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The Old-Age, Survivors and Disability Insurance (OASDI) program, as authorized under the Social Security Act, provides protection against loss of earnings due to retirement, death or disability. It constitutes the largest "entitlement" program in the annual budget of the federal government and touches the lives of almost every American citizen.
During 1993, an estimated 135 million people worked in jobs covered by the OASDI program and paid OASDI payroll taxes on their earnings. At the end of December 1993, 42.2 million people were receiving monthly benefits under OASDI.
In Fiscal Year (FY) 1993, OASDI expenditures totaled $304.6 billion. Net benefit payments accounted for $298.2 billion of that amount. At the same time, the OASDI program took in revenue of $351.4 billion. Payroll taxes on working Americans provided $318.4 billion. Another $6.2 billion in revenue came from income taxes on Social Security benefit payments, and, under the accounting rules of the federal budget, the OASDI trust funds managed by the Social Security Administration also earned interest of $26.8 billion on their accumulated assets (held in the form of bonds issued by the U.S. Treasury).
For purposes of the official federal budget, then, OASDI registered an overall surplus of $46.8 billion in FY 93 alone. This increased the mounting "surplus" in the OASDI trust funds to $365.9 billion. In fact, the programs' Board of Trustees projects that those trust fund reserves will continue to grow to a total of just over $1 trillion in current dollars ($790 billion in constant 1994 dollars) by the beginning of calendar year 2003. That will amount to approximately 197 percent of estimated annual OASDI expenditures at that time. The Board's 1994 Annual Report forecasts that the trust funds' assets will reach a peak of 241 percent of annual OASDI expenditures at the beginning of calendar year 2012. Total trust fund assets at that time will equal approximately $1.2 trillion in constant 1994 dollars.
On the surface, those budget figures suggest that the OASDI portion of Social Security (the Medicare program has a separate trust fund) is on a sound financial footing and will continue to meet the income security needs of millions of retired and disabled Americans for many decades to come.
However, the long-range financial future for Social Security is more troubling. Beginning around 2010, the program's "cost rate" (the ratio of expenditures to taxable payroll) will begin to climb rapidly. Reflecting both the maturing of the baby boom generation and the declining fertility rates of recent decades, the number of Social Security beneficiaries will start to increase more quickly than the number of covered workers and the latter's taxable earnings. Starting in 2013, the OASDI cost rate will begin to exceed the programs' "income rate" (the ratio of taxable income to taxable payroll), i.e., payroll taxes alone will no longer be sufficient to cover annual costs. This shortfall in annual operating income (excluding the effect of "interest" earned on accumulated OASDI trust fund assets) will continue for each future year from 2013 through 2068 (the end of the 75-year long-term projection period used by the OASDI Board of Trustees). In 2068, the shortfall will reach 5.6 percent of taxable payroll.
Crediting the OASDI trust funds (for federal budgetary purposes) with interest earnings on previously accumulated OASDI assets "invested" in special Treasury bonds would still result in further growth of the combined OASDI trust funds for another six years. But by 2019, even OASDI trust fund income under this broader definition will start to fall short of overall OASDI program expenditures. At that point, Social Security benefits could only be paid in full by redeeming the bonds credited to the OASDI trust funds. Over the next decade, the value of OASDI assets will decline steadily, and the OASDI trust funds will be depleted by 2029.
Thus, the projected income of the OASDI trust funds (even as measured under rather lax federal budgetary rules) will only be adequate to ensure timely payment of projected benefits for about the next 35 years. The program fails to meet the long-range test of close actuarial balance (projected income within 5 percent of the long-term cost rate over the next 75 years). The difference between OASDI's income rate and cost rate for the period from 1994 to 2068 will result in a long-range average deficit of 2.1 percent of taxable payroll. (The cost rate will grow from the current level of 11.6 percent of payroll to 18.9 percent by 2068, while the current income rate of 12.8 percent will rise to only 13.3 percent over the next 75 years.)
The fact that the long-term liabilities of OASDI cannot be met with its current structure of taxes and benefits will lead to serious disruptions in the lives of both working and retired Americans. Additional budgetary pressure to bail out the imminent bankruptcy of the Medicare Hospital Insurance Trust Fund (also funded by the payroll tax) will further sharpen the intergenerational conflict between retirees resisting benefit reductions and younger workers burdened by the prospect of both rising payroll tax rates and diminishing returns on them.
Leaving the status quo unchanged will set up an unattractive menu of policy choices to be made in the not-too-distant future: punitive tax hikes, diminished job opportunities, sharp reductions in retirement benefits, a budgetary squeeze on other government programs and/or soaring budget deficits. The later that necessary adjustments occur, the more drastic and extreme they will be. An earlier modification, however, would be stretched out over a longer period and provide more lead time for younger workers to adjust their retirement plans.
