CHAPTER 2
RETIREMENT’S BEDROCK: SOCIAL SECURITY
All we want are the facts, Ma’am.
Everyone is entitled to their own opinion. But they are not entitled to their own facts.
Apart from ensuring national security and domestic tranquility, the most vital goal for the president and Congress should be rebuilding Americans’ shaken belief that their government can actually work for the people; their loss of faith that government can work for them is deeply corrosive to our future. And no domestic policy achievement could do more to recapture lost trust than action to save our Social Security system, the country’s largest, most successful, and most popular government program.
Simply put, the system is a life-and-death resource for low- and moderate-income seniors and for millions of disabled people and survivors. It is vital in keeping middle-class retirees’ heads above water. And Social Security income is surprisingly important even for those well in the top 10 percent of retirees by wealth. (See box, “Social Security for the Well-to-Do,” later in this chapter.) Indeed, the system has become a central pillar of almost all Americans’ retirement income.
Its most striking success is one that all Americans can be proud of: helping to cut the incidence of poverty among elders from 35 percent of seniors in 1959 to just 10 percent today, actually lifting America’s elderly into better financial shape than the young. Fully 60 percent of retirees now receive the majority of their incomes from the system; 21 percent of married couples and 43 percent of unmarried elders depend on it for over 90 percent of what they live on. Absent that monthly check, nearly half of current seniors would fall below the poverty line.
Virtually no one quarrels with either those achievements, or the values they reflect. Instead, the debate is over how best to sustain them because the aging of America is seriously straining the system’s finances. The ratio of current workers to retirees has been falling for decades, from 16:1 in 1950 to 3:1 in 2016, and is projected to be 2:1 by 2035 (Figure 2.1). At the same time, life expectancies for retirees are rising. From 1960 to 2020, life expectancy for Americans who reach age 65 will grow by six years—from 14.3 to 20.3 years. That’s an increase of roughly 42 percent in the time these retirees will collect Social Security. Demographic forces like these move slowly, like a glacier, but with inexorable force.
FIGURE 2.1 The demographic squeeze on Social Security
Source: 2016 Social Security Trustees Report; Center for Disease Control and Prevention (data based on death certificates), 2020 Projection from National Center for Health Statistics, “An Unhealthy America: Economic Burden of Chronic Disease” (2007), Milken Institute.
Indeed, Social Security is far along down a very predictable, and avoidable, path to crisis. If Congress doesn’t act, the system will face a drop-off in benefits of over 20 percent by 2034 or sooner. We’ve known as far back as the 1990s that this cliff-drop in benefits was coming. But the political leadership needed to bring the system into sustainable balance has long been absent, despite a widespread consensus on what needs to be done.
As multiple bipartisan commissions have shown in recent years, the compromises needed to restore Social Security to fiscal health are blindingly obvious, namely a balanced combination of revenue increases and benefit cuts. Among serious policy experts, the intellectual challenge of saving Social Security is widely seen as simple, back-of-the-envelope arithmetic—a policy layup far simpler than healthcare policy’s three-level chess game of moral, financial, and scientific variables. But then politics has to be factored into the equation.
And serious action to ensure Social Security’s long-term solvency has always been politically risky. An old, but all too true, sense of conventional Washington, D.C., wisdom holds that Social Security is too politically risky to reform. That’s one reason we blew a golden opportunity to save Social Security during Bill Clinton’s presidency in a lost retirement reform in 1998 (see box, “The Lost Retirement Reform of 1998”).
Again, just over a decade ago, President George W. Bush’s attempt to introduce private investment accounts as part of an overall Social Security reform failed utterly, and that failure stalled his entire second term’s momentum. President Obama seemed to have drawn a lesson; over two full terms in office, he made no serious attempt to reform Social Security at all.
