Stabilizing Social Security for the Long-Term

Abstract

President Roosevelt founded Social Security in 1935. In 1937, the Federal Insurance Contribution Act (FICA) was signed and mandated that workers contribute 2 % of wages.

1 Introduction

President Roosevelt founded Social Security in 1935. In 1937, the Federal Insurance Contribution Act (FICA) was signed and mandated that workers contribute 2 % of wages.

Over the next sixty-eight years, FICA has been amended numerous times including eight increases to the withholding percentage, which currently stands at 12.4 %. Cost of Living Adjustments (COLA) were added first in 1972 and revised in 1977.

In the early 80s, the system was declared actuarially unsound. The National Commission on Social Security Reform was founded and in 1983 called for:

• 1. An increase in the self-employment tax partial taxation of benefits to upper income retirees.

• 2. Expansion of coverage to include federal civilian and nonprofit organization employees.

• 3. An increase in the retirement age from 65 to 67, to be enacted gradually starting in 2000.

Again, Social Security was declared actuarially unsound. Of course, this declaration was premature as the Social Security Trustees’ Report of 1996 stated that the Social Security system would start to run deficits in 2012, and the trust funds would be exhausted by 2029. All members of the Advisory Panel agreed that some or all of Social Security’s funds should be invested in the private sector. To keep the unchanged system actuarially sound, payroll taxes would have to be increased 50–18 % of payroll, or benefits would have to be slashed by 30 %. In 1997, all members of the presidential-appointed Social Security Advisory Panel agreed that some or all of Social Security’s funds should be invested in the private sector. They also concurred with the Social Security Trustee’s Report that in order to keep the unchanged system actuarially sound, payroll taxes would have to be increased 50–18 % of payroll, or benefits would have to be slashed by 30 %.”

In the eight years since the advisory panel’s recommendation, little has been done to correct the issue only exacerbating the size and scope of the problem. President George W. Bush has put the issue at the forefront of his agenda for the second term with his proposal to privatize a portion of the program.

Responses to the President’s proposal range from acceptance, to labeling it as a retrenchment back to the days before Social Security. Moreover, some groups say the problem is overstated, that Social Security only requires minor modifications. The goal is to use ANP (Fig. 1) to determine the best available option for stabilizing Social Security over the long-term.

Fig. 1

Strategic criteria and BOCR model

2 Strategic Criteria

Tree strategic criteria were identified to be used when assessing any proposed alternative; they are Program Stability, Adequate Means for Participants, and Perception of Fairness.

Program Stability—Program stability suggests that there is a program in place, long-term for all participants. The optimal solution should ensure that the program survives and does not need further significant modifications. Participants should have peace of mind that when they retire, the program will be there throughout their lifetime.

Adequate Means for Participants—Participants should be able to rely on prescribed level of benefits that are adequate to support participants in their retirement. A stable program that pays some insignificant level of benefits is not considered optimal.

No attempt was made to define what that prescribed level of benefits is. Social Security was originally intended to be a supplement to a retiree’s other income. The retiree was also to have a company pension as well as personal savings to rely upon. Over time, there has been an increase in retirees’ reliance on Social Security. At the program’s inception through the forties Social Security only comprised approximately 20–25 % of a retiree’s income. Today, retirees rely on Social Security for 67 % of their income on average. Years of low personal savings levels and pension failures have increased the strain on the Social Security system.

Perception of Fairness—Whatever the solution, the program needs to be perceived as a fair system. One segment of the population should not be seen as benefiting unfairly from any proposed changes.

3 Alternatives

Fourteen alternatives were considered initially. However, there are overlaps in some, while others were considered not viable. This list of fourteen was then narrowed to five alternatives. They are:

Raise Ceiling—This alternative proposes raising the level of income subject to the 12.4 % Social Security withholding. Currently, any income above $90,000 is not subject to Social Security withholding. The cap on the withholding level can be increased as a one-time adjustment, or over a series of years. A more draconian approach would be to remove the cap completely. An increase in the withholding percentage for all participants was also examined. In the current environment, this revenue-enhancing alternative appears to be much more likely.

Raise Retirement Age—The normal retirement age has been raised in the past and this option is considered viable in the current situation. Life expectancy of Americans continues to increase. The tendency causes the ratio of years as a payer to years as a payee to change. As the ratio increases, it places increasing strain on the financial resources of the system. All other factors held constant, the system will either need to find another mechanism to increase revenue or to decrease expenditures.

Privatize—While there are numerous possible scenarios, the proposal by President Bush where certain participants can elect to have 4 % of their wages diverted to a private investment account is used. Lower and higher percentages have been proposed, but it is believed that this proposal has received adequate scrutiny and analysis to enable one to make an informed opinion as to its benefits, opportunities, costs, and risks.

