Listen up lawmakers, there is a huge federal program- nearly 57 million Americans depend upon it- that is not about to fall off the proverbial fiscal cliff. In fact, we’ve got two decades to address and fix it.
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I am talking about Social Security.
Surprised? In their last annual report to Congress, the Social Security Trustees laid out the 75-year financial outlook for the agency. (1) The projections were, to say the least, alarming:
- In 2010 and again in 2011 Social Security did not collect enough in payroll tax to cover the benefits it was obligated to pay out. That had not happened since 1983. The shortfall was covered by using some of the interest paid on the bonds in the trust fund.
- Based on increasing numbers of retirees and expectations of continued low interest rates, by 2021 interest earned on the Treasury bonds in the trust fund will no longer be enough to close this gap and the bonds will begin to be cashed in.
- In 2033, three years earlier than predicted in the 2011 report, the bonds themselves will be gone. The trust fund will be exhausted. At this point, Social Security will only be able to pay out in benefits what it receives in payroll tax. Benefits would decline by 25%.
It’s no secret that Social Security’s finances were set to worsen. The numbers foretold it: after World War II, the nation’s birthrate began to rise, creating what is known as the “Baby Boomer Generation.” According to Steve Goss, chief actuary for the Social Security Administration, from 1946 through 1965 the nation’s fertility rate rose from 3.0 to 3.3%.(2)
Put in these terms, it doesn’t exactly sound like a “boom.” But when you apply it over the entire female population for a 20-year period, it adds up. Instead of having three children, some families included four or five offsping, and those children are now entering retirement.
However, what gets overlooked is that not only did the birth rate decline in the mid-1960s, we also saw a dramatic and permanent change in the age at which women began their families--they started having children later in life. “A fundamental thing was happening,” says Goss. “The age at which women decided to have children shifted from their mid-20s to their mid-30s.
A number of factors played a role in the shift of child-rearing years, including the Vietnam War and the rise of the women’s movement. At this time there were fewer available fathers, safer birth control methods were being introduced and more women were pursuing college degrees and full-time careers. The result was that when the birth rate declined, instead of returning to the previous range of 3%, it fell much more sharply.
To be clear: The key in understanding the demographic dilemma we face in this country today is not that the birth rate went up slightly after WWII, but that it fell precipitously starting in the mid-1960s. The 10% “boom” in births the U.S. experienced starting in the mid-1940s was followed by a “bust” in the birthrate of a much higher magnitude. In fact, in 1976 it hit an all-time low of 1.7% - half the post-WWII rate! In addition, while women were transitioning to the new “normal” of starting their families in their 30s, the birthrate remained depressed for more than a decade.
It is no coincidence that the number of babies born in the United States fell to an historic low in the mid-1970s. Having and raising a child is expensive and when times get tough, people often make the economic decision to postpone expanding their family.
During the 70s, the economy was in a death spiral: The nation was saddled with debt from the failed war in Vietnam. The 1973-74 Arab Oil embargo triggered gasoline shortages, rationing and sent prices soaring. In ’79 the Iranian revolution triggered a second “oil crisis.” The result was that over the decade, the price of gas more than doubled to 86-cents a gallon from 36-cents. That’s the equivalent of paying $8.00/gallon 10 years from now. In 1979, President Jimmy Carter made a televised plea from the Oval Office urging Americans to conserve energy.
The price of energy wasn’t the only thing out of control. Double-digit inflation was killing our standard of living. The Consumer Price index started the decade at 5.84%, rose to 11.03% four years later and peaked at 13.58% in 1980. Interest rates skyrocketed. The prime rate rose to 10.75% in 1974 from 6.75% in 1970. It hit 21.5% by December 1980- setting a record high that has never been broken. People couldn’t afford to buy homes and over the same period, the nation’s unemployment rate climbed to 7.1% from 4.9%.
The drop in the birthrate during this period meant that couples were not even producing enough children to replace themselves. “From 1970 to 1990 the total fertility rate was less than 2%,” according to Goss. “People thought we were going the way of Japan or Italy.” But Goss maintains that Social Security saw it as temporary. “We realized it was a transition. We weren’t surprised when fertility rates went back up to around 2% in the mid-1990s. By then, women had gone thru the transition of having children in their 20s to their mid-30s.” In addition, the economic expansion of the 1980s significantly reduced inflation and interest rates, created jobs and generally made Americans feel more financially secure. Secure enough to have more children.
