The most popular and easiest way to fix the Social Security system would be to boost the overall growth rate of the U.S. economy from 3 percent to 4 percent. If that could be accomplished, Social Security would never go broke, even at current tax rates, benefit rates and projected demographic trends.
Obviously that is not easy to accomplish, or all countries would rush to implement that very solution. The three alternatives that have been suggested can broadly be grouped as raising taxes, making existing contributions grow faster and reducing benefits.
President Bush has already ruled out boosting tax rates, yet that alternative may still appear under the rubric of increasing the amount and scope of income subject to tax. That would be a distinction without a difference. Either way, the concept that we can somehow tax our way into prosperity is akin to a flat-earth solution. The United States would go the way of Germany, with the world’s highest labor costs and a 1 percent growth rate, or Japan, with a national debt equal to 200 percent of gross domestic product facing an actual decline in the labor force. Since higher tax rates logically reduce the growth rate, the targeted break-even solvency for social security would, in fact, never be attained.
Privatizing the accounts has a certain cachet. Many have pointed out that under existing regulations, social security contributions yield only about a 2 percent annual rate of return. While technically speaking that is an accurate statement, it disguises more than it reveals. Those with relatively low incomes who work the minimum number of years actually receive a very handsome rate of return. Those whose income equals or exceeds the maximum taxable income each year and work for their entire post-education lifetime actually receive a negative rate of return. The issue is not so much the low rate of return, but the huge redistribution scheme that is built into the existing system. Perhaps we ought to do away with this — but as the discussion and rhetoric intensify, some blue state senator is sure to point this out, and the idea will be tabled indefinitely.
That leaves reducing benefits as the remaining option. One suggestion now circulating is to replace the annual percentage increase in benefits during working years, which is currently tied to the average gain in wage income, by the average gain in prices. That would freeze benefits in real terms into perpetuity, so future retirees would not share in the growth in productivity over their working lives. Assuming that wages continue to rise an average of 2 percent per year faster than prices, benefits for someone aged 21 would be only 42 percent as high at age 65 as they would under the current scheme. That would certainly solve the problem. However, that choice is probably not politically acceptable either.
That leaves the “stealth solution.” Suppose the words “implicit consumption deflator” were substituted for the words “consumer price index” in the current regulations. Since 1973, when benefits were first indexes, through 2004, the CPI has risen an average of 4.8 percent per year, while the implicit consumption deflator has risen an average of only 4.0 percent per year. Furthermore, this is not just some archaic comparison left from the days before the methodology for calculating the CPI was changed starting in 1994; for the past 12 months, the CPI has risen 3.2 percent, while the implicit consumption deflator has gained only 2.4 percent.
Even more important, the language for boosting benefits could be changed from “average labor income” to “average hourly wage rates.” As calculated by the Social Security Administration, the wage base used to boost future benefits has risen an average of 5.4 percent per year since 1973, while the average hourly earnings series calculated by the Bureau of Labor Statistics has risen only 4.5 percent per year over the same period.
Reducing benefits by 1 percent per year from the time someone is 21 until the age of their death may not seem to be a huge difference, and changing the regulations to incorporate calculations for the implicit consumption deflator and average hourly earnings would probably not be noticed by one pensioner in 100. Yet the changes over time would be enormous. Someone who starts to work at age 21 can be expected to live to the ripe old age of 93; while life expectancy for a 21-year-old today is 79 years, this figure has been rising an average of two years per decade, so that current 21-year-old workers can statistically be expected to live until age 93. Over this 72-year-span, adjusting the benefits by the implicit consumption deflator and the average hourly wage means that benefits by the time of death would be less than half what they would be under current legislation.
This plan would eliminate any Social Security deficit forever without any increase in taxes, without any pitched battles over privatization, without raising the retirement age and without any apparent cuts in benefit rates. Any takers?
Michael Evans is chairman of Evans, Carroll & Associates, Inc. also is a former consultant to the Senate Finance Committee, U.S. Treasury and several other agencies, corporations and industries.