Question

a. The Social Security system is predicted to be on a course to exhaust its trust fund. What is the primary cause of this? (And don’t say that revenues are less than expenses. Explain why this is the case.

b. Cite at least two potential solutions from class or the text to the problem of social security running out of funds and the difficulties of implementing each of these solutions

Answer 1

Social Security System refers to an arrangement of services and payments funded by the Federal Government to help support the old, the poor, the marginalized and the needy sections of society. It is a form of transfer payment which is done without the exchange of any goods or services. Under this social security system, a separate fund is allocated for specifically catering to the aged and the disabled, collectively classified under “Social Security Trust Funds”. These funds are usually pooled through payroll taxes. Recently, the Social Security System has been predicted to be on a course to exhaust its trust funds. There are various causes as to why this prediction has developed and of course all of them point to the bottom line that revenues are less than expenses. But the cause of why tax revenues are less than expenses of these funds is deeper rooted.

To understand why revenues are falling short of expenses, one must understand the mechanism behind the functioning of social security funds. Employers and employees contribute an equal percentage share of income towards these funds in the form of payroll taxes. However, the benefits are not immediately realized by the employee. Rather, the current taxes are used to fund payments for those already retired and other dependents. This means that that those who are currently working and will retire after a few years, will receive benefits from contributions made by the then working population. Thus, there is a lag variable in the working of this model. This is where the actual problem stems from. In order to have a constant and smooth flow of revenue, there has to be a large proportion of workers who do in fact pay taxes. But demographics are standing in the way as a huge obstacle. According to demographic transition, US has reached the third stage where both birth rate and death rate are low. This implies that fewer babies are born and people survive longer. Fewer babies in turn implies that that when that generation reaches the working age and the currently working generation reaches the retirement age, the proportion of working population will be much less than that of the dependent population. Hypothetically, if for every two working parents, there is one child, then when the parents retire and the child starts working, the dependency ratio is 2:1. A high dependency ratio translates directly into a low worker-to-beneficiary ratio, which becomes 1:2, where 1 person puts in funds and 2 dependent people withdraw from the fund.

This is true for the whole population as less number of people will thus be working and putting money into social security funds and more people will be taking money out of those funds. The rate of outflow of funds will be much higher than the rate of inflow of funds. This is another way of saying that the revenue (inflow of funds) is less than the expenses (outflow of funds). Ultimately exhaustion of funds boils down to costs exceeding revenues but the primary reason for this phenomenon is demographics and the structure of current population. Had there been no lag variable and the working population would fund for their generation of dependents, the situation wouldn’t have been this worse where Social Security Funds would walk on the path of exhaustion.

If there’s a problem, there must be solutions to it. So two out of a few potential solutions to stop exhaustion of social security funds can be as follows:

Firstly, the retirement age can be increased. This means, people should be working for longer number of years and contributing to payroll taxes (or revenues). These extra years of work with added contribution will reduce the dependency rate and help in generating higher funds to support the dependent. If people are made to work for 5 more years than the previous retirement age, then considering the contribution of the whole working population for 5 additional years will pump up the social security fund considerably within a short period.

Secondly, the cap on payroll tax should be revised if not removed completely. Previously even lower, the tax cap has been revised to $128,400. This is the new taxable maximum and beyond this amount, income is not taxed. However, considering how incomes are galloping over the years, this cap can be raised further to increase revenue because a big chunk of the population does earn higher levels of income.

However, there are certain practical problems when it comes to the implementation of the above two instruments.

Technically if people are living longer, they should work longer, but raising the retirement age hurts young workers as the need to hire new workers reduces. Also, not everybody is into white collar jobs. People engaged in low income and minority jobs when forced to work harder as they get older, get adversely affected. Physically demanding jobs become more difficult to handle with old age and the efficiency of work reduces. Worst of all, these workers who put in extra physical labour and contribute to funds, are likely to reap fewer benefits from those funds.

Additionally, raising the payroll tax cap has its own costs. This is because the tax cap increase was sharp and swift, making tax payers quite unhappy about the current situation. Since health benefits eat away majority of the funds, fixing health costs instead of increasing taxes would serve the purpose of reducing shortage of funds better. Also, raising tax cap would increase the burden on many middle class families, and the government in need of support of the citizens wouldn’t want to hurt their sentiments. The bottom line is, even with an increase in the tax cap, the increase in revenue would still leave a huge shortfall. Thus, other pragmatic measures should be adopted to prevent the depletion of funds.