A brighter outlook for Social Security

Federal Reserve Chairman Alan Greenspan warned last week that the nation "will eventually have no choice but to make significant structural adjustments in the major retirement programs."

Translation: Cuts in Social Security benefits are inevitable.

But is the situation that gloomy? A number of economists argue it isn't. A hard look at the numbers suggests that Social Security isn't broken, only in need of minor adjustments.

The Social Security system is in better financial shape than it's been for most of its 67-year history, says Mark Weisbrot, an economist at the Center for Economic and Policy Research (CEPR), a Washington think tank.

Some see a conspiracy on the part of those who don't like the government retirement system.

"When you want to reform a popular system, you have to make the case it's broken," says Lawrence Thompson, a senior fellow at the Urban Institute, another Washington think tank.

Predictably, Mr. Greenspan's comments caused a political firestorm, especially since President Bush talks of tackling the Social Security issue if he wins a second term.

No one quarrels with his basic thesis: The population is aging and health costs are rising. And since the baby boomers start to retire in four years and Americans are living longer, the ratio of retirees to working people will rise in the decades ahead.

Greenspan's solution is to adjust the consumer price index (CPI) or raise the age of normal retirement to make benefits less costly. Some pundits praised the central banker for his courage.

He's just telling "the truth," Paul Gigot, chief editorial writer of the Wall Street Journal, said on public TV.

But some economists see any needed adjustments as modest, and perhaps not even needed at present. Here are their arguments.

The trustees of the Social Security administration project say that the payroll tax will provide enough revenue to cover all benefits through 2018. Then the system can draw on both payroll taxes and the Treasury bonds in its trust fund to pay all benefits through 2042.

That's a long time - long enough to weather most of the baby-boomer bulge.

At that point, if nothing is done, the payroll tax revenue would then only provide about 70 percent of promised benefits. That's not as bad as it sounds. After adjusting for inflation, the sum retirees would get in 2042 would still be well above the $900 or so a month the average retiree gets today, though less in relation to future workers.

Why? Because living standards will almost certainly rise by that time - by about 45 percent if current growth rates continue. When workers apply at retirement for Social Security, their pension is calculated as a proportion of their average pay. Future payments are indexed annually to the CPI.

To make the system fully sound for the 75-year period projected by the trustees, only an extra 0.75 percent of the nation's gross domestic product would have to be set aside to finance all promised benefits.

Thus, if the country started tomorrow, workers would have to pay an extra 1.92 percentage points in payroll tax - or about $627 a year for the average wage earner.

That's less of a tax boost than those in the 1950s, '60s, '70s, and '80s, says Mr. Weisbrot. The extra amount could be lowered by imposing the payroll tax on annual income above $87,900 - income now exempt. Repeal of the Bush tax cuts would cover the Social Security deficit three times over.

In future decades, children will be a smaller proportion of the population. So education costs should be reduced.

"We can afford these benefits," says Mr. Thompson.

Greenspan headed a Social Security commission that in 1983 recommended raising payroll taxes sufficiently to create a surplus to guarantee baby boomers funding for their pensions. Congress agreed. By 2012, payroll taxes will have raised $3.5 trillion in revenues more than paid out in benefits.

But Congress so far has used the surplus for tax cuts, defense, and other federal spending. In return, the Social Security Trust Fund has got more IOU's - Treasury bonds.

Some critics of Social Security question whether the bonds held in trust will be redeemed. But with retirees making up a larger proportion of voting Americans than even now, it's unlikely Congress would risk their wrath by not redeeming those bonds - or by weakening Social Security.

Including costs of medical help for retirees complicates the question of "generational equity" - whether working people face too high a burden taking care of retirees in the future. Medicare isn't in as good financial shape as Social Security.

Using assumptions of the Social Security trustees on demography and on productivity gains, Thompson conservatively calculates that workers would see their wages increase 31 percent by 2030 (after tax increases and out-of-pocket health spending).

Average wages, in 2003 dollars, would be $40,092, up from $30,601 in 2003. If payroll taxes were raised now to balance the two programs, workers would still be 21 percent better off.

Social Security pension benefits would rise to $11,034, up 10 percent from $9,999 in 2003. But retirees would get a smaller share of economic gains.

So workers would be able to support their elders in coming decades and still enjoy a steady rise in their living standards.