Confronting the imbalance in Social Security's long-term financing without signing on to growth-retarding tax hikes
will require either reducing the future cost of benefit promises, finding more efficient ways to finance them, or encouraging alternative means to enhance the income security of older Americans. The policy options outlined in this monograph, include (1) gradually reducing the real value of retirement benefits, (2) relying on lower payroll taxes to stimulate greater overall economic growth, (3) making the budgetary effects of Social Security funding more transparent and controllable on a pay-as-you-go basis, (4) privatizing investment of "surplus" revenue in the OASDI trust funds, (5) enhancing self-help options to increase retirement income through wider use of Individual Retirement Accounts (IRAs) and (6) eliminating the earnings test penalty that discourages older Americans from continuing to work and increase their income.
Stephen Entin points out that with the ratio of workers to retirees continuing to decline in the decades ahead, we face a choice between reducing scheduled increases in benefit levels and increasing the payroll tax rate. After noting that higher payroll taxes would mean reduced employment levels, Entin suggests several ways to gradually trim the real growth of benefits and avoid such tax hikes. One approach would change the method of indexing the "bend points" of the Social Security benefit formula. Another would further increase the normal retirement age for full benefits. (Younger retirees could still receive actuarially reduced benefits.) A third alternative would revise the benefit formula by adding a third bend point (with a low replacement factor) and trimming the growth of one of the current earnings brackets (the one with the highest replacement factor). Absent such changes, current benefit formulas would cause the real dollar value of retirement payments to rise sharply over time.
Aldona Robbins emphasizes that the burden of Social Security payroll taxes has grown much greater over the last decade and particularly so for low and middle-income Americans. These higher payroll taxes reduce take-home pay, increase labor costs and lead to lower levels of employment. Robbins points out that workers will also face higher income taxes in later decades to help redeem government debt obligations to the OASDI trust funds. She concludes that reducing payroll tax rates would expand the economic base and lessen the long-term burden of financing future retirement benefits. Moreover, such a tax cut holds greater potential for keeping Social Security solvent than do attempts to accumulate "surpluses" of government debt obligations in OASDI trust funds via higher payroll taxes.
Stephen Moore criticizes the federal budget treatment of Social Security. He finds that moving the OASDI programs completely "off budget" would not prevent the squandering of their trust fund reserves, but would further hinder efforts to establish budget priorities and control overall federal spending. Rather than pre-fund future benefit obligations, Moore would put OASDI on a pay-as-you-go basis and either make periodic adjustments in payroll tax rates or allow IRA-type private investments of annual "surplus" payroll tax payments.
This author observes that the essential task remains how to stabilize the OASDI programs' long-term finances by building up sufficient reserves for the future, but at the same time avoid further political manipulation of such funds. Since we cannot hope to reduce significantly the future benefit levels that will make payroll tax financing increasingly burdensome on a pay-as-you-go basis yet futile on a pre-funded basis, we must develop a private-sector-oriented alternative to escape the horns of this dilemma. We should allow future retirees to gradually turn an increasing share of their payroll taxes into personal savings opportunities that capture higher rates of return in the private sector. Once conversion of the projected payroll tax surplus was well underway, workers could be offered another option: they could redirect additional amounts of their payroll taxes into personal savings and investment accounts -- in exchange for offsetting actuarial reductions in their future claims under the Social Security retirement program.
Gary Robbins emphasizes the need to expand tax incentives for private individual saving, the second most important source of retirement income. Such saving has become more difficult in recent years due to slower wage growth, a rising tax burden and restrictions on eligibility for tax-free IRAs. Robbins recommends making such savings vehicles available to all Americans and indexing the maximum contribution level of $2000 per year. He would add the option of "back-ended" IRAs (initial contributions are taxed immediately but accumulated earnings can be withdrawn tax-free after five years). Robbins predicts that such measures would create new saving and investment, reduce the cost of capital, generate greater economic growth, provide older Americans with a more secure retirement and reduce their dependency on Social Security.
Dorcas Hardy argues that repealing the Social Security earnings test, which penalizes older Americans who remain in the labor force, would expand their options and encourage them to augment their retirement income. Ending this barrier to work would make the retirement system fairer, help lower-income retirees supplement their limited financial resources and increase the pool of experienced and productive workers. Moreover, it would allow more older Americans to support themselves, retain their independence and rely less on the overstretched commitments of the Social Security trust funds.
