The Social Security Dilemma

To get our minds off the subprime mortgage meltdown, the housing market slump, the credit crunch, the impending recession, and looming inflationary concerns, let’s turn our attention to another economic problem that has nothing to do with the aforementioned crises. Last week, Treasury Secretary Henry Paulson reminded us that the Social Security system is in dire financial straits. Within the next 10 years, Social Security will begin taking in less than it pays out; and in 2041, the system will be unable to pay the promised benefits.

Here’s the story: Social Security was enacted in 1935 in the midst of the Great Depression. The concern was that America’s elderly population was particularly vulnerable to the economic crisis, which saw the stock market lose nearly half its value and unemployment rates rise to over 25 percent. There were calls and movements throughout the nation for a government-enacted pension plan.

Every year from its inception up until modern day, Social Security has taken in more than it has paid out. This is because there have been more workers paying into the system than there have been retirees drawing from the system.

When Social Security was first enacted, there were more than 40 workers for each retiree collecting benefits. In recent years, this has narrowed to 3.4 workers per eligible retiree, according to a 2001 report issued by the President's Commission to Strengthen Social Security. According to the White House website (www.whitehouse.gov), “By the time today’s youngest workers turn 65, there will only be 2 workers supporting each beneficiary.”

There are several factors that have led to the shift in the ratio of workers to retirees. One factor was the baby boom, which lasted from 1945 to 1964. The baby boom added lots of young workers to the nation’s workforce, but the early boomers are now beginning to retire. So the same generation that led to a surge in workers will now lead to a surge in retirees.

Advancements in healthcare have led to longer life spans, which also increases the number of retirees. Lower birth rates in more recent generations also deliver fewer workers to the labor market.

The fact that Social Security has taken in more money than it has paid out since its inception has sustained the system for more than seven decades. But that surplus of funds was also an attractive source of revenue for national policymakers; so much so that, over the years, the national government borrowed the surplus money and issued government bonds in its place. The effect was to transfer the surplus Social Security funds into government debt, which must be paid from future tax revenues. These government bonds make up what is commonly referred to as the Social Security Trust Fund. Contrary to a common misperception, the Social Security Trust Fund doesn’t hold money; instead, it holds these bonds, which are sometimes referred to as government IOUs.

According to Secretary Paulson, Social Security will begin taking in less than it pays out in 2017. This means the government bonds in the trust fund will need to be converted back into currency, which means the national government will need to begin paying back, with interest, the surplus Social Security funds it has borrowed over the years.

By 2041, the Social Security Trust Fund, or the accumulated debt that constitutes the fund, will be gone. According to the Social Security and Medicare trustees' annual report for 2008, once this occurs Social Security will be able to pay only 78 percent of benefits promised under the current system.

There are basically two solutions to the dilemma: One is to raise Social Security taxes, the other is to cut benefits. Some have proposed lifting the cap on income that is taxed for Social Security. Currently this cap is $102,000. The problem with this approach is that lifting the cap would also presumably raise the amount of Social Security benefits wealthy contributors are entitled to; which, in addition to the political ramifications, could