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December 2002
Is nothing certain except for retirement reform and increased payroll taxes?
By John Paul Galles

     In 1935, the Social Security Act was signed into law and over 35 million Social Security cards were issued. Over the years the benefits have become available to an increasingly broad pool of recipients, including benefits for disabled workers and adult children and the addition of Medicare in the ‘60s and supplemental security income and cost-of-living adjustments in the ‘70s. The numbers are significant. In 1940, 222,000 Americans received social security payments totaling $35 million. In 2001, nearly 52.5 million Americans received social security benefits totaling $463 billion.

      In his remarks before the Subcommittee of the U.S. House of Representatives (Mar. 3, 1999) [supporting facts added], Alan Greenspan addressed the current state of our social security program:

     “The dramatic increase in the ratio of retirees to workers that seems inevitable, as the baby boom generation moves to retirement and enjoys ever greater longevity, makes our current pay-as-you-go social security system unsustainable. Furthermore, the broad support for social security appears destined to fade as the implications of its current form of financing become increasingly apparent. To date, with the ratio of retirees to workers having been relatively low, workers have not considered it a burden to share the goods and services they produce with retirees. The rising birth rate after World War II, which, in due course, contained the growth of the ratio of retirees to workers, helped make the social security program exceptionally popular, even among those paying the taxes to support it.

     “Indeed, workers perceived it to be a good investment for their own retirement. For those born before World War II, the annuity value of benefits on retirement far exceeded the cumulative sum at the time of retirement of contributions by the worker and his or her employer, plus interest. For example, the implicit real rate of return on social security contributions was almost 10 percent for those born in 1905, and was about 6 percent for those born in 1920. The real interest rate on U.S. Treasury securities, by comparison, has generally been below 3 percent.

     “But, births flattened after the baby boom, and life expectancy beyond age 65 continued to rise. [In 1935, the average American lived 63 years; in 1996, that number increased to 76 years. In 2040, life expectancy is expected to rise to 80 years, a 26 percent increase since the beginning of the Social Security program.]

     “Consequently, the ratio of the number of workers contributing to social security to the number of beneficiaries has declined [in 1935, there were 42 workers for every social security beneficiary; as of 2000, there were only 3 workers for every social security beneficiary] to the point that maintaining the annuity value of benefits on retirement at a level well in excess of accumulated contributions has become increasingly unlikely. Those born in 1960, for example, are currently calculated to receive a real rate of return, on average, of less than 2 percent on their cumulative contributions …[even] based on current law taxes and benefits. In all likelihood, short of a substantial infusion of general revenues, social security taxes will have to be raised, or benefits cut, given that the system as a whole is still significantly underfunded…”

            When the payroll tax was first instituted, the U.S. had about 33 million workers contributing one percent on wages up to $3,000. Today, nearly 152 million workers pay 15.3 percent on wages up to $84,900 and 2.9 percent on wages exceeding $84,900. As Greenspan points out, “For the present value of current law benefits over the next 75 years to be fully funded through contributions, social security taxes would have to be raised about 2.2 percent of taxable payroll; to be fully funded in perpetuity, that is, to ensure that taxes and interest income will always be sufficient to pay benefits, social security taxes would have to be raised much more — perhaps something on the order of 4 to 5 percent of taxable payroll.”

            While our federal government was running a surplus, we could afford to examine the financing of social security and even consider ways to allow workers to invest some of their payroll tax contributions in private funds. Now that we have a deficit again, the stock market is down, and we are near to a war with Iraq, our options for reform are fewer. And if it is any indication of public sentiment, virtually every politician has made a pledge to not eliminate or reduce social security benefits in any way.

            Our current economic recovery has been significantly slower than anyone expected. Businesses are not hiring people back to work as quickly as in previous economic recoveries. Companies are seeking ways to hold down costs and are using technology to improve productivity without adding people. Our payroll tax system is a major disincentive to hiring workers. Did you know that 4 out of 5 workers pay more in payroll taxes than they do in income taxes? Without any further reform, payroll taxes will increase to nearly 20 percent of every worker’s income. Workers are not incentivized at payroll taxes that high. Businesses cannot afford workers at that rate. Neither will contribute to an economic recovery.

            We have to reevaluate our tax sources. At what point does overtaxing our resources (contributing workers) deplete our ability to economically recover? We must find a way to ensure that social security is safe and secure for those who are retired or in need of social security assistance, while not overburdening the employer’s ability to hire and diminishing the incentives of our labor force to obtain employment. At the rate we are going now, it’s just not going to work!

 

John Paul Galles is the publisher of Greater Charlotte Biz.
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