Reduce Benefits—This alternative can encompass a broad array of tactics. The mechanics used to reduce benefits could be the subject of another model if this alternative is deemed optimal. Among the choices are a simple one-time cut in benefit, a temporary freeze in benefit levels, or a reduction in future COLA adjustments. The main theme is a method of expenditure control versus revenue enhancing ideas such as “Raising the Withholding Ceiling”.

Status Quo—This alternative says to leave the Social Security program as it is. There should be no modifications to the system. Proponents of this alternative believe that the current system does not require fixing, and that some external influences will arise to correct the current deficit. While the vast majority of people would agree that some level of correction is required, this alternative was also included because of the tendency to neglect or delay dealing with the problem. The current issues were first identified back in 1996 and have yet to be addressed in any form. History might suggest this as an alternative, no matter how ill-advised.

4 Benefits/Opportunities/Costs/Risk

4.1 Overview

The benefits, opportunities, costs and risks models share the same control criteria. They are: Social, Political, and Economic. The subnets within each, however, may differ depending on the control criterion. Figure 2 shows a sample Control Criteria Hierarchy.

Fig. 2

Hierarchy of benefits control criteria

4.2 Benefits

The Social Subnet (Fig. 3) has two elements within the Stakeholders’ Cluster:

Fig. 3

Social subnet

• Payee Confidence—confidence of those receiving benefits that their benefits will continue at an acceptable rate

• Payer Confidence—confidence of those paying into the program that it is worthwhile and they would see a return on the money they are investing.

The Political subnet (Fig. 4) contains two clusters, President and Legislative:

Fig. 4

Political subnet

4.3 President

• Media Coverage—the benefit that comes from positive coverage in media outlets.

• Voter Perception—the benefit that comes from a favorable impression in the mind of likely voters.

• Legacy Place in History—the benefit that comes from being identified with significant historical achievements.

4.4 Legislative

• Media Coverage—the benefit that comes from positive coverage in media outlets.

• Party Recognition—supporting the alternative results in support or lack of support from the legislator’s political party.

• Voter Perception—the benefit that comes from a favorable impression in the mind of likely voters.

The Economic subnet (Fig. 5) contains only one cluster, the Financial cluster. This cluster contains two nodes

Fig. 5

Economic subnet

• Program Stability—Program that is not overly susceptible to normal political or economic fluctuations.

• US Economic Stability—Program that does not subject the economy to fluctuations or inhibit growth.

4.5 Opportunities

The Social Subnet (Fig. 6) has three elements within the Stakeholders Cluster:

Fig. 6

Social subnet

• Participant Peace of Mind—comfort that comes from the assurance that the program will last throughout the participant’s lifetime.

• Encourage Financial Responsibility—encourages participants to educate themselves on financial matters.

• Decreased Dependence on Government Programs—potential benefit that comes from a more secure financial future where participants increase personal savings rates.

The Political subnet (Fig. 7) contains two clusters, President and Legislative:

Fig. 7

Political subnet

4.6 President

• Media Coverage—the benefit that comes from positive coverage in media outlets.

• Attract New Supporters—the potential benefit from taking a position that brings in likely voters outside the normal base.

• Increased Political Capital—the potential benefit that comes from securing a major political victory that translates into more political power on upcoming issues.

• Legacy Place in History—the benefit that comes from being identified with significant historical achievements.

4.7 Legislative

• Media Coverage—the benefit that comes from positive coverage in media outlets.

• Party Recognition—supporting the alternative results in support or lack of support from the legislator’s political party.

• Attract new supporters—the potential benefit from taking a position that brings in likely voters outside the normal base.

• Likelihood of re-election—increase in the likelihood of re-election from association with a significant political issue.

The Economic subnet (Fig. 8) contains two clusters, Financial and Operational:

Fig. 8

Economic subnet

4.8 Financial

• Effect on Capital Markets—the potential benefit on interest rates or investment rates from the alternative.

• Effect on US Budget—the potential positive impact on the US budget deficit.

• Effect on US Economy—the potential opportunity from for positive impact to the US Economy.

4.9 Operational

• Reduction of Bureaucracy—the potential impact of a reduction in US government bureaucracy and/or a reduction of bureaucracy at employers to comply with the program.

4.10 Costs

The Social subnet (Fig. 9) has three elements within the Stakeholders Cluster:

Fig. 9

Social subnet

• Fees—the amounts paid by participants to third parties to have individual accounts managed.

• Increased withholding—the cost to participants through increased withholding in a given year.

