Briefing Book
Background Material

Social Security's Financial Issues.

Social Security faces a serious problem, not a catastrophe. It will be there for future generations, although the benefits are likely to be less generous than the checks received by today's retirees.

Here's a look at what is happening, stripped of myth and exaggeration.

Social Security is essentially a pay-as-you-go system. Payroll taxes contributed by today's workers and their employers are funneled to retirees. Workers are paying for the retirement benefits of their parents and grandparents, their aunts and uncles.

Taxes are levied on salaries paid to workers - for 1998, the tax will be 6.2% for the first $68,400 in earnings. The worker and employer each pay this amount.

The ability of the system to pay benefits is linked to the growth of the labor force and the expansion of the economy. As more workers are employed, and business productivity expands, giving workers higher incomes, there is an ever-expanding pool of wages.

But the labor force is growing at a negligible pace. The birth rate has been low for 30 years, because the baby boomers are marrying later, and having smaller families.

And the elderly are living longer. In 1940, when Social Security checks were mailed for the first time, a man who reached 65 could look forward to another 12 years of life, and a woman age 65 had a 13 year life expectancy.

By 2040, when all the boomers will have retired, life expectancy at age 65 will likely be 17 years for men and 21 years for women.

"Increasing life expectancy and falling fertility rates in combination mean that fewer workers will be contributing to Social Security for each aged, disabled, dependent, or surviving beneficiary," according to a recent report by the General Accounting Office, the investigative arm of the Congress.

In addition, the economy has been in a slow-growth phase since the early 1970s. The output of goods and services, everything the economy makes, from a haircut to a new car, has been expanding at a historically low rate. This means the pool of wages from which benefits are paid is growing more slowly, too.

In 1997, the Social Security trust funds enjoyed a surplus, with receipts of about $435 billion a year in taxes and interest on investments, compared with $370 billion in benefit payments and administrative expenses. The surplus will likely continue for another two decades, because the ranks of the retirees are growing slowly. People retiring today were born in the Great Depression era, when birth rates were extraordinarily low.

Surpluses now accumulating are invested in special issues of Treasury securities, which earn interest. The surplus will likely be liquidated in the years 2020-29, as the baby boom generation - those born in the years 1946 through 1964 - begins drawing Social Security benefits. The oldest of the baby boomers become eligible for full retirement benefits after the year 2011.

There is not a formal fiscal crisis until 2032 - the first year that Social Security will be unable to pay the promised benefits. However, the system will not be broke, or bankrupt, as is so often mentioned. Instead, revenues will be sufficient to pay 75% of the promised benefit. The gap that must be filled is the other 25%.

The challenge for the voters, and the President and Congress they select, is to agree on a way to close the expected gap long before the year 2032. If we wait too long, only a big tax hike, or a big benefit cut, can close the gap.

"Social Security is not in a crisis," argues Commissioner Kenneth S. Apfel, "and if we take action soon, we can prevent a crisis from ever occurring."

Deciding on the shape of Social Security for the baby boomers will be "the most fundamental debate we will have in the next several years," Apfel said in a Senate committee hearing.

The debate will give Americans an opportunity to decide if they want to keep the current system largely intact, perhaps with some tinkering with both taxes and benefits.

Or they can decide to make a major change in the system by offering individuals the opportunity to invest for themselves and perhaps enjoy a better return on their money than they would get from Social Security. This idea, called privatization, would permit taxpayers to take some of the money they pay into the Social Security system and invest it in individual retirement accounts, purchasing securities.

Yet another possibility would keep the current Social Security system intact and supplement it with new savings accounts to help boomers set aside money for their retirement.

The common goal for all the diverse ideas is to ease the strain on Social Security so it can fulfill its promises to the baby boom generation without imposing too heavy a tax burden on their children and grandchildren.

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