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Government July 1998

Nine Misconceptions About Social Security

To take a voguish example: Privatize Social Security? Any money saved would be eaten up in Wall Street transaction costs, including million-dollar salaries

A close look at Social Security

1. The Social Security Trust Fund is an accounting fiction.

The Social Security tax has been raising more money than is needed to pay for current benefits, in order to build up a surplus to help finance the retirement of the Baby Boom generation. All of this surplus is lent to the U.S. Treasury when the Social Security Trust Fund buys bonds from it. The money is then used to finance the federal deficit, just like any other money the government borrows. The bonds held by the fund pay the same interest as bonds held by the public. These bonds are every bit as real (or as much of a fiction) as the bonds held by banks, corporations, and individuals. Throughout U.S. history the federal government has always paid its debts. As a result, government bonds enjoy the highest credit ratings and are considered one of the safest assets in the world. Thus the fund has very real and secure assets.

It is true that the interest the government pays on these bonds is a drain on the Treasury, as will be the money paid by the government when the fund ultimately cashes in its bonds. But this drain has nothing to do with Social Security. If the Social Security Trust Fund were not currently building up a surplus, and lending the money to the government, the government would still be running a deficit of approximately $60 billion in its non-Social Security operations. It would then have to borrow this money from individuals like H. Ross Perot and Peter G. Peterson and to pay out more interest each year to the people it borrowed from. Therefore, the government's debt to the fund is simply a debt it would have incurred in any event. The government's other spending and tax policies, not Social Security, will be the cause if there is any problem in the future in paying off the bonds held by the fund.

The government bonds held by the Social Security Trust Fund will always be a comparatively small portion of the government's debt, and therefore a relatively minor burden. They will hit a peak of about 14.4 percent of gross domestic product in 2015, whereas the debt now held by individuals and corporations is about 47 percent of GDP. Therefore, at its peak the burden of interest payments to the fund will be less than a third as large as the interest burden the government now bears.

2.> The government uses overly optimistic numbers to convince people that Social Security will be there for them. The situation is much worse than the government admits.

Actually, Social Security projections are based on extremely pessimistic economic assumptions: that growth will average just 1.8 percent over the next twenty years, a lower rate than in any comparable period in U.S. history; that growth will slow even further in later years, until the rate is less than half the 2.6 percent of the past twenty years; that there will be no increase in immigration even when the economy experiences a labor shortage because of the retirement of the Baby Boom generation; and that this labor shortage will not lead to a rapid growth in wages. Both possibilities excluded in these projections—increased immigration and rapid wage growth—would increase the fund's revenues. These projections are genuinely a worst-case scenario.

3. The demographics of the Baby Boom will place an unbearable burden on the Social Security system.

Those who want to overhaul Social Security make their case with the following numbers: in 1960 there were more than five workers for each beneficiary; today there are 3.3 workers; by 2030 there will be only two workers for each beneficiary. At present the fund is running an annual surplus of more than $80 billion, approximately 20 percent as much as its current expenditures. This surplus will generate interest revenue to help support the system as the ratio of workers to beneficiaries continues to fall in the next century. Also, the fact that workers are becoming more productive year by year means that it will take fewer workers to support each retiree. The United States had 10.5 farm workers for every hundred people in 1929; it has fewer than 1.1 farm workers for every hundred people today. Yet the population is well fed, and we even export food. Rising farm productivity made this possible. Similarly, increases in worker productivity (which have been and should be reflected in higher incomes), however small compared with those of the past, will allow each retiree to be supported by an ever smaller number of workers.

In fact the demographics of the Baby Boom have very little to do with the long-range problems of Social Security. The main reason the fund will run into deficits in future years is that people are living longer. If people continue to retire at the same age but live longer, then a larger percentage of their lives will be spent in retirement. If people want to spend a larger portion of their lives in retirement, either they will have to accept lower incomes (reduced benefits) in their retirement years relative to those of their working years, or they will have to increase the portion of their incomes (higher taxes) that they put aside during their working years for retirement.

This is the main long-range problem facing Social Security. Current projections show that the annual deficit will be 5.71 percent of taxable payroll in 2070, long after the Baby Boom will have passed into history. But the annual deficit is expected to be only 4.44 percent of taxable payroll in 2035, when the worst crunch from retired Baby Boomers will be felt.

Examining just the change in the ratio of beneficiaries to workers overstates the burden that workers will face in the future. To assess the burden accurately it is necessary to examine the total number of dependents—beneficiaries and children—each worker will have to support. It is projected that this ratio will rise from 0.708 per worker at present to 0.795 in 2035. But even this number is well below the ratio of 0.946 that prevailed in 1965. And the fund's trustees project a lower birth rate, meaning that the increased costs of providing for a larger retired population will be largely offset by the reduction of expenses associated with caring for children.

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