Social Security: Follow the Math
By Michael Tanner
Cato Instiute Project | January 14, 2005
http://www.socialsecurity.org/pubs/articles/tanner-050114.html
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
---------------------------------------
Michael Tanner is director of the Project on Social Security Choice
at the Cato Institute and author of Social Security and Its
Discontents.
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