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|  | MARCH 31, 2005
 SPECIAL REPORT By David Wyss Social Security: The Economic Issues The seemingly minor Social Security shortfall -- just 0.7% of the GDP -- belies the complexities of finding a remedy to a real problem President Bush has proposed a major reform of the Social Security system that would mark its first overhaul since the Greenspan Commission reforms under President Reagan. The system continues to suffer from resources insufficient to support the promises made to retiring baby boomers. Neither tax revenues nor the trust fund can support the growing population of retirees. The Social Security problem is, however, small enough to fix. The aggregate deficit, although huge ($3.7 trillion), is spread out over 75 years. Keeping reserves up to full funding at the end of that period adds $300 billion to the gap (total: $4 trillion). But a growing economy means the shortfall amounts to only 0.7% of gross domestic product over the entire period. There are many ways to overcome this shortfall, but the accounting deficit represents only part of the problem. MIXED BAG. Most other industrial countries' systems have fallen into even worse shape than America's. Europe and Japan have slower growing or declining populations, largely due to the lack of immigration, which will result in even higher ratios of elderly-to-working-age populations. Europe's earlier retirement ages and generally richer public retirement programs compound the problem. Only Britain, which partially privatized its system in the early 1980s under Prime Minister Margaret Thatcher, has a manageable load. The Social Security program has always consisted of a mix of insurance, retirement savings, and transfer programs. The political consensus as to the relative importance of these goals has varied over time. At the beginning, of course, the first generation to receive Social Security had put nothing into the kitty. But few people were collecting. The government set the retirement age at 65, in 1937, when the average American's life expectancy was only 63. Most people never collected Social Security, and the plan was designed as insurance against becoming disabled or growing too old to work. The program began during the Depression because the elderly were literally starving. Social Security allowed them to live in more dignified circumstances although, in absolute terms and as a percentage of average earnings, benefits were much lower than they are today. The program placed only a small burden on the working population. The low life expectancy meant 40 workers for each retiree. But as life expectancy rose, that ratio dropped to 16 to 1 in 1950 and 3.3 to 1 today. By 2050, it will likely reach 2 to 1. "LEGAL FICTION." Although the government originally set up Social Security on a pay-as-you-go basis, Americans began to think of it as a pension program, with a trust fund behind it. The Greenspan Commission enshrined this view and sought to make Social Security solvent by increasing the trust fund enough to pay the benefits promised. However, life expectancy caught up with the trust fund, and not all potential retirees are working as late into retirement as Alan Greenspan is. But a more serious issue remains: For the most part, the trust fund represents a legal fiction. Its only asset consists of a giant IOU signed by Treasury Secretary John W. Snow, because the fund holds only Treasury securities by law. And, on average, for the life of the fund, the federal government has been running deficits larger than the additions to the trust fund. In fact -- if not in law -- benefits will have to come from current taxpayers, not out of this semi-fictional trust fund. Paying these benefits will require dramatic increases in tax rates or enormous borrowing. If the U.S. does nothing about benefits or tax rates, government debt will rise to 239% -- from its current 65% -- of GDP by 2050. The President has proposed addressing the problem by privatizing Social Security accounts, allowing individuals to put part of their contribution into a private account. Benefits would be reduced proportionately, in such a way that the system would not have further accrued net liabilities. In spirit, the system resembles the British program put in place more than 20 years ago, as well as those in Chile and other countries. Britain, however, was the only major country to convert to such a system, while the others created public pension systems de novo. CHILEAN EXAMPLE. Britain enjoyed several advantages in creating its system. Most important, its baby boomers had 30 years before their retirement to build up these private accounts. The U.S. has no such luxury, with retirement fast approaching for its baby boomers. Even with its time advantage, however, Britain's system has its problems. The baby boom generation is approaching retirement with too little saved, and many worry that retirement will be impossible. On the bright side, Britain has a cradle-to-grave health coverage (run at half the per-capita cost of the U.S. system) and a public housing system that guarantees some form of shelter. The average British citizen will thus need less in personal retirement funds -- but nonetheless those funds remain in questionable supply for many who are now approaching retirement. Already, one-third of British elderly receive supplementary welfare benefits. Many of the newer systems, such as Chile's, began because existing systems were bankrupt or nonexistent. Some observers cite the Chilean system as an example of successful privatization, but it covers only 40% of the country's population.
BW MALL
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