Irrational Exuberance Won’t Save Social Security

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Federal Reserve Board Chairman Alan Greenspan warned against letting "irrational exuberance" cause us to ignore stock market fundamentals, and we should be also careful that today's booming economy doesn't make us ignore the fundamentals of Social Security and wishfully conclude that the system does not face a crisis after all. Some commentators have gotten great publicity by doing just that. The status quo faithful, led by Dean Baker and Mark Weisbrot of the Economic Policy Institute, claim that "any shortfall that Social Security may have in the future can result only from a dismal economic performance." If economic growth exceeds the low 1.7 percent annual rate projected by Social Security's Board of Trustees, they say, "the Social Security system will be solvent into the stratosphere of America's science-fiction future." But close examination shows how irrational this exuberance is.

Social Security's trustees predict low economic growth not because Americanworkers will suddenly become unproductive -- in fact, the trustees actuallypredict that future wages will grow at twice the 1975-95 rate -- but becauselow birth rates and retiring Baby Boomers will slow the growth of the laborforce. Not enough workers equals not enough economic growth. But Baker andWeisbrot, authors of Social Security: The Phony Crisis, believe the economywill grow faster. Faster growth means higher wages, and higher wagesgenerate more tax revenue to pay benefits. Voila! Crisis averted.

The truth is that, regardless of economic growth, Social Security promisesmore than it can pay. Here's why. Social Security pays benefits with moneyit 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 BudgetOffice show that 79 percent of income growth from 1993 to 1996 went toindividuals earning more than the payroll tax ceiling. In other words, mostof the economic growth in recent years hasn't added a red cent to SocialSecurity -- it simply passes it by. Baker and Weisbrot should know that,since their organization recently released a report decrying incomeinequality in the 1990s.

But let's assume the future will be different. Economic growth willincrease and most wage gains will go to people who earn less than thepayroll tax salary ceiling. Guess what? Even under that unlikely scenario,economic growth won't save Social Security. Why? Because each year thebenefits a new retiree receives increase according to wage growth. Wagegrowth increases the money coming into Social Security, but it alsoincreases the amount going out. (Benefits following retirement riseannually according to inflation.) Over the long run, it's a wash.

Social Security's real problem isn't economic, it's demographic. From 1970to 1995, the working-age population grew by 1.5 percent annually and theretiree population by 2 percent. But from 2015 to 2040, the workingpopulation will increase by only 0.2 percent annually while the retireepopulation grows by 2.2 percent. In a pay-as-you-go system, slow laborforce growth is a recipe for disaster.

The solution isn't to increase the labor force; it is to make each person'spayroll taxes work harder. Investing payroll taxes in stocks and bondsthrough personal retirement accounts could help pay full promised benefitswithout a tax hike or an increase in the retirement age, while givingworkers a legal right to their benefits and a bequest to leave to theirheirs. And even if economic growth won't help Social Security, SocialSecurity privatization could give a big boost to economic growth. Harvardeconomist Martin Feldstein calls privatization "the $10 trillionopportunity," because of the 5 percent increase in economic growthprivatization would bring each year.

We may be in a New Economy, but the old rules set up more than 60 years agostill apply to Social Security. Unless we privatize, payroll taxes mustrise by 50 percent or benefits must be cut by one-third. Irrationalexuberance can't change that.