The Social Security Problem
The earliest Social Security beneficiary was a retired Cleveland motorman named Ernest Ackerman, who retired one day after the program began. During his single day of participation in 1937, a nickel contribution was withheld. Upon retiring, he received a lump-sum payment of 17 cents. As return on investments go, it’s been downhill ever since.
Of course, Social Security was never designed as a retirement program. If it were, the program would have done little to address one problem motivating its creation: high poverty rates amongst the elderly. Implementing a 401(k)-style program would’ve been a joke, requiring decades to deal with a problem that society felt demanded immediate attention. Hence, a decision was made to structure a system in which current contributors support current beneficiaries, sometimes referred to as a pay-as-you-go system.
But the pay-as-you-go financing arrangement has its own problems. While an excellent means of starting up a program on the cheap (relatively speaking), the same demographic reality that made it easy to start also makes it difficult to sustain.
Specifically, when the Social Security system made its first payments, the retirement age was 65 and the average life expectancy for 65-year-olds was 77, or 12 additional years. Today’s 65-year-old retiree, however, can look forward to another 17 years of retirement. And even with an extension of the retirement age to 67, starting in 2026, a child born today should live 19 years past that time. Put simply, longevity has extended retirements by 58% since the program’s inception.
Aside from living longer, we’re also having fewer children (i.e. future contributors); today’s fertility rate of 2 per women compares to a figure of 3.5 just 50 years ago. Combining reduced birth rates with longer lives yields the inescapable reality of a rising dependency ratio: the ration of working-age people to those over 65. When Social Security began, that ration was 10-to-1. Now, it’s 5-to-1 and it will hit –to-1 when the average reader retires.
In recognition of this flaw – and the inevitable funding shortfall it produces – the financing system was overhauled in 1983. But instead of fundamental change, the day of reckoning was simply put off with a combination of benefit reductions and tax increases. Benefits were effectively cut by subjecting them to income taxation for the first time, which permanently reduced after-tax benefits by 3% for the typical recipient. The tax increase was more transparent, raising contribution rates from 6.7% to 7.7% of pay – a bump that broke tradition with the pay-as-you-to principle. Ever since that time, contributors have been paying the benefits of existing retirees plus a surplus for their own future retirement.
But you may want to sit down for the next part, as the story gets worse: the “surplus” we’ve presumably been funding for the past 20 years doesn’t actually exist. Instead of piling up in a savings account for future use, the extra contributions have gone toward financing the day-to-day operations of the federal government. All that remains are bookkeeping entries that obligate future generations to make good on past debts.
And so, the fair deal promised to Mr. Ackerman and his cohort was actually quite sweet. But it’s given way to successively less appealing arrangements, with a truly raw deal awaiting those not yet in the system.
