Social insecurity: linking retirement and personal responsibility

ONE OF THE GREATEST fruits of high productivity and rising incomes in a country like the U.S. is the financial ability people have to retire. This possibility was beyond the imagination of pre-World War II workers and is still far beyond the expectations of most people living in Third World countries. For most of human history, people simply worked until their bodies gave out and then depended on their children to care for them in the last years of life. Now, in advanced economies, retirement figures into almost everyone's expectations.

However, an expectation does not by itself create an adequate financial base for retirement, especially when the expectation is based--as it is in the U.S.--on substantial Social Security benefits. The fact that Social Security is in trouble has been trumpeted for more than a decade, but still no major reforms have been introduced to put things right. Because all potential reforms involve costs, politicians have deferred the necessary difficult decisions.

Social Security needs to be thought of in the larger context of retirement. Retirement is never a right. It is possible only through the fruit of productive labor, sacrificial saving, effective investment and responsible budgeting. Retirement depends on the willingness of families to routinely make sacrifices, setting aside some portion of their current income. Retirement also depends on firms using these savings to fund investment in new production facilities, better equipment, and research and development. The link between saving (by both governments and families) and retirement income is key to both a healthy economy and its ability to provide for senior citizens.

The connection between saving and retirement earnings is most obvious for those who contribute to Individual Retirement Accounts. It is visible also to those who work in companies that provide pensions for which employee contributions are required.

The danger of delinking retirement income from saving is that families come to count on a certain future retirement (as with retirement plans that promise a specific benefit) and therefore tend to save less themselves. This has consequences both for the individual and the economy. For individuals, inadequate saving can make retirement difficult, if not impossible, should expectations about future benefits not be met. For the economy as a whole, less saving by individuals means slower growth in productivity. And slower growth in productivity means that there will be less growth in invested funds and so, in turn, less money available to fund retirement.

Even more dangerous to society is the disconnect that has arisen between the government's promises of Social Security benefits and its own commitment to save to provide these benefits. This weakness was built into the system from its inception in 1935. Originally, benefits paid to current retirees were to be funded exclusively from modest payroll taxes (1 percent of the first $3,000 earned) paid by both current employees and their employers. The initial beneficiaries of Social Security made no financial contributions into the system. During the first ten years of the system, the ratio of workers paying Social Security taxes to beneficiaries was more than 40 to 1. Given Depression rates of unemployment and the poverty conditions that prevailed, a commitment of benefits to the limited number of people who survived past the age of 65 seemed like the least society could do to help older workers and to honor their contributions.

Over the years, Social Security benefits have increased, as have the contributions required of workers. The tax rate for 2007 was 6.2 percent (this does not include the 1.45 percent tax rate paid for Medicare) on the first $97,500 of earnings, with this amount paid by both employees and employers. Benefits are now automatically adjusted yearly to offset the effect of inflation.

But demographic changes have rendered the Social Security system unsustainable in its current form. One important factor is the aging of the generation born between 1946 and 1964. In 2008 the first baby boomers can start retiring--at age 62--and receive partial benefits from Social Security. The baby boomers head into retirement at a time when birth rates have dropped--from 16.7 births per 1,000 people in 1990 to 14.2 births in 2007. In addition, life expectancy has increased over the past 40 years from an average of 70.8 years in 1970 to a projected lifespan of 78.5 years in 2010.

Because of these demographic changes, the number of workers for each beneficiary dropped from 5.1 in 1960 to 3.3 in 2006. This ratio is expected to decrease to 2.1 by 2030 and to 1.8 by 2080. As a result, the Social Security system faces serious funding shortfalls beginning around 2018 and continuing into the indefinite future. Given the huge gap between Medicare's current promises to seniors and its basis of funding, the future of retirement for the next generations is even bleaker.

How did we get into this fix? One reason is that people began to think of retirement funding as a right and primarily a public responsibility, and so--not surprisingly--started saving less. For more than a decade, American firms have been funding more and more of their capital investments--the key to economic growth--with money from foreign investors. Foreigners' willingness to place their savings in the U.S. is good for the U.S. economy in some ways, but it means that an increasing share of the fruits of economic growth goes to the foreign investors and are not available for funding the retirements of American workers.