America's social security: reforming a giant

The cost of the United States's trillion-dollar pension system is high on the presidential-election agenda. But turning problems into workable proposals is hard, reports Matt Kennard.
Matt Kennard
23 January 2012

Social security, the United States's federally-run pension system, has become one of the defining issues of the Republican primary campaign as the presidential-election campiagn gathers steam. Think-tanks on both sides of the political divide are racing to outline plans for reform of the system, which politicians so far have been eager to criticise but unable to find an agreed alternative to. The private sector in the US has been waiting for decades to gain access to the trillion-dollar programme; now think-tanks on the right are focusing on ways to let them do it.

Barack Obama's administration announced that, from January 2012, 55 million recipients of social security will get increases averaging $39 a month, or about $467 a year. The boost, reflecting higher inflation, was well received by many in the programme but again highlighted the huge unfunded outlays due over the coming decades.

Rick Perry, the governor of Texas who is running for the Republican nomination, in reference to this shortfall called the programme a "Ponzi scheme". Mike Meedham, chief executive of Heritage Action, a conservative policy-advocacy organisation, is more measured but equally clear in saying: "Everybody on the right in this country knows that social security is on a fiscally unsustainable path."

Before the primary season got underway, the issue of reform of social security on the right was still muted. The main reason was George W Bush’s abortive attempt to part-privatise the system early in his second-term.

In 2005, Bush wanted to take part of social-security taxes (at a point when social security was running at surplus) and put the bulk of the money into a thrift-savings plan. That would then be invested and social-security benefits would accrue from both the government and the private account.

That idea is now widely repudiated by conservatives. But reform is not.
"We stopped using the word privatisation around 1999," says David Corn, a fellow at Heritage. "I desperately want to avoid that, it doesn’t describe the kind of reforms that people are talking about."

"The country was not in the mood during the Bush presidency," adds Meedham. "Now Americans are realising we are at a tipping-point, we see in Europe what the future could be."

Social security in the US, like most countries, is a pay-as-you-go system where people contribute 6.2% of income, which is matched by their employers for a total of 12.4%. That pays for retirement survivors’ benefit and a smaller disability programme. The system is facing a dilemma as it faces low economic growth-rates, a declining birthrate, and rising numbers of elderly people.

The social-security trust fund has about $2,600bn invested in special-issue treasury bonds. For much of the early 2000s analysts believed the programme would go "cashflow negative" in 2017, but that happened in 2010. Under current projections the trust fund will run out of money in 2036.

"The supporters of the current system talk about changes with taxation or the fact that social security is still financed for twenty-five years, but it’s like fixing a roof: the longer you leave it the most expensive the repair becomes," says Corn.

"We are close to having a third of the adult population on social security," says Eugene Steuerle, fellow at the Urban Institute, which has authored its own plan to reform social security. "It will be roughly two working people to one person on social security when baby-boomers retire, it was six-to-one before."

He adds: "It either means workers will have to pay a lot more, or beneficiaries are going to get less as a share of national income. People on left and right want to dodge that issue."

The trillion-dollar bullet

The stakes are high. Social security - alongside Medicaid/Medicare and defence spending - is one of the three "trillion-dollar problems", which if solved could wipe out the fiscal deficit that led to a recent downgrade of the US’s sovereign credit-rating.

Most analysts say that social security is the only one that can be easily solved. There are three ways in which the programme can avoid insolvency - pay more into the system, cut the benefit, or move back the retirement age. There is a bipartisan consensus that a benefit structure change can work if it is progressive, i.e. it lowers the schedule more for higher earners than lower earners.

Social security is not price-indexed. When computing initial benefits an average of career earnings is caculated and increased by the percentage of the increase of wages over that career, not prices.

"Here’s the question", says Robert Pozen, a senior lecturer at Harvard Business School and expert on social security. "If today we only go from wage index to price indexed initial benefits, and we kept everything else the same, we have a $13tr deficit - well, we would wipe it out immediately."

Wages, he says, go up 1% more than prices. Pozen calls his proposal "progressive benefit reform". He argues that the programme should take the lower third of workers, which is roughly $25,000 career earnings based on much lower incomes. These people don’t have 401-Ks or IRAs: in their case the replacement ratio is very important for them, so Pozen proposes to wage-index them.

The top third then see their benefits grow at price index, and in the middle there is a blend. He estimates it would reduce the long-term deficit from $13tr to somewhere between $3-5tr.

"The beauty of this multi-trillion dollar number that we could come to grips with it and solve it," says Pozen. "On healthcare there is no agreement and on defence we have gone as far as we can go, that’s why I’m a little optimistic."

Heritage meanwhile proposes a public-private partnership, and a streamlining of benefit structure. "What we’re saying at Heritage is that there should be a flat-rate benefit," says Corn. It would be equivalent of 140% of the poverty, which works out at $1,200 dollars a month as the average benefit that individual receives.

They would raise the etirement age, which reflects changes in longevity, alongside changes to the formula used for annual cost-of-living increase. The political divisions in the United States, both inside and between the parties, make any such plan hard to implement. But a big problem needs an imaginative response. The next few years will show whether the US political system can still produce one.

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