A recent headline seemed clear: “Social Security will go broke in 2033.” The accompanying story described the latest projections for the Social Security trust funds. Everyone understands what it means to “go broke,” but most readers probably don’t understand exactly what this means in regard to Social Security or how the panel arrived at its conclusions.
First, let’s review some basics. Any “earned income” from employment or from someone’s own business is subject to Federal Insurance Contributions Act taxes for Social Security and Medicare. The 12.4 percent designated for Old Age, Survivors and Disability Insurance only applies to the first $110,100 earned this year, but the 2.9 percent designated for Medicare has no cap. Wage or salaried employees pay only half of these amounts, and employers contribute the other half.
In 2011 and 2012, FICA taxes on employee and self-employment income are reduced by 2 percentage points as part of the Obama administration’s economic stimulus efforts, but the statutory rates will return in 2013.
What we think of as “Social Security” has three distinct benefit programs. The most familiar is for retirement. But there also are benefits for the surviving minor children of covered workers and for their spouses as long as there are qualifying children. Of the 12.4 percent of earnings paid in FICA taxes, 10.6 percent goes into a combined fund for these two programs.
The other 1.8 percent goes into a separate designated fund to pay benefits for disabled workers. By law, each year the trustees of the two trust funds are supposed to make an actuarial estimate of their projected cash flows and future solvency. Hence the recent report.
As for any estimate that stretches decades into the future, the conclusions reached depend on assumptions made. These are far more complex than most people realize. Some are about the general economy, some about Social Security itself. Here is a sample:
Fertility: How many people will be born? After a lag, this determines the number of young workers paying into Social Security and, after a longer lag, the number of people eligible for benefits.
Mortality: How many people are dying at what ages? The longer people live after reaching retirement, the greater the outlays on retirement benefits. Changes in this also affect survivors’ benefits, but not to the same extent as 60 years ago.
Immigration: How many people will be moving to our country? The more immigrants of working age who come in, the more taxes flow in on the front end, and later, the higher the outflows when they retire. Increased immigration at this point would help get us past the crunch of baby boom retirement because most people coming in now will still be working after many of us baby boomers have passed on.
Productivity: How much output will we get from each worker? The greater productivity growth, the easier it will be to manage the baby boom crunch, regardless of how we structure Social Security or any other pension program. But it also has crucial impacts on the program itself.
Inflation: How much will consumer prices increase? Social Security benefits increase automatically with inflation, so the more the Consumer Price Index increases, the more noninflation-adjusted outlays will increase.
Average earnings: How much will future workers earn? This is a two-edged sword. As earnings rise, so do revenues from FICA withholdings. But an increase also boosts outlays. An index of average earnings is used to adjust new beneficiaries’ past earnings to current dollars in computing their starting benefit levels. As wages rise, such starting benefit levels rise for all new beneficiaries, increasing outlays.
Labor force: How many people are working or looking for work? This determines the number of people who will be paying into the program. It depends on population, but also on the “participation rate” or proportion of the population that is in the labor force. If women continue to work at high levels, this helps. The same will be true if more people continue to hold at least some employment into their retirement years. But the recent downward trend in participation rates for adult men is troubling.
Unemployment: How many people who want jobs don’t have them? People without jobs represent the waste of a valuable resource. They also represent lost revenues for Social Security. The higher the unemployment rate, the worse it is for the program’s solvency.
Interest rates: Some of the funds for Social Security come from interest paid by the general treasury on bonds held by the trust funds. These interest rates vary with market conditions and Fed policy, just like bonds held by the general public. Low interest rates hurt the solvency of Social Security, just like they hurt the income of private savers who buy them and then hold them to maturity.
These are not the only variables considered. (The full 252-page report, a shorter summary and other supporting information is available at www.ssa.gov/oact/tr/2012/index.html.) But based on the best estimates of what these variables will be over the next decades, any balance in the combined Old Age, Survivors and Disability funds would be zero in another 21 years. At that point, absent any other policy changes, there would only be enough money coming in to pay some 70 percent of the benefits due under existing legislation.
Actual events are not likely to match a forecast made decades into the future based on myriad factors assumed now. But it is a best estimate at this time. Understanding the complexity of all the relevant factors is a good first step toward sensible reform.