Policy Paper

The Politics of Social Security

Why Wage Growth is the Best Way to Ensure the Program’s Solvency
  • By Eric Laursen, Co-Author, Understanding the Crash
October 28, 2010 |

The Social Security debate is the longest-running domestic political tug-of-war in Washington. It began in 1981 when President Reagan floated a proposal to drastically cut old-age and survivors' benefits that met with immediate rejection from leaders of both parties in Congress.

Reagan subsequently appointed the Greenspan Commission to develop proposals to extend Social Security's fiscal solvency. His signing in 1983 of a set of amendments to the Social Security Act based on the commission's recommendations disappointed influential critics of the program, who complained that modest improvements were not enough: Social Security needed to be fundamentally restructured and its growth curtailed.

Since then, Social Security has been a constant of Washington's domestic policy debates. But in a way, not much has changed over the past three decades. The issues involved and the positions that conservatives and liberals staked out shortly after President Reagan entered office are almost exactly the same ones that President Obama's National Commission onFiscalResponsibility and Reform are debating today: Can today's workers rely on Social Security to be there in the long run? Will this vitally important program become a burden on taxpayers in future decades? Conservatives say no to both while liberals say yes.

According to the trustees' intermediate projections, Social Security will have enough money coming in through payroll taxes and interest on the assets in its trust funds to pay full benefits through 2037.  After that, unless changes are made to boost revenues or reduce benefits, Social Security will only be able to pay a little more than three-quarters of promised benefits. Keeping in mind that these numbers are projections, not prophecy, the Social Security shortfall has two primary causes: stagnant wages and rising health care costs.

The Effects of Wage Stagnation

The three decades of the Social Security debate also coincide with the long period of low or no growth in wages for American workers. Real wages for low- and middle-income earners were actually lower in 1996 than they were in 1973. A tight labor market drove them up during the next half-decade, but by 2001, stagnation had set in again. Wages budged very little during the economic recovery that ended in 2007. [1]

The effect on the Social Security trustees' solvency projections is clear. In 1982, after the first decade of no progress in real wages, the program was close to insolvency. The 1983 Amendments restored it to health for a projected 75 more years. But in 1998, the projected year of exhaustion for the two trust funds that underpin Social Security – one for Old-Age and Survivors' Insurance, the other for Disability Insurance – was 2032. By 2003, when the effects of a half-decade of rapid wage growth during the late 1990s had played themselves through, the date of exhaustion was 2042. Last year, after a long relapse into wage stagnation, the date of exhaustion slid back to 2037. It remained there this year, in the trustees' latest report.

The other big source of pressure on Social Security is health care costs. The new health reform legislation, or the Patient Protection and Affordable Care Act, may help to ease those costs, perhaps even more than is projected – but only if it is allowed to remain in place. The ultimate effect of the new law will not be known for a decade, as federal and state regulators implement the rules that make the new system operative and the results of a host of small-scale programs, demonstration projects, studies, and research efforts become clear.

Meanwhile, more and more of seniors' Social Security checks are being eaten away by rising health expenses. In 1970, five years after Medicare was enacted, seniors' out-of-pocket expenses for health care were minuscule. Today, they pay an average of slightly more than $250 a month out of a Social Security benefit check that averages about $1100 a month.[2]  By 2084, the trustees project that Medicare Parts B and D costs will absorb more than half of that Social Security check – and that is not counting other health care expenses not covered by Medicare.[3]

If the costs associated with our health care system are not brought under control, the fundamental purpose of Social Security will change dramatically. To prevent this – to preserve the program's ability to cover elder costs other than health care – Social Security will need to expand and be made more generous. Unfortunately, the opposite has been happening. Critics of Social Security often portray the program as overgenerous. But a2005 study of 30 member countries by the Organisation for Economic Co-operation and Development (OECD) found that the U.S. spent a smaller share of national resources on retiree benefits through Social Security than most other countries. The income replacement rate for U.S. retirees ranked fifth from the bottom of the list.[4]

