May 2, 2001

The Social Security Time Bomb: Still Ticking

Worrisome predictions about Social Security's future

Get those T-shirts printed now. Y2K may have come and gone, but according to Federal Reserve Board Governor Edward M. Gramlich, 2038 will be another banner year. That's the year, says Gramlich, when the Social Security system will run out of money.

Gramlich delivered this pleasant news to some 60 investment advisors on April 19th at the American College in Bryn Mawr, Pennsylvania, marking the College's 24th Frank M. Engle Lecture in Economic Security.

We begin with a history lesson. For the first 40 years of Social Security, the program ran pretty much on an even balance, Gramlich notes, paying out nearly as much as the system collected in payroll taxes. In the 1980s, however, the future funding issue was foreseen and Congress raised payroll taxes to head off the problem. Subsequently, the Social Security Trust Fund has been generating a surplus of $150 billion a year, and even that figure is expected to increase over the next several years.

By 2013, however, Gramlich says that the surplus will become a deficit due to the rapidly aging American population. While there were 16 workers for every retiree in 1950, that ratio has dropped to 3.4 now and will continue declining to the point where the ratio will be two workers to each retiree in another 30 years. "The retirement of the Baby Boomers as well as the fact that people are living longer is what is to blame," Gramlich says.

Despite this, the trust will continue to grow from the interest it receives from assets invested in U.S. Treasury bills until roughly 2020, when it will have an estimated $3 trillion in assets. "From there [it] is a very precipitous drop until we run out of money entirely around 2038," the Fed governor says. "And it's not as if the problem will go away entirely following the [retirement of the] Baby Boomers. The increase in life expectancy will worsen the deficit into the future."

So what to do?

Three Solutions

There are three possible ways of addressing the problem, Gramlich says.

First is the standard solution of raising payroll taxes. Under present actuarial estimates, an immediate 1.9% increase in the combined payroll tax rate is necessary to finance the present benefit schedule for the next 75 years. While this approach has the merit of simplicity, it has not received a warm welcome by the public. And, according to Gramlich, no politician of either party will give this approach even passing consideration.

The second proposal, one that Gramlich himself devised as an alternative to raising payroll taxes, is to raise the national savings rate by instituting mandatory individual savings accounts. "Instead of raising payroll taxes, I suggested that a more popular approach might be mandatory individual accounts held on top of Social Security."

Gramlich believes that since individuals would be holding these accounts, they might not think of them as tax increases. These individual accounts would give people the freedom to invest their money as they wish, says Gramlich, though he concedes that the costs of running such a program may outweigh any gains. "It would cost Social Security more to administer a system of individual accounts than to administer the present system. Since the accounts would be separate from the Social Security Trust Fund, there would also be some gradual cuts in the growth of benefits over time to bring the trust into long-term actuarial balance," Gramlich says.

The cuts would be made by adjusting the normal retirement age, and by trimming benefits to high-income individuals, leaving lower-income and disability benefits largely intact, according to Gramlich: "I designed the combination of the returns from the individual accounts and the benefit cuts to leave overall future retirement payments roughly constant as a share of total output."

The final and most controversial proposal is to raise the age at which workers can begin to collect benefits. Gramlich feels this approach is misunderstood, however, and says "if workers are still permitted to retire and collect benefits at age 62, the rising normal retirement age really means only a slight cut in benefits for workers retiring at any fixed age. It does not mean that these workers actually have to work until these older ages." As a further argument for this approach, Gramlich points out that workers are increasingly arriving at present retirement ages in a healthier state, and will be living longer lives.

Regardless of which strategy is implemented, Gramlich feels the hardest job will be arriving at a national consensus on picking reform measures that will generate enough savings to ensure the long-term viability of Social Security. While years of debate are likely in the future, hopefully the year 2038 will come and go as the second most-hyped doomsday of the 21st century.

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