The Social Security Squeeze Can Be Solved

The footsteps of an aging America are hard to ignore, especially with daily alarms ringing over the federal government's debt and deficit. The leading edge of the baby boom generation is reaching its retirement years and at the core of the long-term fiscal challenge lie the three main entitlement programs, Social Security, Medicare, and Medicaid. (The other main spending items weighing on the fiscal ledger are defense and interest on the debt.) Spending on entitlements is growing faster than the economy and revenues.

"This debt is like a cancer," said Erskine Bowles, co-chair of President Obama's bipartisan panel on deficit reduction, at the annual meeting of the National Governors Assn. on July 11.

Little wonder Americans seem gripped with dread about an aging society. And there are no magic elixirs or fiscal wands that will painlessly put the federal government's fiscal house in order. It will take political compromise to do that, a classic mix of higher taxes and reduced benefits to accomplish the deficit-and-debt reduction task.

That said, there is a fiscal carve-out maneuver that would greatly ease the job. Most commentary assumes that socialsecuritymedicaremedicaid is one word. Yes, they're all entitlement programs, yet the bulk of the long-term budget pressure comes from higher health-care spending. For instance, the benchmark 75-year projection by the Social Security Trustees guesstimates the cost of Medicare alone will swell to 11.4 percent of gross domestic product in 2083—94 percent larger than Social Security's cost.

Separate and Fix

Fact is, there is no Social Security crisis. The system isn't broke. There's financial trouble down the road but it's manageable. Yet the title of the House Ways & Means subcommittee on Social Security hearing on July 15 got to the essence of the matter: Social Security at 75 Years: More Necessary Now Than Ever. So, separate Social Security from the rest of the entitlement fight and deal with it on its own merits. "The health-care problem is hard," says David Cutler, economist at Harvard University and senior health-care adviser to the Obama Presidential campaign. "Social Security isn't."

For one thing, it's important to remember that economic growth alone can't solve the long-term budget deficit and debt overhang, but a healthy economy will address at least some, if not all, of the projected Social Security shortfall. For instance, a critical assumption in the long-term projection of a Social Security shortfall is based on average annual productivity growth of 1.7 percent after 2018. The far more optimistic long-term scenario has productivity growth averaging 2.0 percent after 2019 and, with increased productivity boosting wages, the shortfall is put off well into the future. (The low-cost scenario assumes a number of other economic factors such as higher immigration than the baseline intermediate scenario forecast, but productivity growth is critical to the outlook.)

To be sure, rising wages pump up benefits as well as revenues over time. And while economists know that boosting productivity involves a mix of improving education and worker skill, investing in knowledge and innovation, encouraging entrepreneurship and a sound infrastructure, there's a great deal of uncertainty surrounding the impact of the policy mix, let alone the timing. So, prudence dictates shoring up the fiscal soundness of the system through a modest mix of changes, such as raising the retirement age and doubling the cap on annual wages subject to the payroll tax. (The Congressional Budget Office offers a list of options in its July 2010 report, Social Security Policy Options.)

Improvement Proposals

That's fine as far as it goes. But instead of just keeping the S.S. Social Security afloat, why not take the opportunity to make it better? The U.S. population is aging and it's well-known that Americans haven't been saving enough for their old age. One way to bolster retirement savings is to add to the Social Security system a program of voluntary additional contributions. The money could be invested in a limited menu of low-cost, broad-based options reminiscent of the federal government's Thrift Savings Plan, which offers participants five basic investment options plus a life-cycle fund. The details of such an option have been sketched out by a number of scholars, including the late Robert Eisner; Dean Baker, co-director of the Center for Economic & Policy Research in Washington; and others.

Even more intriguing is the idea of a mandatory savings program advocated by Robert Fogel, Nobel laureate at the University of Chicago. Fogel believes that people should be able to retire earlier in the world's richest country, free to pursue their passions and dreams, to find "spiritual fulfillment" and community engagement. He worries that the mantra of "we can't afford it" is pushing us in the wrong direction. The policy of raising the retirement age is essentially "privatizing" the system: People are more and more responsible for saving until the official retirement age kicks in. "The principal form of privatizing is the delay in the age at which full social security income will be made available to retirees," writes Fogel in The Fourth Great Awakening and the Future of Egalitarianism.

Instead, Fogel proposes the outline of a new mandatory pension system that would sharply increase freedom of choice later in life. For instance, under reasonable growth assumptions he calculates that a household that was required to put aside 14.7 percent of its annual income into retirement savings would accumulate enough at age 55 to fund a pension paying 60 percent of peak earnings. Want to cover their health-care needs in retirement as well? It would take another 9.4 percent in savings. Low-income people would get help through a progressive tax of 2 percent or 3 percent on the better-off half of households. The money would belong to the individual and be completely portable.

The details are less important than the fundamental insight: The real economic resources are there to finance early retirement and freedom of choice in the last third of life; it's the financing method that needs to be made better. We can afford it.

Of course, that kind of bold idea isn't on the table. But it shows the range of solutions in the marketplace that will make the woes of Social Security far easier to address than those of its entitlement cousins. If we can't get "spiritual fulfillment," financial independence and peace of mind for our elderly population will do nicely.

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