by Michelle Bazie
January 09, 2005
Is Social Security "in crisis"?
The Administration has portrayed the Social Security shortfall as so massive that it threatens to destroy the program and engulf the rest of the budget. Such rhetoric seems designed to further the impression that the program will eventually go completely bankrupt, leaving today's younger workers with no Social Security benefits at all in exchange for their years of contributions.
In 2018 Social Security will start paying out more each year in benefits than it receives each year in tax revenues. But contrary to recent claims by supporters of private accounts, this does not mean the program will begin "collapsing" at that point. In 2018 the Social Security Trust Fund will contain $5.3 trillion in U.S. Treasury bills, and the Trust Fund will grow by another 25 percent over the next decade because of the interest it earns on those Treasury bills.
Some supporters of private accounts argue that the Treasury bills in the Trust Fund are nothing more than paper IOUs that may never be honored. To the contrary, Treasury bills are widely regarded as among the world's safest investments. The U.S. government cannot choose not to repay them -- with interest -- unless it is willing to default on its obligations for the first time in U.S. history.
Over the next 75 years, the combined cost of the tax cuts and the Medicare prescription drug benefit -- the President's two principal domestic priorities during his first term -- will be at least five times as large as the Social Security shortfall.
Specifically, the Social Security shortfall over that 75-year period is projected to be 0.4 percent of GDP (according to CBO) or 0.7 percent of GDP (according to the Social Security Trustees). In contrast, the tax cuts will cost 2.0 percent of GDP over that period, based on cost estimates from CBO and the Joint Committee on Taxation. (Experts from the Brookings Institution and other leading organizations have produced a similar estimate.) The Medicare drug benefit will cost 1.4 percent of GDP, according to the Medicare Trustees.
The reality is that the Social Security shortfall, while sizeable, is not gargantuan. It can be closed without undermining the program's basic structure, through a mixture of modest benefit reductions and revenue increases phased in over several decades.
Problems with "Price Indexing" Even Larger than Advertised
Press accounts this week reported that the Administration's Social Security plan is likely to include a fundamental change in the formula used to determine a worker's Social Security benefits. Though this change is usually called "price indexing," its real effect would be to reduce significantly the share of their pre-retirement earnings that workers receive in Social Security benefits.
Moreover, this benefit cut would apply to all beneficiaries, whether or not they elect to forego a portion of their benefits in return for an individual account.
The magnitude of the cuts under price indexing can be seen in this example: under price indexing, an individual who works at average wages throughout his career and retires in 2075 would receive monthly Social Security benefits that replace just 20 percent of his pre-retirement earnings. Under the current benefit structure, his benefits would replace about 36 percent of his pre-retirement earnings. Price indexing, in other words, would cause a 46-percent drop in this worker's Social Security benefits compared to current law.
This claim is contradicted by the Congressional Budget Office's analysis of the so-called "Model 2" reform plan put forth by the President's Social Security Commission, which includes price indexing. CBO found that under price indexing, the combined income from Social Security and individual accounts would be below the benefits that would be paid if policymakers took no action and Social Security benefits were reduced to the levels that the program's revenues could support after its trust fund was exhausted.
CBO estimates, for example, that workers born between 1990 and 2000 who earned median wages and retired at age 65 would receive combined benefits from Social Security and individual accounts that, on average, would be 20 percent - or $3,600 a year in today's dollars - below what would be paid if no action were taken to shore up Social Security's finances (i.e., under a "do nothing" scenario). (1)
But closing the Social Security shortfall entirely through benefit cuts is hardly the only option. Instead, the Administration and Congress could adopt a more balanced approach that combined much more modest benefit adjustments with modest revenue increases. They could, for example, retain a smaller estate tax rather than repealing it permanently, or scale back the tax cuts for the highest-income 1 percent of households, and dedicate these revenues to Social Security. They also could made modest changes to the payroll tax, such as raising the level of wages subject to the tax.
Thus far, however, the Administration has rejected using new revenues to help close the Social Security shortfall. This means the entire load of closing the shortfall must come through deep benefit cuts, such as those imposed under price indexing.
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