July 13, 2016

Restoring and Modernizing Social Security through Sustainable Reform

Testimony Before the House Committee on the Budget
Key materials

Good morning, Chairman Price, Ranking Member Van Hollen, and members of the committee. Thank you for inviting me to testify today.

My name is Jason Fichtner, and I’m a senior research fellow at the Mercatus Center at George Mason University, where I research fiscal and economic issues, including Social Security. I am also an affiliated professor at Johns Hopkins University, Georgetown University, and Virginia Tech, where I teach courses in economics and public policy. Previously I served in several positions at the Social Security Administration (SSA), including deputy commissioner of Social Security (acting) and chief economist. All opinions I express today are my own and do not necessarily reflect the views of my employers.

I’d like to begin by thanking Chairman Price and Ranking Member Van Hollen for holding this hearing and creating an intellectual space that allows for reasoned discourse and ensures that important public policy issues involving Social Security and retirement security get the attention and debate they deserve. It is truly a privilege for me to testify before you today.

My testimony focuses on three key issues: first, the extent of the Social Security financial shortfall; second, whether we’re actually facing a so-called “retirement crisis;” and third, how the current structure of the nation’s largest retirement program, Social Security, provides disincentives to work and save and is in need of modernization if the program is to fit the needs of the twenty-first century and achieve fiscal sustainability.

From this discussion, I hope to leave you with the following takeaways:

  1. The Social Security crisis is not only real; it is already upon us.
  2. Painting all Americans with the broad brush of facing a “retirement crisis” creates an incomplete picture of the true financial landscape faced by America’s future retirees.
  3. The narrative of the “retirement crisis” tempts us to look toward greater dependence on, and the expansion of, government programs—such as Social Security—which are already facing severe financial problems.
  4. Social Security is in need of modernization. Reforms should not exacerbate existing problems; instead they should encourage savings and labor force participation.

SOCIAL SECURITY IS IN FINANCIAL CRISIS

The Social Security Board of Trustees now estimates that the combined trust funds will be depleted in 2034. It’s important to understand that there are actually two separate trust funds: one for the retirement program (Old-Age and Survivors Insurance or “OASI”), and one for the disability program (Disability Insurance or “DI”). For the retirement program, the trustees estimate that the trust fund can continue to pay full benefits until 2035, at which point the program will only be able to pay about three-fourths of scheduled benefits. For the disability program, the trustees estimate the program will hit insolvency in 2023—less than a decade from now. 

To further put this in perspective, the 75-year financial shortfall for the combined trust funds is $11.4 trillion in present-value terms. If we indefinitely extend past the 75-year period, the so-called infinite horizon, the shortfall is a whopping $32.1 trillion. For comparison, our nation’s gross domestic product is slightly over $18 trillion—and our gross national debt (not including unfunded liabilities) at the end of June is $19.3 trillion.

The original intent of Social Security when it was signed into law in 1935 was to provide income insurance against poverty in old age and to provide benefits to survivors of deceased workers. The key word is “insurance.” Insurance is designed to provide coverage against a high-cost but low-probability event. When Social Security was enacted, a small percentage of the population lived many years past age 65. But times have changed. People born today are living longer than those born when the program was created. Living longer is a good thing. But longer lives create a financial strain on Social Security because the retirement age is not indexed for increases in longevity.

For example, using cohort life expectancy data, males born in 1940 were expected to live, on average, about 70.5 years and females 76.7 years. And males who reached age 65 in 1940 could expect to live, on average, another 12.7 years and females another 14.7 years. In 2015, the life expectancy for men was 83.1 years and 85.3 for women. But for those who turned 65 in 2015, a male can expect to live another 19.1 years and a female 21.5 years. Jump forward to 2035, a year after the combined trust funds are estimated to be depleted, and males turning 65 in that year can expect to live another 20.4 years and females another 22.7 years. Also, it is important to note that about 54 percent of men and 61 percent of women survived to age 65 in 1940. In 1990, the percentage surviving to 65 was 72.3 percent for men and 83.6 percent for women. 

