Social Security: What Are Our Options?

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Social Security: What Are Our Options?

A brief history:

  • 1935 - Social Security Act was first drafted by President Roosevelt's commitee as part of the New Deal
    • This Act only paid benefits to the elderly
  • 1937 - Payroll taxes were first collected; also the first year in which benefits were paid
  • 1939 - Several important amendments are made to Social Security
    • The old-age benefit is extended to widowed, non-working spouses
    • Benefits were extended to the orphaned and the widowed
    • Elderly who never paid FICA taxes became eligible for benefits
  • 1956 - The Social Security tax rate raised to 4.0%
    • Disability benefits were added at this time
  • 1965 - Medicare is added to Social Security
  • 1983 - Amendments are made to Social Security to create the first sizable trust fund

The Current System:

The current system for social security in the United States is considered to be a "Pay as you go" system. This means that money is paid through a social security tax to the government. This money is used to paid social security checks. Any unused money is put into the social security trust fund. However, the government often uses the money in this trust fund to fund other government activities and programs. In turn, they leave United States Treasury Bonds in place of the money.

Trust Fund

The trust fund of the Social Security system is the source of a lot of controversy. Over the years, trillions of dollars have been removed from this fund and used for other purposes. What those purposes are is unclear.

  • 1) Consumption

Some people believe that the money taken from this trust fund has been used to fund the war in Iraq, goverment programs promoting education, and other such activities. If this is the case, the government's spending has been boosted by the trust fund, meaning that the money is gone and the treasury bonds inside the fund are worthless. This idea leads to the estimate that social security will run out of money by 2018 because at this time the amount brought in with social security taxes will be less than that paid out.

  • 2)Investment

Other people believe that the government spending would have been the same with or without the supplemental funds taken from the social securty trust fund. If this is true, then the primary use of the funds has been to pay back the debt of the United States. This means that the deficit would be higher without the trust fund. If this is the case, the treasury bonds should be paid off in full, since the money was used in an investing transaction. This leads to the estimate that social security will run out of money sometime around 2040 or 2050.

Whether or not the United States government defaults on the payment of these bonds will determine how long the current social security system lasts.

The Problem

Most people have become interested in the Social Security issue over the last few years because it has become a hot political topic. Assuming the the government does not default on the payment of the treasury bonds held in the social security trust fund, the Social Security Administration has projected that they will be running out of money by 2040. The yearly cash out-flow will surpass the in-flow in 2018. The degree to which this occurs will increase each year thereafter until about 2080. This can be seen in the graph below:

Description

Taking Action

There has been a huge number of proposed social security alternatives. For this project we decided to focus on three of the most popular ideas for the future of social security:

  • If it isn't broken, don't fix it
  • Privatization as it would be executed by the Bush plan
  • Scrapping Social Security altogether

Leaving the Current System in Place

Many people believe that the system we have now is completely capable of handling the increase in cash out-flow and the decrease in cash in-flow. Some changes, such as increasing the tax on workers or decreasing the payment to people receiving benefits, would allow the system to continue functioning without altering any of the underlying structure after the trust fund is completely depleted in 2040. According to the Social Security Administration, there would be two primary options for action if the system were left as it is until 2040. The first option is to increase the payroll tax to 16.6% and then continue raising it gradually until it reaches 17.78% in 2080. The other option is to decrease the amount of money paid to those receiving benefits. The Social Security Association has said that a reduction of payments by 26% in 2040 would be needed with a gradual increase to 30% by 2080. The results of each of these actions can be seen in the graph below:

Description

While these solutions may seem reasonable, by applying the models we have learned in this class, it can be seen that such action would have some negative economic side effects.

Increasing the Payroll Tax

As we have learned over the semester, an increase in taxes will cause the demand curve in the labor market to shift to the left. This means that fewer workers will be willing to work with the next tax rates. This results in a lower level of employment as well as lower overall wage rates. This can be seen in the left graph below. Also, the demand curve in the real GDP and price level graph would shift to the left. This means that the amount of output will decrease and the price level will decrease. This can be seen in the right graph below.

Description
Description
Decreasing Benefits

Decreasing benefits from social security would have pretty much the same result on the economy as increasing the payroll tax. We can use the expectational model to show these results. People would have plenty of warning before the change was made so this would be an anticipated shift. The aggregate demand curve shifts to the left, resulting in a lower level of employment and a lower level of output. This can be seen in the graph below.

Description

Result

Neither of these changes seem to be good solutions to the problem at hand. They both result in a lower GPD and a lower level of employment, which is, of course, harmful to the economy. It can be concluded that this is probably not the best option available for handling our current problems with social security.


Privatization as per the Bush Administration

Introduction

The "pay-as-you-go" system that is used today takes out a percentage of workers' paychecks, and a portion of that money is used to pay out the Social Security benefits of the current retirees. Fully privatizing Social Security would give people the opportunity to put a portion of their wages into private investment accounts. There is higher risk involved in the private accounts, but there is a good chance for people to make more money in these accounts than what they would receive in benefits in the current system.

President Bush’s Plan for Partial Privatization

President Bush has realized that there would not be nearly enough support for a completely privatized social security, so he has devised a plan for partial privatization that would go into effect in 2010.

Beginning in 2010, people would have the option to put 4% of their wages that would normally go to social security into optional private accounts, set up by the government. The investors would be cut off at investing $1,100 the first year, and each year following, until 2016, they would be allowed to increase the previous years total by $100. Everyone would still be paying a decreased amount of their wages into the current Social Security system. Upon retiring, the individual must set up an annuity, rather than having access to all of their saved money instantly.

Arguments Against the Plan

Many who are opposed to the plan feel that it is unfair that people’s ability (or lack there of) to invest wisely can determine their well-being after retirement. The risk of the stock market is too great, and downturns in the market would have an affect on a worker’s return if they were to retire at that time. Their only other option would be to continue work until stock prices recovered.

There are also arguments that the cost would go well beyond the $700 million that Bush proposed in the 2010-2017 budgets. Since the tax revenue that normally pays the retirees benefits would be going to set up these private accounts, the government would need to borrow the money from other places to pay for these benefits. It is feared that one way to cover these cost would be to cut benefits drastically for those receiving Social Security.

The other big issue with this plan are the costs that it will bring to the investors. These are the administrative costs of the private accounts.Once they retired, they would incur more costs for setting up an annuity.

Ending Government-Sponsored Social Security

The case for eliminating the Social Security program in its current incarnation is based upon logical economic principles. To make the case, two things must be established:

  • The current system is inadequate
  • Private industry has the capacity to take over

There is an underlying concept that is fundamental towards understanding the benefits of privatization. Simply put, private enterprise can deliver goods and services more efficiently than the government can deliver goods and services. This is true for a variety of reasons. In the end, though, it really boils down to incentive.

Incentives to Perform

The government operates as a tax-collecting monopoly. It has few incentives to perform well, and even fewer economic incentives. Motivation is politically driven. Given the lack of competition created by their monopoly, a government-run system will maintain the status quo.

Private enterprise, on the other hand, has every incentive to work efficiently and in the best interest of their clients. Such is required to maintain a competitive advantage. Motivated by profit, clients are better served and the company has incentive to improve efficiency.

Sources

  • Friedman, Milton. Free to Choose. New York and London: Harcourt Brace Jovanovich.
  • Social Security Administration. http://www.SSA.gov History sections, Frequently asked questions section.
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