

In order to finance the deficit, every year the government takes the extra $100 billion raised by the Social Security system and spends it, and places a Treasury Department IOU in the "trust fund." Even so, the government is still short $50 billion every year, and so it borrows this money from the private sector in order to pay its bills. Now a reformer comes along and signs legislation that allows all of the money raised by the Social Security tax (i.e., the contributions of employers and employees) to be diverted away from present government spending, and into private accounts. Proponents rightly point out that this has raised the supply of savings by $200 billion, and will thus tend to reduce interest rates and foster private investment.

However, if the government continues to pay the same level of benefits to current retirees, and if it refuses to cut spending on other government programs, then it must now borrow not $50 billion but rather $250 billion from the private sector, in order to finance its activities. (This is because total current expenditures are still $850 billion, while the government now only has the general tax revenue of $600 billion.) There is simply no way around this; if the government spent all of the Social Security revenues under the status quo, then it must borrow that much extra whenever any portion of these revenues are diverted away from current spending. Thus the $200 billion in extra savings channeled into the private sector is exactly offset by an increased (official) deficit of $200 billion.

Interest rates on net will not fall, because the rightward shift of the supply curve of loanable funds is matched perfectly by a rightward shift in the demand curve for loanable funds. Really the government has done nothing but placed the $200 billion into the loan market with its left hand, in order to borrow it right back with its right hand. The only difference between the status quo and the "reformed" situation is that Treasury IOUs now pile up in the hands of private creditors rather than in the Social Security "trust fund."

Murphy, Robert. “Bush’s Impossible Social Security Plan”. Ludwig Von
Mises Institute. May 12, 2005. Accessed on December 5, 2006.
http://www.mises.org/story/1813

REFERENCES AND WORKS CITED



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