Q&A: The great Social Security debate

Q: Social Security seems to have been working fine for decades. Why is there a problem with it now?

A: The underlying cause of most of the current fuss about Social Security can be summed up in two words: "aging population." In the not-too-distant future, the US baby boom is going to begin hitting retirement, and wave upon wave of boomers will begin trading paychecks for Social Security payments. The raw numbers are amazing - in 2000, there were about 35 million Americans age 65 or older. By 2050, there will be 87 million, an increase of well over 100 percent.

The number of retirees will thus rise much faster than will the number of young people in the workforce. This disparity is important, because money from the payroll taxes of current workers is what the government uses to pay the benefits of today's recipients.

Back in 1950, each person on Social Security was financed by the taxes

of about 16 workers. Today, the ratio is about 1 recipient per every 3 workers. By 2050, it will be about 1 recipient for every 2 workers.

One important caveat - this demographic picture is complicated by the fact that Social Security is much more than a retirement program. It also pays benefits to disabled workers and their dependents; spouses and children of retired workers; and the survivors of deceased workers.

Thus Social Security is huge - the single largest program of the American government. This year alone it will pay out $500 billion, constituting almost a quarter of all Washington's spending.

The current cash crunch aside, the program has also been hugely successful. Take just one measure - poverty among the elderly. In 2000, 48 percent of Social Security recipients would have been poor without their government check, says the Government Accountability Office (GAO).

A targeted antipoverty program might arguably have accomplished that same goal more efficiently. But the poverty issue shows the potential emotions and sensitivities that could arise as lawmakers consider changes in the system.

"It is precisely because the program is so deeply woven into the fabric of our nation that any proposed reform must consider the program in its entirety, rather than one aspect alone," said David Walker, Comptroller General of the US, in a February testimony to the House Budget Committee.

A: That depends on the meaning of the word "bankrupt." Let's put it this way: If nobody does anything to fix the system, in just under 40 years it will hit a financial wall, according to Social Security's own numbers, and be forced to implement an immediate 30 percent cut in benefits. Technically, it wouldn't be in Chapter 11. But the cries of outrage from beneficiaries would probably be so loud that members of Congress could hear them without having to pick up their phones.

As virtually every worker in the US learned when they read their first pay stub, and were shocked at the sums deducted for taxes of various sorts, Social Security is financed by a 12.4 percent payroll tax levied on the first $90,000 of annual wages.

Right now, the money raised by this tax is more than enough to pay today's Social Security recipients. But as the baby boomers retire (see above) that will change. By 2018 or so, annual taxes won't equal annual benefits, according to Social Security data. Social Security will have to begin drawing on the Treasury bonds it bought with its surplus cash during its recent flush times.

Any change in Social Security's cash flow from black to red would likely be important for political, as well as financial, reasons. Social Security is part of the overall federal budget, and right now its surplus is making the deficit look less bad than it is. (That's hard to imagine, given the $422 billion size of the 2004 deficit, but it's true.)

If it flips to red, this masking effect will end, and Social Security will begin adding to Washington's overall red ink. That might increase pressure to deal with the system's financial imbalance.

A: First off, fixing Social Security is more than making the numbers add up, government economists point out. It also involves ensuring the proper balance between the program's sometimes competing goals. It involves consideration of equity both within and between generations.

That said, the numbers do need to add up, and achieving that might not be politically easy. According to the GAO, right now the US has promised about $3.7 trillion worth of benefits over the next 75 years that it has not funded. That's the bottom line any package of reduced payouts and increased inputs needs to reach for the system to regain its balance.

The earlier that Congress grapples with this problem, the smaller the changes will need to be. An immediate increase in the payroll tax of about 1.5 percentage points could wipe out the 75-year problem, according to Social Security's own trustees. That would take the tax from today's 12.4 percent to 13.9 percent.

Or if the problem were to be entirely solved with benefit reductions, a cut of about 13 percent is needed, according to trustees.

These are just rough indications of the size of changes that might be necessary, of course. Many people have proposed many different ways of reaching the balance goal. Tax rates could be increased, or the $90,000 annual cap on the amount of income subject to Social Security levies could be raised. Initial benefits could be reduced, or the mechanism used to determine the annual increases of existing beneficiaries could be changed.

