Social Security: Apocalypse Soon Or Sooner

Economists generally shy away from predicting growth or interest rates beyond the next four quarters. Longer horizons are considered too hazy for accuracy. But when it comes to the debate over the financial solvency of Social Security and Medicare, 10 years is considered the near term, and 75-year forecasts are just part of the job.

Yet Social Security is so large a program that being off by a fraction can lead to errors with huge fiscal consequences. With 43 million elderly people receiving $428 billion each year--a quarter of all government spending--small mistakes can force big benefit cuts or payroll-tax hikes to make up the shortfall.

Right now, the great danger is that even the government's worst-case scenario may be too upbeat. The pace of real wage gains is the main determinant of how fast Social Security revenues grow. The most pessimistic official projection calls for wages to rise by an average of 0.4% annually over the next 35 years. But the economy has eked out only a 0.1% rate of real wage growth over the past five years. If earnings stay depressed, Social Security cash flow could go negative much sooner than anyone has been willing to admit: 1997.

ROSY AND ROSIER. Unfortunately, the Clinton Administration is still singing Happy Days Are Here Again, despite mounting evidence to the contrary. True, economic assumptions were toned down after the disappointing experience of the 1970s and 80s. But when it comes to economic prognostication, things have a way of going wrong more often than right. "Even the most pessimistic assumptions don't give you any idea of what would happen if the next 25 years matched the last 25," says Roland E. King, chief actuary of the Medicare system until 1994.

Indeed, the numbers have been breaking badly for the government's forecasters. The most widely accepted "intermediate" economic projections still proved too optimistic in eight of the past 10 years. And the last two major attempts to fix the Social Security system--the latest led by Alan Greenspan in 1983--fell short because they were based on overly rosy assumptions. To close the long-term gap expected in just the retirement and disability portion would require a payroll-tax increase of 2.17 percentage points--a huge jump.

Actuaries have had their biggest problems predicting real wage growth, which they have consistently overestimated over the past 20 years. The reasons? The slowdown in productivity growth and the surge in the proportion of compensation going for health-care benefits, which are not subject to the payroll tax. The latest projections bank on a rebound in wage growth, as health-care costs moderate and as productivity grows again. But there's still no proof that real wages are rising (chart).

Changes in life expectancy could also throw all the calculations out of whack. Today's 65-year-old man can expect to live a further 15.3 years, an improvement of nearly two years since 1975. But the latest Social Security report, released on Apr. 3, assumes that life expectancy will grow at half that rate--less than an extra year in all. None of the projections takes into account "what could happen if there is a radical breakthrough in science--if cancer or heart disease were cured, for example," says economist John Goodman, president of the National Center for Policy Analysis.

Another hit to the system could occur if people start living longer once they get sick. So far, AIDS hasn't had much negative effect in Social Security payouts, since HIV-positive people tend to work and pay taxes until they become ill. They then die fairly quickly. But if a more potent drug were developed to prolong life expectancy, "it could add a tremendously high cost to the system," admits Robert Myers, former chief Social Security actuary and deputy commissioner in 1981 and 1982. In fact, disability payments in general are climbing far faster than expected, perhaps because examiners are getting more sympathetic. The disability fund ran out of money in 1992 and 1993, and taxes from the retirement program had to be diverted to bail it out.

Politicians have long counted on the multibillion-dollar surpluses from Social Security to help hold down the budget deficit for the rest of this decade. But if current trends continue, the entire system may be running a deficit of its own--and sooner than anyone expects.

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