The Political subnet (Fig. 10) contains only the Legislative cluster with one node:

Fig. 10

Political subnet

• Constituent Alienation—the likelihood that efforts on an alternative would anger or disenfranchise constituents.

The Economic subnet (Fig. 11) contains one cluster, the Operational cluster:

Fig. 11

Economic subnet

4.11 Operational

• Conversion Costs—one-time costs to implement the alternative.

• Agency Costs—ongoing costs necessary to implement the alternative.

• Marketing/Communication to Public—costs to ensure that the general public understands the alternative sufficient to plan appropriately.

4.12 Risks

The Social subnet (Fig. 12) has three elements within the Stakeholders‘Cluster:

Fig. 12

Social subnet

• Payee Confidence—confidence of those receiving benefits that their benefits will continue at an acceptable rate.

• Payer Confidence—confidence of those paying into the program that it is worthwhile and they will see a return on the money they are investing.

• Increased Potential for Profit—potential that an alternative will lead to higher rate of return on investment.

• Loss of Potential Profit—opportunity cost of not pursuing a different alternative.

• Reduced Benefits—risk that an alternative will lead to a reduction in benefits.

The Political subnet (Fig. 13) contains two clusters, President and Legislative:

Fig. 13

Political subnet

4.13 President

• Constituent Alienation—the likelihood that efforts on an alternative would anger or disenfranchise constituents.

• Legacy Place in History—benefit that comes from being identified with significant historical achievements.

• Media Coverage—benefit that comes from positive coverage in media outlets.

4.14 Legislative

• Constituent Alienation—the likelihood that efforts on an alternative will anger or disenfranchise constituents.

• Likelihood of re-election—increase in the likelihood of re-election from association with a significant political issue.

• Media Coverage—benefit that comes from positive coverage in media outlets.

• Party Recognition—supporting the alternative results in support or lack of support from the legislator’s political party.

The Economic subnet (Fig. 14) contains two clusters, Financial and Operational:

Fig. 14

Economic subnet

4.15 Financial

• Long-term Insolvency—risk that an alternative would lead to or contribute to the insolvency of the program.

4.16 Operational

• 3rd Party Failure—risk that a non-government agency associated with the program would experience bankruptcy.

• Increased Corruption—risk that the alternative would lead to increased abuse or corruption.

5 Results

To synthesize the priorities of the alternatives from the benefits, opportunities, costs and risks, we first need to rate the BOCR subnets according to the strategic criteria. Using the scale of intensities given in the last row of Table 1, we rate the benefits, opportunities, costs and risks by first selecting the best alternative under each subnet and score it for each strategic criterion. The results are then weighted by the priorities of the strategic criteria. The priorities of the alternatives from each subnet (Figs. 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14) are given in Table 2. The synthesized priorities of the alternatives for benefits, opportunities, costs and risks in ideal form are given in Table 3. The normalized results (column 3 of Table 1) are the priorities used to synthesize the priorities of the alternatives (Table 3).

Table 1 BOCR ratings

Table 2 Priorities of the alternatives from each subnet in the BOCR model

Table 3 Synthesized priorities of alternatives in ideal form under BOCR

The synthesis of the individual subnets (Table 3) indicates that Raising the Retirement age provides the highest benefits. This is likely due to the fact that it both reduces expenditures as well as raises revenue. Privatization provides the most upside opportunity related to the potential for increased returns from investing in the capital markets.

Turning to costs, Privatization also brings with it the highest costs (Table 3). Privatization would have the highest conversion and agency costs as well as any fees associated with maintaining individual personal accounts. Reducing Benefits yields the highest risks (Table 3). The political backlash associated with such a widely unpopular alternative is significant.

6 Sensitivity Analysis

Except at low levels (below 0.20), the model is relatively insensitive to changes in the priority of Benefits. Raising the Retirement Age consistently delivers more benefits.

Below approximately 0.28, Raising the Retirement Age has the highest Opportunity. Above a priority of 0.28, Privatization yields the highest opportunity (Fig. 15).

Fig. 15

Sensitivity analysis of opportunities

When examining the sensitivity to Costs, Privatization consistently yields the highest costs. Raising the Ceiling and Maintaining the Status Quo share the lowest cost at various degrees of priority (Fig. 16).

Fig. 16

Sensitivity analysis of costs

Raising the Ceiling and Raising the Retirement Age nearly share the lowest risk. Reducing Benefits and Maintaining the Status Quo share the highest risks at differing levels of priorities (Fig. 17).

Fig. 17

Sensitivity analysis of risks

7 Conclusion

Among the major factors influencing the results are:

• Approximately 90 % of all wages were subject to Social Security withholding in 1980; by 2004, that percentage had slipped to 85 %.