Complicating the Search for Compromise
One reason that politicians hesitate to take on Social Security reform is that the system’s basic structure is confusing even to experts, and impossible to distill to a sound bite or bumper sticker. The formulas used to define benefits are arcane. There are bookkeeping gimmicks like the Social Security Trust Funds; these funds consist of special-purpose government bonds issued by the Treasury exclusively to the Social Security Administration (SSA) to cover tax moneys that Treasury “borrowed” from the “surplus” revenues that SSA collected from the 1980s until 2014. That’s when actual cash-flow surpluses ended, and SSA began to spend more in benefits than it took in as tax revenue. Talk about confusing!
None of this is easy to explain to a skeptical public. Voters rarely reward politicians who tell them they need to make sacrifices. Complicating the search for compromise, Social Security is ground zero for bitter clashes of ideologies and values: community versus individualism, solidarity versus economic freedom, Democrat versus Republican. Bridging those deep emotional divides won’t be easy. But a secure retirement for generations to come will depend on politicians making compromises, and voters supporting them for doing so.
As a businessman who has devoted a career to building up private workplace savings in America, I’ve pored over decades of data on working Americans’ savings patterns, their net worth, and their ability to replace their working incomes for life. And what I’ve seen convinces me that Social Security provides a uniquely valuable, irreplaceable base for everything else we do to encourage private retirement savings.
Precisely because Social Security relies exclusively on taxes drawn from labor income, we must supplement it with a system of investment accounts that can capture capital income as well—interest, dividends, and capital gains. The good news is that America’s public and private retirement finance systems actually complement and reinforce each other in ways that few nations have achieved. (See box, “America’s Twin-Engine Retirement Finance System,” later in this chapter.)
Pay-as-You-Go: A Fateful Decision
To understand why we need to restore Social Security’s solvency and also supplement the system with near-universal access to private workplace savings, it helps to look back at the system’s origins in the depths of the Great Depression.
When the Social Security Act of 1935 was adopted, the United States became the last major industrial nation to join a wave of social insurance reform that began in Europe in the 1870s and only reached the United States amid the catastrophic unemployment and social unrest of the Depression.
That dire economic situation forced the policy architects of Social Security to make a fateful choice. To mitigate truly wrenching poverty among elderly Americans, they needed to get incoming revenue back out quickly. So the system’s founders were forced to adopt a pay-as-you-go structure for the program. This meant that as payroll taxes were collected, they went directly from the Treasury to the Trust Funds run by the Social Security Administration (SSA), which were then used to pay current beneficiaries.
In the debates leading up to the 1935 act, Congress had seriously weighed the idea of creating a prefunded retirement system. Such a system, like most pension plans, would have invested in stocks and bonds, accumulated investment earnings, and used those earnings to pay future benefits. But the need to get money out fast, compounded by the fear and loathing of Wall Street that followed the Great Crash of 1929, made the option of investing in the real economy and then waiting years for returns to build up significantly before paying benefits deeply unappealing. Many early beneficiaries, after all, were aging and destitute veterans of the First World War.
This decision to pay out immediately was good news, even great news, for the system’s first beneficiaries. They got immediate relief without having paid much in taxes. Miss Ida May Fuller, who received the very first Social Security check in 1940—for $22.54—had only paid $24.75 into the infant system during her whole working life. She lived to be 100 years old and collected more than $20,000 from Social Security during her lifetime.
But the fabulous rate of return that Miss Fuller and her cohort received from Social Security has been declining steadily ever since. That’s because as a pay-as-you-go system matures, more people spend their whole working lives paying in. And since their taxes are not invested, but instead are used to pay current beneficiaries, their own future benefits can’t take advantage of long-term compounding of interest or stock market growth. Instead, they depend on tax flows from future generations of workers and on changes to taxes and benefits enacted by Congress and signed by presidents.
Congress and various administrations have, in fact, frequently tweaked Social Security’s taxes and benefit levels over the years. From the Eisenhower era in the 1950s through the Nixon years in the 1970s, the trend was to expand the number of people covered by the system, raise their benefits, or both. Richard Nixon’s administration, for example, indexed future benefits to gains in workers’ wages, which typically rise slightly faster than the CPI.
