When President Bush stated earlier this year "I don't think [Social Security reform] is going to happen" it was a matter of political reality trumping policy necessity. The urgency has not diminished, only the political resources.
"Fixed" before, the system that issued its first payments 70 years ago labors under fundamental demographic and economic contradictions. Certainly the impending baby boomer deluge highlights its demographic dilemma, but Social Security's problems go even deeper. By accentuating financial markets' volatility and fictionalizing Social Security's stability, anti-reformists have fostered the myth that the system not only ameliorates the economy but transcends it. In truth, financial markets are neither as volatile, nor Social Security as stable, as popularly perceived. If Social Security is to meet its requirement for fundamental reform, it must be reestablished so that it reinforces the economy, not seeks to replace it.
According to this year's Trustees' report, Social Security serves 49 million beneficiaries and is funded by 162 million contributors. Today's ratio of 3.3 workers for each beneficiary was 49 to 1 when the baby boomers first began being born in 1946. When those boomers begin entering their octogenarian years, that ratio will have fallen to 2.2 to 1 and America's number of retired workers will have doubled.
The real reason these demographic trends matter is economic. Social Security operates on a pay-as-you-go system. Today's contributors pay today's benefits -- rather than pre-funding their own, they produce only an entitlement for future benefits. Even surplus revenues do nothing to offset future benefit requirements because they are not invested.
Together the demographic and the economic gaps mean that Social Security will demand a rapidly growing proportion of America's economy. Social Security's share of GDP will increase 50 percent -- from 4.3 percent today to 6.2 percent in 2030; however as the Trustees' report points out, dedicated "tax income is projected to be about 4.9 percent of GDP in both 2007 and 2030, and then to decrease to 4.5 percent in 2081." The Trustees currently project this gap to begin in 2017, when payroll taxes are no longer able to pay current benefits. The widening gulf between contributions and commitments will have to be made up from general revenues -- either cutting spending elsewhere or raising taxes and increasing borrowing.
As inevitable as the system's failures are and as dire as the consequences would be, Social Security's anti-reformists amazingly have been able to paint the economy as risky. A baby boomer born in 1946 would have realized an annual average rate of growth of 7.4 percent from a DJIA- and 7.9 percent from an S&P 500-indexed investment. As the Congressional Budget Office points out the same would have happened "from 1926 through 2000 [when]...the real rate of return on large-company stocks averaged about 7 percentage points more than the real rate of return on three-month Treasury bills." Neither time frame avoids volatility -- both encompass six recessions, and in the case of the 1926-2000 time, period, the Great Depression.
And Social Security? While its trust fund has grown dramatically on paper since 1946, it has never invested a dime nor returned a penny. It remains completely dependent on what the economy can later produce and the government tax or borrow from it. Even ignoring its trust fund faÃ§ade, it has hardly been a paragon of prosperity. The Congressional Research Service points out that it ran deficits in 21 of 27 years from 1957 to 1983.
In 1982, Social Security reached such a crisis that insolvency was imminent and prevented only by a multi-billion dollar government bailout (via a shift of from other entitlement trust funds that, like Social Security, held no financial assets) and enormous increases in beneficiary numbers and contributions were legislated in 1983. The 1983 changes would bring essentially the entire American workforce into the system, increase payroll tax percentages, and tax benefits. While they forestalled disaster, they did not fix Social Security. In fact, they represented the last levers left to pull. There are now no large untapped populations to be taxed to pay for current benefits. Even if more money could be taxed in, it could not come with the promise of future benefits because these would simply generate future commitments -- when current commitments already are unsustainable.
The demographics and economics that have hounded it and transformed it now threaten to sink it because Social Security is not what it seems. In contrast to the economy, which has not only survived but thrived in spite of numerous temporary downturns, Social Security cannot survive itself. It cannot because it is essentially a pyramid scheme. A pyramid scheme appears to generate revenue by taking in ever more participants and their contributions. The early contributors at the pyramid's apex do quite well, but as the pyramid's base grows, it is unable to continue attracting enough new participants to deliver on its promises.
While the most focal flaw of both Social Security and a pyramid scheme is their inability to maintain sufficient contributors to fulfill their commitments, their real flaw is economic: because neither invests, neither produces the means to meet its obligations.
Social Security's grand illusion is far bigger than the charge of stock market volatility. It is that the government can supplant the private sector in producing assets -- that government is somehow separate and above its economy's ability to produce. Government is only the recipient of wealth -- obtained by taxing and borrowing -- not its creator. It therefore cannot deliver resources beyond what the private sector creates. And the more government takes, the less productive the private sector is, as resources are diverted from their most productive uses. Far from being insulated from its private sector, government is susceptible not only to its vicissitudes but to the failings of its own system -- as the impending debacle and 1983's near one demonstrate.
Belying those who seek to maintain Social Security's status quo by impugning the stability of private financial markets, Social Security now poses a greater risk than the private sector ever has. It poses this risk not only to its beneficiaries but to the nation's economy as a whole. In order to meet the commitments for which it has produced no resources, it will have to take more and more resources from the private sector, thus depleting its ability to produce. This vicious cycle needs to be replaced with a positive one. One that relies on the real returns of real investments by private individuals. It would offer workers a chance to replace their currently required investment in government with one that would yield real returns. This would not only guarantee their future benefits but would reinforce the economy's ability to produce them. While today's politics may not allow such a move now, tomorrow's policy reality will continue to demand it.