Since the 1990s the birthrate remained relatively stable at around two children per adult woman. Until 2010 when for the first time in 20 years the fertility rate fell below 2%. The same thing happened in 2011. “We were not surprised,” says Goss. “The recent recession hit harder than previous ones.” While he believes the birthrate will pick up when the economy recovers, "the future is unpredictable.”
Assuming the birthrate climbs back to 2%, Goss says there are still serious implications for many aspects of society, not the least being Social Security. For the elderly couple of the future, “there will be two children behind them in the workforce to contribute to their support in retirement. In the past, we would have had an average of three.”
Something’s got to give. “If we’re going to support our elders in the future as we have in the past, either contributions of the younger generations are going to have to be half again larger or what elders receive will be reduced to about one-third less,” says Goss. That’s the extreme way to look at it. Others point out that by making small tweaks in a number of factors that affect Social Security benefits, we can close the funding gap with a minimal amount of pain.
In a 2012 report, the Social Security trustees point out that the long-term actuarial funding deficit for the program (intermediate projection) is 2.67%. (3) In other words, if we raised the payroll tax rate by this amount today, we would solve the problem. This would mean increasing the OASDI rate from 12.4% to roughly 15.1%. Since employers and employees split the tax, the impact on an individual worker would be small: instead of paying 6.2%, s/he would pay 7.5%.
Allow me to re-phrase this: we could solve the shortfall in Social Security funding for the next 75 years if workers and employers each kicked in 1.3% more.
That’s it. Everyone shares the pain, but everyone gets what’s coming to them over the next 75 years. I bet if you asked your friends and colleagues if they’d be willing to pay 1.3% more to shore up Social Security for the foreseeable future, the overwhelming response would be, “Is that all we need to do? I’m in!”
Of course, no politician will ever mention this. That would entail uttering the deadly phrase “raise taxes.” (It would also make Social Security less useful as a means for scaring voters.) But, really, that’s what it would take: 1.3% more- if we act today. The longer we delay, the bigger the adjustment.
What most people forget- including baby boomers (because we were never going to get old)- is that Social Security was very close to falling off its own “fiscal cliff” 40 years ago. In fact, when Ronald Reagan assumed the presidency in 1981, one of his first actions was to appoint a blue ribbon committee to “fix” Social Security, which was projected to be insolvent in two years.
Obviously, that didn’t happen. The National Commission on Social Security Reform (4) issued its report in early 1983. It included recommendations to address both the short and long-term funding issues affecting Social Security. Congress adopted the recommendations and we are living with them today. They include: gradually raising the payroll tax; requiring non-profit workers as well as federal employees to be covered by, i.e. contribute to, Social Security; reducing benefits to individuals who are eligible for both Social Security and a government pension, taxing an individual’s Social Security benefit if their income exceeds a certain threshold, increasing the “full” retirement age from 65 to 67 in two stages and increasing the “delayed retirement credit.”
The point is, we have had to make adjustments to Social Security in the past and if we want it to be there for future generations, we’ve got to do so again. But this “fiscal cliff” is 20 years away. There is plenty of time to act. Unfortunately, human nature and partisan politics suggest that nothing will get done until the 11th hour, as we’ve seen in the current case of expiring tax regulations and budget cuts. That would truly be a sad situation. Not just because of the uncertainty and upset it would create for this country’s seniors, but perhaps more importantly, what it would say about our politicians.
1. http://www.ssa.gov/oact/tr/2012/index.html. Social Security is required to provide this analysis to Congress on an annual basis. The 2013 report will be issued in the spring.
2. Social Security defines the Baby Boom as running from 1946 through 1965- a year longer than other sources. That’s because, although the birthrate began to decline in 1965, it was actually higher that year than it was in 1946.
3. In the early 1990s it was around 2.0%. In other words, the funding gap didn’t explode overnight. It’s been gradually getting worse.
4. Informally, it was known as the Greenspan Commission, after Alan Greenspan, its chairman.
Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content.
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