By the early 1970s, though, the benefit creep that made Social Security such a great deal for those born before World War II was winding down. By contrast, reforms enacted in 1977 and 1983, when the system twice veered toward financial crisis, have all trimmed back on benefits rather than expanding them by changing payout formulas for lifetime earnings or raising the retirement age for full benefits to 67.
The last major reform of Social Security, in 1983, based on recommendations from a commission headed by future Federal Reserve chief Alan Greenspan, included one of the largest long-term tax increases in American history. That set the Federal Insurance Contributions Act (FICA) taxes that fund Social Security on track to rise from 10.8 percent of payroll in 1983 to the current level of 12.4 percent, while full retirement age was set to rise gradually from 65 to 67, a substantial reduction in benefits.
In theory, half of these taxes come from employers, half from employees. In economic reality, though, all the taxes are experienced by employers as part of the overall cost of hiring labor. So they actually reduce workers’ potential take-home pay dollar for dollar. And Social Security taxes have consistently ratcheted up, never down. Today, more than three-quarters of American families pay more in payroll taxes than in income taxes.
By law, Social Security has no private investments comparable to the stocks and bonds held by private pension plans. Instead, and by design, its benefits have traditionally been paid mostly by FICA taxes on wages, supplemented by any interest that SSA earns on the special, nonmarketable, interest-bearing Treasury obligations it holds in its Trust Funds.
Franklin Roosevelt and the New Deal architects of Social Security firmly believed that keeping the system “off budget,” having it be financed almost exclusively by the tax contributions that workers themselves paid in, would strengthen its political legitimacy and make it nearly impossible for future Congresses to cut back. To a large extent, FDR’s vision has proved correct. The problem is that this sense of entitlement has also made Social Security very difficult to reform, even as its long-term ability to self-fund is steadily eroding.
Today, roughly 10,000 baby boomers reach age 65 every day; meanwhile, the number of active workers per retiree has been declining for decades. But Social Security’s pay-as-you-go structure still reflects mortality and family patterns of the 1930s, an era of large families, rising populations, and short life spans. When the Social Security retirement age was set at 65 in the 1930s, for example, life expectancy was just over 61 for American men and 65 for women.
As of 2015, these mounting pressures brought Social Security into cash-flow deficit, with the system now paying out more in benefits than it takes in from FICA taxes; the shortfall is made up by drawing on the special bonds in its Trust Funds. These are unique, nontradable, intragovernmental debts. What are assets to Social Security are liabilities for the Treasury. So when SSA puts these bonds to Treasury for payment, Treasury has to pay these debts, just as it pays off any other bond, from general tax revenue or from the proceeds of new borrowing.
But unless current law is changed, even today’s more than $2.8 trillion in Trust Fund assets will diminish steadily to zero sometime in the early 2030s. From the moment Social Security went into negative cash flow and began drawing on its Trust Fund holdings, the system’s FICA tax income began covering a smaller and smaller portion of its obligations to retirees each year. That FICA share will drop from roughly 99 percent in 2014 to about 75 percent by 2034, when the system’s trustees project that the Trust Funds will be exhausted. At that point, the system would be technically insolvent—that is, unable to pay its promised benefits in full. Current law would then require an across-the-board drop in benefits variously estimated at between 21 percent and 25 percent.
That doesn’t mean that Social Security will ever go bankrupt. By definition, a pay-as-you-go system can’t go bankrupt. Even assuming no reform to current law, the Social Security Administration has a claim on 12.4 percent of future U.S. payroll, a very tidy sum indeed, which would enable it to deliver between three-quarters and four-fifths of promised benefits. But once the Trust Funds are depleted, a sudden 20 percent to 25 percent cut in benefits would deliver a devastating blow to tens of millions of retirees, survivors, orphans, and the disabled, plunging many into near-destitution and squandering decades of progress in reducing elderly poverty.
What Needs to Be Done
To prevent such a human policy disaster, our political leaders can choose among an array of options for increasing tax revenues to SSA, reducing future benefit increases programmed in current law, or securing higher rates of return for assets in the Social Security Trust Funds.