• In 1935, Social Security was designed to support older Americans who were dependent and beyond their productive period, originally calculated to begin at age 65, when men had an average of 12 years ahead of them.

• Today, a 65-year-old man can expect to live for 17 more years (women, 20)—5 years longer than original budget estimates. A system designed for men with 12 years ahead of them today would set the retirement age between 70 and 75

Given the relative scores under the additive model and the sensitivity analysis, the Raise the Ceiling and Raise the Retirement Age alternatives are almost identical in every respect, leaving each or a combination of the two as the optimal alternatives.

Appendix Schedules

1.1 Alternative Detail

Below is the detail of the original fourteen alternatives that were identified and the rationale for either including or excluding the alternative in the final ANP model.

Raise Tax Rate—While not specifying a specific amount, this alternative proposes increasing the withholding percentage for all participants from the current level of 12.4 %. This alternative was not included in the final model do to nearly non-existent support to the idea.

Raise Retirement age—The normal retirement age has been raised in the past and this option is considered viable in the current situation. The life expectancy of Americans continues to increase. The current normal retirement age ranges from 65 to 67 years of age. This alternative is included in the final model.

Eliminate Maximum WH income—This would eliminate the current ceiling on wages that are subject to Social Security withholding. This alternative was included in the final model but was modified to say increase the ceiling.

Reduce Benefits—This is a one time global reduction in benefits. The formula for calculating benefit levels would be reduced. This alternative is in the final model, but is revised to more-broadly incorporate any mechanism that reduces benefits such as temporary freezes on increases, broad benefit level cuts, or a reduction in COLA levels.

Freeze Benefits—This alternative suggests freezing the level of benefits for some period of time, rather than forcing people to deal with a benefit cut. It was deemed more practical than an outright reduction in benefits. This alternative was combined into a broader reduce benefits alternative in the final model.

Cut COLA formula—Rather than reduce current benefits or freeze them for a period of time, this alternative seeks to limit the growth in benefit levels and would at first glance be to most practical of the expenditure containing alternatives. This alternative also was combined into a broader reduce benefits alternative in the final model.

Overhaul/scale back SSI disability—Support for those unable to care for themselves through disability needs to occur regardless. Elimination or reduction of these benefits would just shift to other federal/state programs such as Medicaid or Medicare. This alternative was rejected because while fixing Social Security it would exacerbate issues in other programs.

Divert 4 % to Private accounts—We are using the current proposal by President Bush where certain participants can elect to have 4 % of their wages diverted to a private investment account. This alternative is included in the final model.

Increase immigration—This alternative proposes an increase immigration as baby boomers retire to reduce the level of payees-to-payor ratio. This alternative was not deemed viable due the level of immigration that would be required to influence this ratio in any appreciable manner. It could be a viable part of a plan that incorporated numerous alternatives as a solution.

Subsidize SS fund by cutting spending in other programs—Given current levels of deficits and that Social Security already comprises a large portion of federal budget expenditures, this alternative in itself is not deemed to be feasible. Social Security is already by far the single large expenditure. The cuts in other programs, including Defense and Education would be too severe to make this an economically viable alternative.

Recreate “lock box” (specific SS fund unavailable to the general fund) and invest for higher returns—This alternative is essentially the same as the Divert 4 % to private accounts except for who would bear the risk of loss. There is a great deal of skepticism in making the federal government such a significant force in the capital markets. The federal government in many instances would be both the regulatory body as well as the owner; such conflicts of interest have yet to be overcome. Due to its similarity to another alternative and significant issues yet to be resolved, this alternative was not included in the final model.

Base lifetime payments on lifetime contributions—This alternative suggests a link should be established between contributions and payments, moving social security closer to a 401(k) type program. This alternative was rejected because of its potential conflict with the strategic criteria of adequate means for participants. Additionally, justification for rejection of the alternative rests in the fact that for most people age 45 and younger will not recover 100 % of their contributions during their retirement. In order to achieve this alternative the benefits of retirees and soon-to-be retirees would need to be cut effective immediately and this alternative has been covered in the Reduce Benefits alternative.

Do nothing—This alternative relies on a future positive externality to resolve the current issue. It would also encompass those who believe the current problem is an overstatement or fabrication. These individuals, however minor, do exist. For periods of time, issues with Social Security have been ignored, this too makes this alternative relevant.

Phase program out—This alternative suggests that over time, the US should eliminate the Social Security program in its entirety. This alternative was not included in the final model because there is clearly no significant support for the idea. Americans do not want to potentially see a significant number of senior citizens living on below subsistence levels of income.