Social Security: If It Ain't Broke, Don't Tinker

Social Security is supposedly in long-term demographic crisis--too many retirees living longer, not enough wage earners to pay the freight. As a result, there have been calls for reduced Social Security payouts, deferred retirements, perhaps even means-testing. But a closer look at the economic assumptions behind the Social Security Trustees' Report reveals a very different sort of crisis--one that calls for different solutions.

Social Security is financed by payroll taxes. Unless we raise tax rates, growth in payroll-tax receipts will depend on growth in taxable wages. The trustees project likely annual real wage growth of just 1% per year over the next 75 years. By contrast, during the past 75 years, annual real wage growth was about 1.7%. Because of compounding, this seemingly small difference puts the economy on a wholly divergent growth trajectory. With 1% real annual wage growth, Social Security will be hundreds of billions in the red. With 1.7% growth, the system will be in the black forever.

Why the trustees' pessimism? Wage growth has indeed been dismal during the past two decades. From 1953 to 1973, annual productivity grew by 2.3%, and wages grew annually at 2%. But in the slow-growth decades from 1973 to 1993, while annual productivity grew at just 0.9%, real wages actually declined--an average of 0.2% per year.

PRODUCTIVITY. The key question is whether coming decades will resemble the fat years or the lean ones. Here perhaps is some good news. First, 1973-93 had unusual demographic trends unlikely to be repeated. Baby boomers and women flooded into the workforce, leaving less wage per worker. Baby boomers, male and female, are now more experienced and presumably more productive workers. Women workers are now being paid wages closer to their male counterparts. On both counts, the one-time depression in wages should be reversed.

A second source of lower wages has been the galloping increase in the cost of fringe benefits. Wages are subject to Social Security taxes; benefits are not. Here again, the recent past does not predict the future. One way or another, via market forces or government regulation, the escalation in health premiums will level off. The other major fringe benefit, pensions, is already declining as a share of total compensation.

Third, many economists expect the boom in information technology to translate, at last, into higher productivity. Economic history suggests long lags between the introduction of new, productivity-enhancing technology and its broad economic diffusion. In addition, as Massachusetts Institute of Technology economist Frank S. Levy notes, the productivity gains of the 1950s showed up almost immediately in higher purchasing power because they were concentrated in consumer goods. The productivity improvements of the 1980s and '90s, in contrast, have been in producer technologies. However, as computers proliferate and information technology produces productivity gains in everything from banking and retailing to telephone service, these gains will likely yield gains in real wages, too.

"MORONIC." Offsetting this optimism, however, are two other factors. First, income distribution has become increasingly unequal. If that trend continues, too few of the productivity gains will show up in pay packets subject to payroll taxation. Moreover, despite the new competitiveness and resulting low inflation, the Federal Reserve seems determined not to let the economy reach its full growth potential. But here the solution is not to wreck Social Security. It is rather to pursue policies that reverse the growing income inequality and permit greater economic expansion.

Nobody, of course, can predict the rate of wage increases 75 years into the future. As one expert working on the Social Security actuarial assumptions confesses, on deepest background: "The whole exercise, really, is moronic." During the past 75 years, we experienced one entirely unanticipated wage collapse, the Great Depression; an equally unexpected stimulus to wage growth, World War II; and a third unpredicted slowdown after 1973.

In truth, even under pessimistic assumptions, Social Security will remain nicely in balance for at least the next 20 years. Whether the system goes into the red after that depends on trends nobody can forecast with certainty. Rather than hack away at Social Security, Congress should legislate standby adjustments to take effect only if the doomsayers prove right. We should continue to pursue economic expansion and rising wages--both for Social Security and for their own sakes.

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