In 2011, I collaborated on just such a solution in partnership with James Roosevelt, then CEO of Tufts Health Plan, a former associate commissioner of the Social Security system and Franklin Roosevelt’s grandson. Our policy proposals, published in an op-ed in the Boston Globe (see Appendix B: “How to Fix Social Security”) were an almost exact balance between adding revenues and reducing the growth of future benefits.
Whatever mix of policies you might support, it’s critical to recognize that saving Social Security is overwhelmingly a political problem, since both its revenues and its benefits are set by Congress. To say that the system faces a long-term funding shortfall, or is headed for insolvency, simply means that Congress has failed to bring its revenue into line with its promises. Fixing Social Security is a job for Congress and will likely require strong presidential leadership to get moving.
To have any chance of passage, any fix will almost surely require a balanced combination of added revenues and reductions in future benefit increases. Democrats won’t accept a reform made up exclusively of benefit cuts; Republicans won’t accept one made up wholly of tax increases. Anyone proposing such one-sided reforms is actually aiming for stalemate, no action, and ultimately, insolvency. Having no viable reform plan is, in fact, itself a plan for failure.
The most politically viable way to secure a bipartisan reform would be to follow the path last traveled in 1983—a presidential commission with representatives from both parties, and independent experts who are charged with producing reforms that Congress can vote up or down, but not amend.
Recent years have seen a number of such balanced reform plans advanced. The Simpson-Bowles Commission brought one forward in 2010. So did a study led by former Senator Pete Domenici and former Budget Director Alice Rivlin. Again, in 2016, the Bipartisan Policy Center delivered a comprehensive retirement savings plan that covered both Social Security and private workplace systems.
Each of these plans found that it would be possible to make Social Security solvent for the indefinite future mainly by slowing the rate of growth of future benefits for those above median income and by raising the cap on income taxed under FICA to cover roughly 90 percent of wages. What’s more, it would also be possible to step up the baseline minimum payment to above-poverty income levels and add some additional benefits for the very old—people over, say, 85.
In short, these reforms would actually make Social Security somewhat more progressive and more effective at preventing poverty in late old age. Any one of these reform packages would, of course, be vastly better for most people than having the system drift steadily toward a 20-percent-plus drop in benefits by the 2030s. And time is not on our side. Delay causes the system’s funding gap to grow steadily wider, and then will require deeper and more painful tax hikes or benefit cuts in the future, as Figure 2.2 illustrates.
FIGURE 2.2 Time is not on our side
Source: Social Security Administration, Committee for a Responsible Federal Budget calculations.
However necessary, relatively painless, and even beneficial any proposed Social Security reform may be, getting it started will take real courage on the part of political leaders. As with every other issue in our fractured republic, changes to Social Security will be hotly contested and feature a tsunami of lies, fearmongering, and exaggeration. It’s not easy to take even the first step toward reform for politicians who may find themselves pilloried—and “primaried”—just for contemplating benefit cuts or tax increases.
We can only hope that a new constellation of strong leadership and real political courage will emerge that is willing to take up America’s retirement finance challenge again. And we can urge members of Congress to step up. If and when they do, these brave men and women are going to need help, from every one of us, to get the job done. As citizens, voters, party members, donors, businesspeople, or workers, all of us should urge our elected officials to take on the challenge of Social Security solvency, make real compromises, and cut a fair deal. The sooner they act, the better.
As we develop retirement policy, we need to take this trend into account so as not to make a difficult situation worse. We are already seeing signs of real financial stress among elders who are far into retirement and whose assets have drained down. MIT economist James Poterba and colleagues at Dartmouth and Harvard’s John F. Kennedy School of Government estimated in a 2012 study that 46 percent of senior citizens now die with less than $10,000 to their names. Most of them depended almost entirely on Social Security to live.
So if policy makers do choose to raise the retirement age to help make the system solvent, a strong case can be made to offset the “ultimate inequality” of diverging longevity with some form of new, means-tested supplemental income benefits for those living beyond, say, age 80.