Social Security’s trustees predict low economic growth not because American workers will suddenly become unproductive — in fact, the trustees actually predict that future wages will grow at twice the 1975–95 rate — but because low birth rates and retiring Baby Boomers will slow the growth of the labor force. Not enough workers equals not enough economic growth. But Baker and Weisbrot, authors of Social Security: The Phony Crisis, believe the economy will grow faster. Faster growth means higher wages, and higher wages generate more tax revenue to pay benefits. Voila! Crisis averted.
The truth is that, regardless of economic growth, Social Security promises more than it can pay. Here’s why. Social Security pays benefits with money it collects from a payroll tax of 12.4 percent on wages up to a ceiling of $76,200. But income tax return data collected by the Congressional Budget Office show that 79 percent of income growth from 1993 to 1996 went to individuals earning more than the payroll tax ceiling. In other words, most of the economic growth in recent years hasn’t added a red cent to Social Security — it simply passes it by. Baker and Weisbrot should know that, since their organization recently released a report decrying income inequality in the 1990s.
But let’s assume the future will be different. Economic growth will increase and most wage gains will go to people who earn less than the payroll tax salary ceiling. Guess what? Even under that unlikely scenario, economic growth won’t save Social Security. Why? Because each year the benefits a new retiree receives increase according to wage growth. Wage growth increases the money coming into Social Security, but it also increases the amount going out. (Benefits following retirement rise annually according to inflation.) Over the long run, it’s a wash.
Social Security’s real problem isn’t economic, it’s demographic. From 1970 to 1995, the working‐age population grew by 1.5 percent annually and the retiree population by 2 percent. But from 2015 to 2040, the working population will increase by only 0.2 percent annually while the retiree population grows by 2.2 percent. In a pay‐as‐you‐go system, slow labor force growth is a recipe for disaster.
The solution isn’t to increase the labor force; it is to make each person’s payroll taxes work harder. Investing payroll taxes in stocks and bonds through personal retirement accounts could help pay full promised benefits without a tax hike or an increase in the retirement age, while giving workers a legal right to their benefits and a bequest to leave to their heirs. And even if economic growth won’t help Social Security, Social Security privatization could give a big boost to economic growth. Harvard economist Martin Feldstein calls privatization “the $10 trillion opportunity,” because of the 5 percent increase in economic growth privatization would bring each year.
We may be in a New Economy, but the old rules set up more than 60 years ago still apply to Social Security. Unless we privatize, payroll taxes must rise by 50 percent or benefits must be cut by one‐third. Irrational exuberance can’t change that.