President Bush, for his part, has not suggested a package of changes, other than to say there should be no benefit cuts for today's retirees and workers 55 or older. He has said he is flatly against any percentage increase in the payroll tax.

At least one senior GOP Senator has suggested that Republicans need to be at least willing to discuss a tax hike, as a possible exchange for Democratic acquiescence in the establishment of private retirement accounts.

A:No. President Bush is pushing for private retirement accounts within Social Security as a means to sweeten the system for younger workers, and not as a fix for any looming financial crisis.

Theoretically these accounts would not affect Social Security's long-range finances. True, workers would be paying less in payroll taxes into the traditional system, but they would get correspondingly smaller benefits when they retire. The difference - plus something extra, according to proponents - would be made up by the superior investment gains of private accounts.

But in the short run, private accounts would make Social Security's cash flow problem worse. Social Security depends on the contributions of younger workers to pay today's retirees; if some of that money were held back for individual private accounts, the government would somehow have to make up the difference. Most likely, that would mean more borrowing - 1 trillion or more over the next 10 years.

A: The private retirement accounts President Bush is proposing would seem familiar to anyone who participates in a 401(k) program offered by a private employer. The basic concept is a simple one: Allow workers to divert some of their payroll taxes into a privately held reserve. This money would then be invested as owners see fit.

Participation in these accounts would be voluntary, stress administration officials. They would not be offered to workers who are today 55 years old or older. "If you were born in 1949 or before, you would not be impacted by any of the changes envisioned by the president for Social Security," said a senior administration official at a briefing this year.

And even if established this year, the accounts would be phased in over a long period. The White House foresees them beginning in 2009, for workers who are today between 40 and 55 years of age. In 2010, workers who are now between 27 and 55 would be eligible. In 2011, everyone under 55 could establish a private account, if they wanted.

Contribution levels would similarly be phased in. The administration envisions a cap on initial accounts of $1,000. This cap would rise by at least $100 each year thereafter, up to a maximum of one-third of a worker's Social Security tax.

A: Probably not. Although the White House has not offered a detailed menu of options, collectible baseball cards, precious metals, and can't-miss stocks suggested by brothers-in-law would be unlikely to be approved.

Instead, officials have compared possible investments to those available to federal employees under their thrift savings plan - a choice of five or so mutual funds, ranging from international stocks, to blue-chip US equities, and corporate or Treasury bond funds.

A life-cycle fund would also be a likely choice. These are funds in which the percentage of an individual's investment devoted to stocks automatically declines as they near retirement. This would be a means of locking in any gains, and guarding against losses from market volatility.

A: No. Under the White House plan, participants would not be allowed preretirement access to their money - nor would they be permitted to make loans to themselves through the accounts, or borrow against them.

There would be at least one important restriction on how the money can be used after participants reach retirement, as well. According to the White House, individuals would not be permitted to withdraw money from their personal account if it would plunge them below the poverty line.

If a worker's payment from traditional Social Security was not by itself large enough to keep them out of poverty, the government would require them to use some portion of their personal account money to buy an annuity - an investment with a fixed monthly payout for life.

You can't pass most annuities along to your heirs, so to some extent this would reduce the amount of freedom that lower-income workers would have in terms of personal account distribution.

With this exception, retirees would be free to use the cash in their personal accounts as they saw fit. They could leave it alone, so it would continue to appreciate. They could withdraw it as a lump sum to meet some pressing need. Or they could pass it along to heirs as an inheritance.

A: Yes. That would be only fair - workers with private accounts would be diverting some of their tax money away from traditional Social Security, so when time came for retirement they should get less out.

The thing to remember is the investment benchmark: 3 percent. Under Bush's plan, the bean-counters at Social Security would assume that payroll tax money paid into the traditional system earns 3 percent interest per year. So when the time came to figure a retiree's benefit, they would deduct the money diverted into the private account, plus the figured interest.

The bottom line of the Bush plan: If you opt for a private account, and over the course of your working life it earns more than 3 percent per year, on average, you come out ahead. If not, you'd have been better off putting all your payroll tax money in the traditional system.

[Editor's note: Peter Grier's byline was missing on the original version.]