Although the contributors to this monograph offer different approaches for dealing with the chronic, long-term financial bind confronting the Social Security retirement program, they all agree that we cannot afford the risks of the status quo. To at least some degree, each of the six major reforms outlined herein can be combined with other ones.
The most important step, however, is to chip away at the glacial mass of political inertia that has frozen the essential components of Social Security policy since 1983. The series of difficult compromises enacted by Congress that year (based on recommendations of the National Commission on Social Security) may have temporarily solved a short-term financial problem. They failed, however, to head off the more insidious, longer-term crisis stemming from the unresolved contradictions in the retirement system's underlying structure. If the dangerous imbalance between Social Security's promises and its resource limitations is allowed to keep growing undisturbed just beneath the surface, the dreams and aspirations of both retired and working Americans several decades from now will be crushed in its tidal wave of debt.
The task ahead will be long and arduous, but the sooner that we get started, the more time we will have to complete it. The chapters that follow offer intellectual down payments to reclaim our highly-mortgaged future.
1. Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 1994 Annual Report (April 11, 1994), Table II.C5, pp. 46, 47.
2. Ibid., p. 24; Table II.F4, p. 86; Table III.B2, p. 176; and Table III.B3, p. 178.
3. The Disability Insurance (DI) Trust Fund portion of the overall OASDI social security program is projected to be exhausted in 1995. However, this analysis focuses upon the combined financial condition of the Old-Age and Survivors Insurance (OASI) Trust Fund and the DI Trust Fund for a number of reasons. The DI program is a small fraction of overall OASDI expenditures ($34.6 billion in FY 93, or a little more than 11 percent of OASDI outlays). The OASDI Board of Trustees has recommended that Congress reallocate to the DI fund a larger share of the overall OASDI tax rate. This action is likely to be carried out in the near future, before the DI program runs out of money. If so, the total revenue of the reconfigured OASDI program will be adequate to cover the needs of both OASI and DI for at least two, if not three, more decades. Similar reallocations of OASDI taxes between the two trust funds were approved in 1977 and 1980. In 1981, Congress authorized the OASI Trust Fund to temporarily "borrow" from the DI Trust Fund. Thus, although the contributors to this monograph recognize that the DI program itself is in need of major reform, their overall analyses will assume that the DI and OASI trust funds will continue to operate in tandem. The combined trust funds (OASDI) represent what Americans usually refer to as "Social Security," and the financial condition of OASDI as a whole will determine the future of its various retirement and disability programs.
4. Redeeming Treasury bonds credited to the OASDI trust funds, however, will still require raising new funds within the overall federal budget -- either through higher taxes or making offsetting expenditure reductions in other government programs. Without such new sources of money, the remaining policy alternatives would consist of reducing the total amount of OASDI benefit payments, diminishing their real value through inflation or defaulting on the federal government's debt obligations.
5. The duration of long-term solvency for the OASDI trust funds has steadily deteriorated since the 1983 Amendments to the Social Security Act. After the 1983 legislation, the combined OASDI trust funds were projected to remain in long-term actuarial balance for the next seventy-five years (until 2058). The 1989 Annual Report of the OASDI Board of Trustees projected those trust funds to run out of money by 2046. The year of insolvency was moved up to 2041 in the 1991 Annual Report and to 2036 in the 1993 Annual Report.
6. The Board of Trustees for the Medicare program estimates that the Federal Hospital Insurance Trust Fund, which pays inpatient hospital expenses for the elderly, will be able to pay benefits for only about seven more years and is severely out of long-term actuarial balance. Board of Trustees of the Federal Hospital Insurance Trust Fund, 1994 Annual Report (April 11, 1994).
7. For example, in response to the latest Annual Report of the OASDI Board of Trustees, then-House Ways and Means Committee chairman Dan Rostenkowski (D-IL) proposed on April 19 another traditional "spread the pain" package of tax hikes and benefit reductions to deal with the financial problems of the Social Security system. The Rostenkowksi legislation (HR 4245) would increase OASDI payroll taxes to a combined employer/employee rate of 14.7 percent by 2024 (the current rate is 12.4 percent), and hike them again to a combined rate of 16.3 percent by 2058. The bill would increase taxes on Social Security income by lowering the annual income thresholds at which retirees are taxed on 85 percent, rather than 50 percent, of their benefits. HR 4245 would also make a small, one-time cut in the annual cost-of-living adjustment for beneficiaries; move up the date at which the normal retirement age is increased to 67; and, beginning in 2003, phase in a slight reduction in the benefit formula for future retirees with average or above-average earnings.
Competitive Enterprise Institute | 1899 L ST NW Floor 12, Washington, DC 20036 | Phone: 202-331-1010 | Fax: 202-331-0640