This disparity is only getting worse. The 1983 Amendments included a gradual hike in the age of eligibility to collect benefits to 67. This has reduced benefits for many seniors. During the Clinton administration, a series of adjustments to the components of the Consumer Price Index used to calculate benefits began to push down the replacement rate for final average income. As a result of both these changes, the median replacement rate is projected to slip from 39% to 31% for workers born between 1956 and 1965 even if nothing is done to further downgrade the system.[5]

The Zero-Sum Game

Three sides, not two, have defined the Social Security debate for the past three decades:

  • Traditional defenders of Social Security want to keep the basic structure as it is and oppose further erosion of benefits.
  • The privatizers want to funnel a portion of workers' payroll taxes to the financial services industry in the form of private accounts and cut benefits from the benefits that remain.
  • The deficit hawks simply want to continue cutting benefits.

Each of these three groups has a different view on the crucial issue of wages. Social Security's defenders would like to see wages start rising again, because this is the best way to assure the program's fiscal health going forward. Privatizers adamantly oppose new or higher taxes and would like to see income from private investments replace wages as the main source of wealth for nearly all workers, creating what Karl Rove described as the “ownership society.” The deficit hawks tend not to be wedded to the idea of carving private accounts directly out of payroll taxes. But they generally agree with the privatizers that the direction that wages have been trending for most of the past 30 years is not going to change – and probably should not be encouraged to do so.

If they are correct, income tax and payroll tax revenues will trend down, not up, over the long term. That means government, including Social Security, will have to shrink, creating a zero-sum game for all domestic government programs and services. That logically means a race to the bottom: cutting Social Security, and cutting and cutting it, until there is nothing left to cut.

The problem with this approach is that there is a price to be paid to cutting programs and services, just as there is for raising taxes. In the short run, cutting Social Security – and Medicare and Medicaid – takes money out of the consumer economy at a time when consumption and economic growth are dependent on government income support. In the long run, it reduces retirees' income, making them more dependent on the “sandwich generation” of middle-aged workers struggling to raise children, support their elder relatives, and save for their own retirements.

A more productive route would be for the commission to consider ways to boost employment and raise wages, especially for lower-income workers, who bear a disproportionate share of the payroll tax burden. This could include nurturing domestic industries for which there is a growing need, such as renewable energy and long-term care for the elderly. It could also mean raising the minimum wage and expanding affordable day-care for working parents, allowing them to hold onto more of their paycheck.

Tight labor markets and policies that encourage wage growth have a powerful effect on Social Security. For instance, during the recession of the early 1990s, payroll tax contributions rose 17.1%, from $296.1 billion in 1990 to $357.2 billion in 1995. Once the economy took off and wages began rising again, payroll tax revenue picked up. Through 2000, payroll tax receipts rose 27.5%, to $492.5, greatly extending the projected life of the trust funds.[6]

Payroll Taxes and Tax Expenditures

If policy recommendations to encourage job and wage growth are deemed too far outside the commission's mandate, there is another course it could pursue: modest, phased-in payroll tax increases and reform of tax expenditures.

The critical question in assessing Social Security's long-term impact is how much pressure it places on the economy as a whole. The answer is: not very much. According to the trustees' 2010 report, the Social Security deficit over the next 75 years – in other words, the benefit promises that payroll taxes and interest on the trust fund assets don't cover all by themselves – will come to just 0.7% of GDP.

According to the Center on Budget and Policy Priorities, that is about the same share as the cost of extending the Bush tax cuts for the top 2% of taxpayers, or about 1.92% of taxable payroll.[7] A shortfall of that size is small enough that it could be eliminated by a series of modest boosts in payroll tax that would not endanger economic recovery and would never exceed a modest rate of wage growth. This is how Congress maintained long-term fiscal balance in Social Security up through the 1983 Amendments, the last time major changes were made to the program.