These numbers mean that the Social Security Old-Age and Survivors Insurance program now has to finance more people over a longer period of time. Instead of an insurance program, Social Security is now a de facto national retirement program—that is an important distinction because those are quite different policy purposes. With insurance, the intent is to tap resources contributed by a larger group to protect a subgroup from an unanticipated income shock. By contrast, retirement programs are intended to benefit all participants. Increasing the challenge in the case of Social Security, the program now has to fund individuals for over 20 years of retirement based off the same number of years of worker contributions as when the program was originally created.

Changing fertility rates also create a financial strain on Social Security’s finances. In a largely pay-as-you-go financing structure such as Social Security, the fertility rate has an impact on the number of workers providing payroll taxes to cover retiree benefits. In 1940, the fertility rate was 2.23, meaning a woman born in 1940 could be expected to have at least 2 children in her lifetime. The fertility rate jumped up to over 3 beginning around 1950 and peaked in 1960 at 3.61. Today, however, the fertility rate has dropped to an estimated 1.87. To put this in context, in 1945 there were almost 42 covered workers paying into the program for every OASDI beneficiary receiving benefits. As the program matured, around 1965 when Medicare was signed into law, there were 4 workers for every beneficiary. The ratio has been declining ever since. It now stands at 2.8 workers per beneficiary and is estimated to drop to 2.2 by 2035, the year after the combined OASDI trust funds are estimated to be depleted. To turn these numbers around, in 1965 there were 25 OASDI beneficiaries per 100 workers. In 2015, there were 35 beneficiaries per 100 workers. And in 2035 there will be 46 beneficiaries per 100 workers. Jumping out to 2090, the furthest out the trustees estimate, the ratio will be 50 beneficiaries for every 100 workers.

PERCEPTION OF A RETIREMENT CRISIS

The national newspapers are full of stories claiming that Americans are woefully unprepared for retirement. A top story on the Wall Street Journal–affiliated MarketWatch was titled “Our Next Big Crisis Will Be a Retirement Crisis.” An often-cited index of retirement preparedness compiled by the Center for Retirement Research at Boston College claims that “53 percent of households are ‘at risk’ of not having enough to maintain their living standards in retirement.” Referencing a similar study by Putman Investments, financial reporter Robert Powell writes, “Americans are on track to replace just 61% of their current income once they reach retirement.” Powell further notes that the picture looks even gloomier for those without an employer-sponsored retirement plan, who are “projected to be able to replace just 42% of their working income once they retire, even with Social Security factored in.”

The economic meltdown that began in 2008 and resulted in a great and unanticipated loss of wealth for millions of Americans fueled the perception that we are facing a “retirement crisis.” The uneven pace of the economic recovery and lingering effects of the financial crisis have further underscored this perception. The US stock market, as measured by the broad S&P 500 Index, fell nearly 57 percent from a peak on October 10, 2007, to a bottom on March 9, 2009. Housing prices plummeted and unemployment rose quickly to double digits. Survey research suggests financial wealth for the median household declined by 15 percent as a result of the 2008 financial crisis.

But do these statistics truly equate to a looming “retirement crisis”? Economists Syl Schieber and Andrew Biggs wrote that “the story about the declining income prospects of retirees is not true.”Schieber and Biggs base their argument on the fact that the data most often cited to show there is a crisis is compiled by the Social Security Administration based on the Current Population Survey (CPS) from the US Census Bureau. The CPS data do not accurately reflect the total amount of income in retirement derived by individual retirement accounts. When Schieber and Biggs instead looked at tax return data from the Internal Revenue Service, the reported income was much higher: “The CPS suggests that in 2008 households receiving Social Security benefits collected $222 billion in pensions or annuity income. But federal tax filings for 2008 show that these same households received $457 billion of pension or annuity income.”

