The changing demographic profile of the U.S. population is the single biggest factor in the decline of the Social Security fund. People are living longer, the birth rate has decreased and, most significant, the baby-boom generation is nearing retirement.
To look at it from a different angle, in 1960 there were more than eight workers making contributions to Social Security for every retiree receiving benefits. In 1998 the ratio of workers to beneficiaries dropped to about three to one. By 2025 the ratio will be closer to two to one.
At this rate, by 2032, Social Security payments will exceed benefits.
These were the findings presented in the AICPAs Understanding Social Security: The Issues and Alternatives (for more on this study, see AICPA Initiates Debate on Social Security Reform, JofA, Jan.99, page 11).
The good news
Established in the 1930s, Social Security has fulfilled its purpose of reducing poverty among the elderly (see Poor Old Social Security, page 16). In 1959 the poverty rate for elderly people was 35.2%, more than twice the rate of the general population. The percentage of elderly living in poverty in 1996 was 10.8%, lower than the rate for the general population.
Today, approximately 90% of retirees receive a monthly check from Social Security. The average check is about $750. For retirees with the lowest incomes, Social Security provides more than 75% of their total income.
The bad news
The Social Security system was created in the 1930s as a pay-as-you-go system. Early beneficiaries got more out of the system than they put in. Thus they earned an above average rate of return on the contributions they made.
Increases in returns on contributions to the system are tied to population and productivity growth and not to investment returns. Returns on contributions generated in the system have been historically limited by the funds investment in government securities.
If we compare rates of return, future retirees (particularly post-boomer-generation singles, two-earner couples and high-income individuals) will earn below-market returns on their Social Security contributions.
What changes would mean
A discussion of Social Security reform would not be complete without examining how any changes in the system may affect the economy. The study focused on Social Securitys current impact on the labor supply and on savings. It also examined the implications of investing the fund in the stock market.
The study found that although Social Security did not significantly decrease the labor supply, early retirements and the decreased level of employment during retirement could be attributed to the Social Security system.
Similarly, the study does not give a definitive answer on the impact Social Security reform will have on future savings. However, it notes that, because future retirees no longer believe they can depend on Social Security, they are likely to save more.
Currently the Social Security trust fund is invested in interest-bearing government securities. The two factors to be considered in the event the fund is invested in the stock market, either by the government or by individuals, are risk and administrative costs.
Although stocks are inherently riskier than government bonds, higher returns on investment would be expected of stock market investments. Accordingly, the study projected that, even adjusting for risk, higher returns could be obtained from stock investments.
The study also said there would be higher costs associated with administering the trust fund if its in the stock market. If the plan included individual accounts, the costs would be even greater.
The reform options
The reform options fall into three broad categories: reduce benefits, increase revenue or increase the rate of return of assets in the fund. (A brief summary of the effects of these options, Weighing the Alternatives, ran in the January issue, page 11.)
Reduce benefits. Several reform proposals seek to avoid future fund deficits by reducing current and future benefits. Below are three proposals that would reduce benefits.
Across the board cuts. A 70% cut in current benefit levels would eliminate projected shortfalls. Such cuts, however, would increase the level of poverty for current retirees and decrease the rate of return on contributions for future retirees.
Raising retirement age. As with benefit cuts, financial soundness of the fund would improve at the cost of a lower rate of return and higher poverty.
Means testing of benefits. This method, achieved by cutting benefits on the basis of family wealth or income, would increase the programs administrative costs.
Increase revenue. Increases in Social Security revenues could be obtained by the following:
Increasing the payroll tax rate. Payroll tax increases would improve fund solvency. The increase would also reduce net benefits for future retirees.
Increasing the limit on taxable earnings. This proposal would concentrate the burden of reform on high-wage workers. Many people consider this method unfair because high-income workers, particularly younger ones, will receive the lowest rate of return on their contributions.
Using general tax revenues. This proposal would improve the soundness of the trust fund but would most likely result in tax increases, cuts in other government benefits and the loss of popular support for the Social Security system.
Increase rate of return. Most of the proposals for reform include investing the Social Security funds assets in the stock market. Individuals, the government or a combination of both could direct the investment.
The study found that stock market investment probably would improve the financial condition of the fund. However, the higher return would be achieved with a corresponding increase in risk.
Understanding Social Security: The Issues and Alternatives is available on the AICPA Web site at www.aicpa.org .
To order a copy (product code 061059), call 888-777-7077 or fax your order to 1-800-362-5066. Orders may also be mailed to AICPA Order Department, P.O. Box 2209, Jersey City, New Jersey, 07303-2209. The study is $9.95 for AICPA members and $12.45 for nonmembers.