Is Social Security going Bankrupt? Essay

Background of Research When the US Social Security retirement system was instituted in 1937, one major objective was to provide incentives for older workers to retire so that more jobs would be available for younger workers. At that time, life expectancies were considerably lower, and there were far more working-age adults than elderly. Now, however, continuation of current benefit levels has been presented as a major funding problem. 2 In order to increase the ratio of workers who pay Social Security and Medicare taxes to the number of people receiving Social Security retirement income and Medicare benefits, or at least to reduce the rate of decline, public policy is turning toward encouraging people to delay retirement. Similar changes in attitude are apparent throughout the economy. In decades past, workers in the US were required by many employers to retire at a certain age, usually 65, and seldom later than 70. Today mandatory retirement ages are rare. How does the Social Security retirement system in the US work? All workers in the US are required to participate in the Social Security retirement program, regardless of citizenship. Currently, 6. 2 percent of a worker’s pay is withheld, up to a maximum that is adjusted annually. An additional 1. 45 percent (with no maximum) is withheld to support Medicare, making a total of 7. 65 percent of earnings for most workers. The employer contributes the same amount. Self-employed workers must pay not only their own but also the employer’s portion, a total of 15. 3 percent up to the Social Security maximum for the year and then only the Medicare tax on any excess. To receive benefits upon retirement, one must have received credit for working at least 40 quarters. Full benefits have long been available at age 65; reduced benefits are available at 62 years of age, with increased benefits for those who continue to work up to age 70. In order to help maintain the solvency of the system, the full retirement age (FRA) is gradually being increased to 67 years of age for those born in 1960 and later. 4 Reduced benefits are still available at 62 years of age but will be reduced proportionately more since they will eventually be available up to five years earlier than the FRA. The maximum age for earning increased benefits for delaying retirement will still be age 70. Most Americans know that Social Security is headed toward bankruptcy. Nothing makes the point better than the poll taken a couple of years ago in which young people said they had a better chance of spotting a UFO than receiving Social Security benefits. But many may not know why the system is threatened. In order to develop a solution – one that meets my goal of saving Social Security for today’s retirees and those near retirement, the baby boomers and their children – we need to understand the serious difficulties facing Social Security. However, little research has been conducted on those who continue to work beyond the traditional retirement age, sometimes for many years. Since this group is gaining in size we need to better understand the factors associated with the decisions these workers make about maintaining their attachment to the labor force (or, in some cases, beginning employment). Increased healthcare costs for the elderly, in particular the costs of prescription drugs not currently covered by Medicare, have undoubtedly been a factor for many who have decided to continue working for pay. Employer-provided health insurance generally pays for most prescription drugs, minus a modest co-payment. Recent erosion of the retirement savings of many Americans after a precipitous decrease in the US stock market during the first half of 2000 has also contributed to the reversal of the trend towards earlier retirement that reached a low in 1993. By 2003, the overall labor force participation rates for those 65 years of age and over had increased to 18. 6 percent and 10. 8 percent of men and women, respectively, from lows of 15. 6 and 8. 2 percent. One important question that has yet to be answered satisfactorily is what impact having to work longer will have on the well-being of the oldest old. American policy-makers seem to assume that there will be little negative impact because the elderly are, in general, healthier, and are living longer. In recent years there has been much alarmist talk of the impending bankruptcy of Social Security, but it is in the private sector that real dangers of default now loom. Social Security is safe through 2041 or longer, but the pension fund crisis is already squeezing corporate budgets, with disastrous consequences for jobs. If nothing is done, this pension-and-jobs crunch will intensify over the next two years. While many CEOs sold at the top of the market, the pension funds and holders of 401(k)s were left with depreciating paper. Swooning stock markets have caused the major pension funds to lose 40 percent or more of their value since March 2000. Even the well-stuffed 401(k) has become a 201(k). Pension funding has become so central to today’s capitalism that these developments menace the financial good health of corporate giants as well as individual retirees. Most reports on the crisis have, understandably, focused on the plight of the 42 million Americans who have 401(k)s or the equivalent. But the impact on corporate pension schemes, on which a similar number of people depend, has been just as bad. Many businesses must now forgo investment or face bankruptcy because they cannot meet their pension obligations. (Achenbaum, 1986) In a â€Å"defined benefit† scheme (DB) the employer guarantees a pension calculated as a proportion of salary; this can be an onerous obligation for a company with many former employees. In a â€Å"defined contribution† scheme (DC), like the 401(k), only the contributions are defined, so benefits rise and fall with the market. Public-sector DB schemes are generally well and cheaply run, and are anyway guaranteed by state or federal authorities. But balanced-budget rules often force those authorities to meet pension underfunding by cutting other programs. Most large private schemes are now badly underfunded, their asset values depleted by stock declines and too many past-contribution holidays. We know this courtesy of recent reports from analysts at Merrill Lynch and UBS Warburg. Adrian Redlich of Merrill has undertaken massive