By Laura D'Andrea Tyson
Is the Social Security system facing a crisis? President George W. Bush certainly wants us to think so. Indeed, he recently warned that the "crisis is now." After years of repeated warnings by conservative political thinkers, the word crisis has become the mental frame that shapes the way many Americans think about Social Security's future. But as a recent Brookings
Institution book by Peter A. Diamond and Peter R. Orszag demonstrates, Social Security does not confront a crisis; in fact, its solvency for future generations can be ensured through modest benefit reductions and modest revenue increases.
To defuse the crisis hype it is useful to begin with a few facts. First, Social Security is a significant source of income for elderly Americans, providing the majority of income for two-thirds of elderly beneficiaries and all of the income for 20% of them. Second, according to the most recent report by the Trustees of Social Security, even under the cautious assumption that the U.S. economy grows at the anemic rate of 1.6% a year, the revenues into Social Security from the current level of payroll taxes will cover promised benefits for another 38 years and will be enough to finance about 70% of benefits through 2078. The net present value of the shortfall in revenues over the next 75 years is $3.7 trillion, only about one-third of the net present value of the Bush tax cuts of 2001 and 2003 and about 0.7% of gross domestic product projected for the same period. An immediate payroll tax increase of about 2% would eliminate this gap. So would paring the Bush tax cuts of 2001 and 2003 back by less than 50%, and transferring the added revenues to Social Security.
THIRD, THE PROJECTED financing gap in Social Security is not the result of overly generous benefits. Under current law, projected benefits are slated to fall from only 33% of previous earnings for an average worker of 62 today to a low 29% by 2030. And retired workers with low lifetime earnings as well as disabled workers and their families often live in poverty despite Social Security's progressive benefit formula. Any proposal to restore solvency through benefits cuts alone would require a 20% reduction in payouts in addition to the declines built into current law, sharply increasing poverty rates among future beneficiaries (assuming that the disabled and those presently 55 and older are exempt).
In contrast, Diamond and Orszag propose a plan that calls for modest cuts in overall benefits, some improved treatment of the most vulnerable categories such as workers with low lifetime earnings, and a gradual increase in the combined employer-employee payroll tax rate from 12.4% today to 13.2% in 2035 and 15.2% in 2075. Benefits for the average worker aged 45 today would be cut by about 1%, and for the average worker aged 25 today by about 9%, relative to currently scheduled benefits. However, the level of inflation-adjusted benefits would continue to rise.
A major lesson of this analysis is that Social Security can be put on a solid financial footing without dramatic change. In contrast, President Bush is using the specter of an impending crisis to justify allowing workers to divert up to 4% of their payroll taxes into private, individually controlled retirement accounts. This would reduce payroll tax revenues available to cover promised Social Security benefits by as much $2 trillion to $4 trillion, transforming an imaginary crisis into a real one. The Bush Administration has recently indicated that it plans to finance these transitional costs of creating private accounts through additional government borrowing. But the amounts involved are as much as an added $100 billion a year in government borrowing for the next decade, rising to $350 billion a year after 20 years. Additional borrowing of this magnitude on top of already large government deficits could spook global investors, triggering sharply higher interest rates on U.S. government debt and a collapsing dollar. But President Bush has been silent about the possibility of such a crisis. He has also been silent about the fact that individual accounts would require paying financial management fees that could amount to more than 25% of Social Security's current 75-year funding gap.
For nearly 70 years, Social Security has provided all working Americans with a basic level of income protected against inflation, financial market fluctuations, not to mention the risks of disability, losing a family wage-earner, or outliving one's assets. With a few modest changes, it can continue to deliver this remarkable security. There is no crisis.
Laura D'Andrea Tyson is dean of London Business School (email@example.com)