Dr. Mike Walden
The battle over Social Security has begun.
President Bush wants to make the biggest changes to Social Security since its inception by allowing workers to direct some of their contributions to private accounts. Others propose alternative Social Security changes; still others want no changes at all.
There are many questions about Social Security's status and the ideas for changing this important program. I'll try to answer some of the key ones as completely and evenly as possible, and then let you decide about the program's future.
Is social security going broke? The key factor determining Social Security's financial future is economic growth. The faster the economy grows, the longer Social Security will survive. Faster economic growth means more income per worker and more contributions to the Social Security system.
In fact, if the economy grows at the average rate it has in the last decade, Social Security could easily last until the end of the century. Conversely, if the economy grows more slowly, Social Security could very well face a problem by mid-century. But the bottom line is, the economy is the key.
Are Social Security's savings worthless? Social Security has accumulated $1.3 trillion in savings for future retirement payments. By law, the savings are invested in U.S. government securities. Some say these government IOUs are worthless, meaning Social Security's "savings" are a mirage.
If this is true, then many investors are also in trouble because U.S. government securities are one of the most common and safest investments around. The U.S. government has never missed an interest payment or redemption on these investments. It would take a major financial collapse of the federal government for Social Security's IOUs not to be cashed in. I don't see this happening, but others aren't so sure.
Would private accounts solve social security's problems? Privatized Social Security accounts would operate like 401K plans. The pensions produced by the accounts would depend on how much money workers invested and what investment returns were earned on the money.
The current investment returns on Social Security funds are low - between 2 and 3 percent - because the system invests only in low-risk government securities. So for a worker to do better with private accounts, the worker will have to invest in funds giving a higher return, which usually implies some degree of higher risk. There's no free lunch!
What other options are being considered? One option being pushed is to increase the ceiling of income subject to the Social Security tax. Currently any worker earnings over $90,000 are not liable to the tax.
Some say this is a free ride for the rich, and therefore the ceiling should be eliminated. However, the taxation ceiling exists due to a comparable ceiling on Social Security pensions. Social Security pensions received at retirement generally are higher for persons who earned more when working. But this increase in the retirement pension stops at a certain income level, which is the same as the ceiling on earnings subject to the tax.
So any increase in the income ceiling on Social Security taxes without a comparable increase of the ceiling for pension payments would simply mean higher-income workers would pay more without receiving any additional benefit. Some call this unfair; others don't!
A second idea is to alter how earnings are increased and used as the base for Social Security pensions. Currently, a worker's initial Social Security pension is established by adjusting his or her average career earnings by the growth in wages over the work career. One proposal is to use growth in prices for the adjustment instead.
This matters because wages typically increase faster than prices. So changing to "price indexing" for a worker's initial pension would make that pension smaller and save the Social Security system over $1 trillion in coming decades.
There are many more issues surrounding Social Security reform. The program affects virtually all of us, so it's crucial you decide where to stand.
Dr. Mike Walden is a William Neal Reynolds Professor and extension