research into the 348 companies in the Standard & Poor’s 500 with a DB scheme. He warned in November that these schemes would end the year with a pension shortfall of $300 billion, and this is still the best estimate. If underfunded nonpension benefits are included, an even scarier deficit looms. (Hudson, 1999) The pension crunch is not simply a result of CEO misbehavior; it’s also rooted in a flawed structure that aggravates the boom-and-bust cycle. During a boom, the pension fund soars and no contributions are needed to maintain fund solvency. But when times are bad and the employer faces cash ebb, the actuaries insist there must be more dough on the table. Companies hide the unpleasant truth by fancy accounting. When they can no longer do this, they cut investment programs. This financing regime is dangerously pro-cyclical–that is, it encourages booms and aggravates recessions. New laws could enhance the rights of those in pension plans, but last year’s House and Senate approaches to reform of DC schemes offered the wounded patient a Band-Aid, when what is needed is a blood transfusion. (Achenbaum, 1986) The House bill was quite gentle on corporations. It reduced the time employees have to wait before their pension holdings are vested, but it allowed employers to continue contributing to 401(k)s with matching company stock. Ted Kennedy’s Senate proposal limited the amount of their own stock employers can contribute and gives employees more say in how their retirement fund is invested. But Kennedy didn’t propose obliging employers to offer a contribution. More robust proposals are not yet in sight. In addition to reliable regulatory structures, more resources are needed. The pension-jobs squeeze has only just begun. For individuals its reality has been softened thus far by house price inflation and earnings that continue to rise slowly. But while many investors prefer not to know about it, the goosing of the DB pension numbers by unreal assumptions could well prove as dangerous to economic health as the Japanese banks’ huge inventory of nonperforming loans. Will the Bush Administration stand by and do nothing as this time bomb ticks away? If the Administration simply wished to help the corporations out of a tight spot, they could be legally released from their obligations to retirees. This would allow them to resume investing. But it would be grossly unfair and provocative. Another solution might be to pump money into the PBGC. But to use taxpayers’ money to bail out pension funds in the current deflationary situation would be a dangerous exercise. And the PBGC arrives on the scene too late anyway: It only kicks in once Chapter 11 is staring a company in the face. The DB funds might be rescued by imposing on employees compulsory additional contributions. But this would weaken demand and could spark a firestorm of resentment. The most likely outcome is one that would allow employers to convert DB schemes to a DC logic, using â€Å"cash balance† or some kindred formula, but shortchanging employees in this way would create legal as well as political difficulties. A determined plan could address the pension crisis before it gets any worse. Corporations should be obliged to make up for their past and present derelictions by replenishing their employees’ retirement funds. However, simply forcing employers to contribute cash to every worker’s pot or company scheme is not the answer. Opponents would rightly warn that this would raise labor costs, drain cash flow, undercut investment and reduce demand. Applied anytime soon, it would mug an ailing economy and send unemployment skyrocketing. It would aggravate, not solve, the pension crisis. There is one approach that would shore up depleted savings without threatening a shaky economy: The funding gaps could be plugged by obliging all corporations to issue new stock or bonds each year equivalent to, say, 10 percent of their profits. This share levy, or stakeholder premium, would be calculated like a corporate tax, but unlike such a tax, it would not be a deduction from cash flow, nor would it be passed on to consumers. And unlike payroll taxes, it would not add to labor costs, thus giving no reason to lay off workers. A great advantage of the share levy is that unlike an ordinary tax, it would not exacerbate the problems of an economy threatened by recession. The issuing of new shares does not oblige companies to pay out more in dividends–it simply adds to those who will receive such dividends in the future. The levy should be calibrated to insure that all retirement funds gain more than they lose. While it would act in some respects like a wealth tax, it would not take demand out of the economy. And its revenues and payments could be adjusted to moderate the swings of the business cycle. (Kingston, Schulz, 1997) Defining the Problem Believe it or not, in 1945 there were about 42 workers for each person receiving Social Security benefits. By 1960, that ratio had shrunk to about 5 to 1. Today, it’s 3. 4 to one and by 2030, there will be just 2. 1 workers for each beneficiary. At the same time, Americans are living longer. That’s good news. But it means retirees will receive benefits for a longer period. Americans are also having fewer children, which mean relatively fewer workers paying Social Security payroll taxes. It is those taxes that finance current benefits. (Buell, 1999) Aside from these demographic trends, first-time Social Security benefits are growing far faster than inflation. These benefits now rise with overall wage growth, and wages are rising faster than prices. The result: over the next 75 years, benefits will increase more than 20 times, while prices will go up at half that rate. A retiree in 2060, for example, has been promised annual benefits starting at over $140,000. The result is a system that would require people in the future to work longer hours and pay more in taxes to support retirees. By 2034, payroll taxes would need to be increased by 50% to pay promised benefits or benefits would need to be slashed. Between now and 2070, benefits will exceed payroll taxes by a cumulative $120 trillion. Is it any wonder young people don’t expect to receive their Social Security? Something better can be done and is happening. Every generation of Americans has left a legacy of prosperity for its children. We cannot let our legacy be a Social Security system drowning in a sea of red ink.