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Tuesday, March 3, 2009

A Bright Light in a Dismal Landscape

Alicia H. Munnell
Peter F. Drucker Professor of Management Sciences and Director of the Center for Retirement Research, Boston College

Original Published 3/25/09, The Boston Globe

President Barack Obama has said that overhauling Social Security and Medicare would be "a central part" of his administration's efforts to contain federal spending. But amid all the economic calamity, the Social Security program is functioning perfectly, meeting the crucial economic needs for millions of Americans. When older workers are losing their jobs and their 401(k) accounts are down about 30 percent, the ability to claim Social Security benefits serves as a backstop against severe economic hardship. Therefore, policymakers should tread carefully.

Social Security checks are not large, but they are reliable. For workers who claim benefits at age 66, the full retirement age, monthly benefits range from $850 for low-paid workers to about $2,200 for those who have consistently earned the maximum taxable amount. In fact, many workers claim early and receive reduced benefits. But Social Security benefits are increased each year to reflect changes in the cost of living, and they continue for as long as the recipient lives. So, despite the modest amounts, the benefits are predictable and people can count on them.

Are these valuable Social Security benefits endangered by the current economic crisis?

Certainly, a higher-than-predicted unemployment rate means that fewer people will be working and contributing to the system than originally projected. This shortfall could be a problem if Social Security operated on a pure pay-as-you-go basis, where today's contributions were the only source of funds for benefit payments. But the system has always had a contingency reserve to serve as a buffer in the event of economic downturns, and today's trust fund is more than adequate to ensure full benefit payments for decades.

How about Social Security's long-run outlook?

A worse-than-expected short-term economy will have only a tiny impact on Social Security's 75-year projections; the long-run costs of the program are driven mainly by the aging of the population, which has not changed. Over the next 75 years, the Social Security actuaries project a program shortfall equal to 1.70 percent of taxable earnings.

This number equals the size of the tax increase required to maintain solvency for 75 years. That is, if the payroll tax rate were raised immediately by roughly 1.70 percentage points - 0.85 percentage point each for the employee and the employer - the government would be able to pay the current package of benefits for everyone who reaches retirement age at least through 2082.

A lasting fix for Social Security would require a little more attention to the fact that the aging of the population will present an increasing financial challenge over the 75-year period. Thus, a lasting fix for Social Security could have smaller tax increases initially and larger ones later. This pattern would avoid the prospect of suddenly running short of money right after the end of the 75 years, and would achieve "sustainable solvency."

When crafting a solution to Social Security's long-term deficit, the lesson from the current financial crisis is that Social Security benefits are crucially important to older Americans.

This importance has increased with the shift in the private sector from traditional defined benefit pensions, which promised benefits for life, to 401(k) plans, which are exposed to the vagaries of the stock market. Americans, with little else to rely on in retirement, may be willing to pay up to maintain the country's successful Social Security program.

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