Additionally, in order to have a financially secure retirement, many financial planners suggest a total “replacement rate”—or the percentage of preretirement income a person will need in retirement—of 70 percent. Social Security was designed to replace about 40 percent of a person’s preretirement income, with higher replacement rates for lower-income workers, and the remaining amount to be covered by an employer pension or personal retirement savings. For example, a person who earns $50,000 in each of the final five years leading up to retirement should plan to have enough retirement savings to generate $35,000 a year in income ($50,000 × 0.70). The 70 percent figure includes income received from Social Security. This is just a general rule of thumb, and everybody’s retirement needs are different. For example, some find they need less in retirement as their consumption tends to decline and their house may be paid off. It is worth noting that, for many groups, Social Security replacement rates are higher than most people understand, due to the way the Social Security Administration historically presented replacement rates. In many cases total retirement income, including Social Security benefits, far exceeds a 70 percent replacement rate. It is further worth noting that the proper way to measure replacement rates is currently debated by scholars—whether they should be based on average lifetime earnings, wage-adjusted earnings, earnings in the final year before retirement, or a combination of these and other factors.

To be clear, I’m not arguing that everyone has adequately saved for retirement. Nor am I arguing that policymakers shouldn’t focus their efforts on public policy options that will help Americans save for their retirement. But I do want to stress that painting all Americans with the broad brush of a “retirement crisis” creates an incomplete picture of the true financial landscape faced by America’s future retirees. Further, I’m concerned that the narrative being told of a “retirement crisis” is leading us to look toward greater dependence on—and even the expansion of—existing government programs, many of which, Social Security included, are already facing severe financial problems. This is not a reasonable plan. It’s certainly not a sustainable plan. We must turn instead toward policy options that will encourage individuals to work, save, and invest so that they can build their own financially secure retirement.

REFORMS FOR A FINANCIALLY SECURE RETIREMENT

It is important that Social Security reforms improve work incentives and promote individual saving while also addressing the program’s financial solvency problems. 

As I have discussed in a previous congressional testimony (see attachment), possible reforms include:

  • basing future cost-of-living adjustment (COLA) increases on the chained CPI,
  • gradually raising the early and full retirement ages,
  • increasing the delayed retirement credit,
  • adjusting the benefit formula,
  • constraining nonworking spousal benefits for high earners,
  • providing payroll tax relief to seniors,
  • increasing access to personal retirement accounts, and
  • increasing financial literacy.

Within the past several months, nonpartisan research organizations have released reports with their recommendations for reforming Social Security. The Committee for a Responsible Federal Budget released a book on ways to reform the disability insurance program that brought together experts from across the political aisle and included both academics and practitioners. A more expansive project sponsored by the Bipartisan Policy Center suggested policy reforms to improve retirement security and personal savings. The BPC report includes reforms to Social Security that would put the program back on a secure financial footing, while also reducing senior poverty and improving work incentives, by making changes to both benefits and taxes.

CONCLUSION

Social Security faces real and increasingly urgent financial challenges. Reform is not only the wise thing to do, it is critical to ensure that Social Security remains solvent and fiscally sustainable and can continue to provide retirement security for generations to come.

Social Security reform must not only address the program’s fiscal solvency issues but also remove the disincentives to working later in life. This means reforms must focus on reining in the growth of program costs, encouraging personal saving and investment, and rewarding those in middle and early retirement age who make the decision to extend their working careers.

Finally, Social Security reform must begin immediately. We can reform this critical program, and we can do it in a way that will improve the financial security of all future Americans in retirement. But we must act now. The Social Security trust fund for the retirement portion of the program is projected to become insolvent in 2035, while the disability trust fund is projected to become insolvent in 2023, less than a decade away. To close the current financial shortfall of the combined trust funds would require an immediate 21 percent increase in the OASDI payroll tax rate (from 12.4 percent to 14.98 percent) or an immediate 16 percent cut in benefit payments (19.6 percent if applied only to new beneficiaries after 2016). The magnitude of the changes necessary will only increase with time. 

Thank you again for your time and this opportunity to testify today. I look forward to your questions.