One way to make payroll tax hikes more palatable would be to reform tax expenditures. Deficit hawks often caricature Social Security and Medicare as “entitlements,” because they are automatic payments, determined by a formula, not by Congress each year. But tax expenditures such as for home mortgages and property taxes, employer-provided and self-employed health insurance, and tax incentives for pensions and retirement saving, can also be regarded as entitlements. Each is determined by a formula written into the tax code and lawmakers do not review them from year to year. They total $5 trillion over the next five years, according to the Congressional Budget Office. The Social Security shortfall, by contrast, is projected to total $5.4 trillion over the next 75 years.[8]

The income gains from tax expenditures, furthermore, are skewed in favor of high-end wage earners, according to a recent study.[9] Tax incentives for pensions and retirement saving, for example, total $148.7 billion in the 2010 federal budget, including for employer-contributory pension plans, 401(k) and other employer-sponsored salary reduction plans, individual retirement accounts, the Savers Credit, and Keogh plans for self-employed persons. Eliminating these tax incentives would have the same effect as reducing all marginal tax rates by 14.9%; nearly 80% of the cost of doing so would be borne by the top-quintile of income distribution. The distribution would be about the same for eliminating home mortgage and property tax deductions, which total $120 billion.

Conclusion

Reducing tax incentives for saving and gradually raising Social Security payroll taxes by a roughly equivalent amount, for example, would be a progressive tradeoff, since Social Security benefits skew toward lower-wage workers. But members of the president's fiscal commission are unlikely to consider reducing tax expenditures for saving, since they reward wealth-building rather than wage-earning. The members seem also to have agreed not to discuss the Bush tax cuts, despite their high budgetary cost. Reportedly, several are instead pushing for the commission to recommend more cuts in corporate and capital gains taxes.

That suggests that any real deficit reduction the commission recommends will come from spending cuts, not tax hikes: even though some members of the commission, including co-chairs Alan Simpson and Erskine Bowles, advertised it as an attempt to achieve a compromise involving revenue raisers and spending cuts. Partly, this is because of politics. Republican lawmakers smell victory in November, so it is understandable that they would not be inclined to compromise any part of their agenda – especially their opposition to higher taxes. The president, meanwhile, has been careful about saying anything that could suggest he is undercutting the good work of his commission. That makes it difficult for his administration to exercise any influence on the discussions.

The more fundamental problem, however, is the lack of will in Washington to take steps to end wage stagnation. If not addressed, this threatens to become a self-fulfilling prophecy in which many people find themselves permanently cast aside by the workforce, the quality of most American jobs continues to decline, wages continue to stagnate, and payroll tax receipts dwindle. If that continues, the U.S. is likely art some point in the future to face a real Social Security crisis. Because just as the problem of rising Medicare and Medicaid costs cannot be solved in isolation from the problems facing the larger health care system, Social Security's long-term funding can only be assured by creating good jobs for American workers.

Eric Laursen is an independent journalist based in western Massachusetts. He is co-author of Understanding the Crash (Soft Skull Press/Counterpoint, 2010) and author of the forthcoming The People’s Pension: The War Against Social Security from Reagan to Obama (AK Press, Spring 2012). He blogs on Social Security, Medicare, and related issues at http://peoplespension.infoshop.org/blogs-mu/.

 

Notes

1. Jared Bernstein and Lawrence Mishel, “Economy’s Gains Fail to Reach Most Workers’ Paychecks,” EPI Briefing Paper #195, Economic Policy Institute.  September 3, 2007.

2. 2010 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.

3. 2010 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.

4. Organisation for Economic Co-operation and Development, Pensions at a Glance: Public Policies Across OECD Countries (OECD Publishing, 2005); “Solving the Pension Puzzle,” OECD Policy Brief, March 2005.

5. Barbara Butrica, Howard Iams, and Karen E. Smith, “It's All Relative: Understanding the Retirement Prospects of Baby Boomers,” Urban Institute, Washington, D.C, 2003.

6. 1991, 1996, and 2001 Annual Reports of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.

7. Kathy A. Ruffing and Paul N. Van de Water, “What the 2010 Trustees' Reports Shows About Social Security,” Center on Budget and Policy Priorities, August 13, 2010.

8. Annual Report of the Board of Trustees of the Federal Old Age, Survivors and Disability Insurance Trust Funds.

9. Eric J. Toder, Benjamin H. Harris, and Katherine Lim, “Distributional Effects of Tax Expenditures,” Tax Policy Center of the Urban Institute and the Brookings Institution, 2009.

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