Social Security: Follow the Math

January 14, 2005 • Commentary

President Bush has made it clear that reforming Social Security is one of his top priorities for his second term. Battle lines are forming among supporters and opponents of his proposal to allow younger workers to invest privately a portion of their Social Security taxes through individual accounts. At times the debate can seem mind‐​numbingly complex, full of arcane actuarial terms and competing claims about insolvency and rates of return.

But underneath all the noise, there are only a few things that Americans need to know in order to understand the Social Security crisis.

First, the current Social Security system is what is known as a “pay‐​as‐​you‐​go” system. It is not a savings or investment system, but a simple transfer from workers to retirees. The payroll taxes from each generation of workers are not saved or invested for that generation’s retirement, but are used to pay benefits for those already retired. The current generation of workers must then hope that when their retirement comes, the next generation of workers will pay the taxes to support their benefits, and so on.

Obviously, a pay‐​as‐​you‐​go system is very sensitive to the number of people paying in versus the number of people collecting benefits. In other words, the ratio of workers to retirees is crucial to the financing of the current system.

The current worker‐​to‐​retiree demographics in the United States spell trouble for Social Security and its ability to keep up with its promised benefits. People are having smaller families resulting in fewer new workers paying taxes into Social Security. And seniors are living longer and collecting benefits for many more years. Add to this the fact that the Baby Boom generation is about to retire and you end up with far, far fewer workers than retirees than when Social Security started.

In 1950, there were 16 workers paying taxes into the system for every retiree who was taking benefits out of it. Today, there are a little more than three. By the time the baby boomers retire, there will be just two workers who will have to pay all the taxes to support every one retiree.

Fewer workers for more retirees mean each worker bears an increasing financial burden to pay the benefits that Social Security has promised. The original Social Security tax was just 2 percent on the first $3,000 that a worker earned, a maximum tax of $60 per year. By 1960, payroll taxes had risen to 6 percent. Today’s workers pay a payroll tax of 12.4 percent.

It is going to get much worse. In order to continuing funding retiree benefits, the payroll tax will have to be raised to more than 18 percent. That’s nearly a 50 percent increase.

Let’s look at that financial burden another way. The Social Security payroll tax is already 12.4 percent of wages, or one eighth of a worker’s total annual wages. It is the biggest tax the average household must pay. Roughly 80 percent of American families pay more in Social Security taxes than they do in federal income taxes.

Despite that already huge tax burden, the payroll tax will have to be increased by nearly half in order to continue paying Social Security benefits. That’s a terrible burden to impose on our children and grandchildren.

The only way out of this problem is to change Social Security from a pay‐​as‐​you‐​go model to a system based on savings and investment. That is why President Bush wants to allow younger workers to begin saving some of their Social Security taxes. Those who disagree have an obligation to tell the rest of us how they would deal with the grim demographic reality.

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