Does Social Security give Americans their "money's worth"? The old answer -- of course it does -- has in recent years come under increasing attack. Small wonder. Rates of return on contributions keep falling. According to most experts, a growing share of new retirees are not getting back the market value of what they paid in and the vast majority of tomorrow's retirees will find themselves deep in the red.
Because a fair return is so basic to the public's understanding of Social Security, defenders of the status quo are tempted to deny the obvious. In a recent letter to the Washington Post, Acting Social Security Commissioner John J. Callahan makes the indefensible claim that the program offers younger Americans "an excellent financial deal." When denial doesn't work, the status quoists scold anyone crass enough to talk about "individual equity," as does Callahan when he reminds people that Social Security also helps the poor. When all else fails, they say that the whole issue is too complex to admit definite answers -- and quickly change the topic.
The facts are as follows. Yes, Social Security does and should provide a relatively better deal to some categories of workers, especially low-earners. But among today's younger Americans, virtually all categories -- including the favored categories -- will do worse than the market. In fact, typical workers in their mid-thirties could at least triple their rate of return by investing their FICA in a conservative portfolio of stocks and bonds rather than in Social Security. Such a dismal payback suggests that Social Security fails not only the test of individual equity, but of "social adequacy" as well.
Getting Worse and Worse
Any honest effort to determine the money's worth of Social Security is essentially a three-step process.
The first step is agreeing on how much a worker contributes. The main issue here is whether to count both the employer and employee halves of the FICA. The status quoists often exclude the employer half. They rarely call attention to this exclusion -- and with good reason. The vast majority of economists believe it is nonsensical.
The employer share of the FICA, after all, is a labor cost, and as such is ultimately borne by the employee. If FICA did not exist, what employers spend on it could just as easily go to higher take-home pay or better fringe benefits. Were this not so, Social Security's treatment of the self-employed, who pay the entire FICA themselves, would be a colossal injustice. It isn't. The self-employed pay both halves of the FICA precisely because economists acknowledge that employees pay both halves too.
Step two is calculating benefits for different categories of workers (by earnings and year of retirement) and figuring out their rates of return over their lifetimes. This calculation requires determining the probability of a number of contingencies -- including whether a worker gets married, is survived by a spouse, or dies before retirement age. Economist Eugene Steuerle of the Urban Institute has run the numbers. His results for average-earners are summarized below. They are in line with those of other experts and include the full value of all Social Security retirement and survivors' benefits.
Social Security (OASI) Real Rates of Return for Average-Earning Workers by Retirement Year Single Single Two-Earner Male Female Couple 1975 5.0 6.5 7.2 1995 1.8 2.9 3.5 2010 1.2 2.1 2.5 2030* 1.0 1.9 2.3 2030** 0.1 1.0 1.4 * -- Assumes current-law benefits are paid in full. ** -- Assumes benefits are cut to match revenues starting in 2029.
A glance at the table shows that rates of return have been dropping like a stone. For average-earning single males, the real rate of return on contributions fell from 5.0 for workers turning 65 in 1975 to 1.8 for workers turning 65 in 1995 -- and it is slated to keep sinking to 1.0 for workers turning 65 in 2030. Because women live longer on average and because married people qualify for survivors' benefits, single females and couples do better. But not much better. From 1975 to 2030, the rates of return for new retirees will fall from 6.5 to 1.9 among average-earning single females and from 7.2 to 2.3 among average-earning two-earner couples.
These projections, moreover, assume that all benefits promised to younger workers will actually be paid. But since Social Security is scheduled to go bankrupt in 2029, they can't be. Assuming that benefits are cut to match revenues from that year on, rates of return for workers retiring in 2030 would fall by nearly 1 percentage point meaning that for single males they would fall just about to zero. Social Security's "excellent deal," it seems, keeps getting worse and worse.
Failing the Market Test
This brings us to the third step, which is comparing Social Security rates of return to equivalent marketplace investments. Some economists believe that a prudent comparison is with the long-term Treasury rate, which has averaged a real 2.6 percent from 1960 to 1995 and which the Social Security Administration projects will average 2.7 percent over the next seventy-five years. As constitutionally protected property, a Treasury bond is a very safe investment -- safer indeed than a Social Security promise. So perhaps we needn't be this prudent. Other economists have shown that it is possible to earn a real return of at least 4.5 percent with very little additional risk by investing in equities when young and gradually shifting into bonds as retirement approaches.
By either yardstick, younger Americans are big market losers. To be sure, some will fare better than others. Women will do better than men, low-earners better than high-earners, and couples better than single people. But as the second table shows, none of these complexities alters the overall conclusion. Already today, no major category of new retirees earns a return of more than 4.5 percent. By 2030, no major category will earn a return of more than 2.7 percent, even before adjusting benefits for bankruptcy. The only exceptions are lifelong one-earner couples, and these comprise a tiny and fast-vanishing share of all new retirees.
Year of Retirement in which Social Security Rate of Return Falls Beneath Market Rate of Return Market Single Male Single Female Two-Earner Couple Rate Low Avg High Low Avg High Low Avg High 4.5 1983 1979 1974 1990 1984 1982 1992 1988 1983 2.7 1998 1986 1984 2023 1998 1992 2021 2006 1994
Social Security's failure to provide a market rate of return condemns younger Americans to huge losses in potential lifetime wealth. An average-earning worker who took his or her FICA contributions and invested them would accumulate, by age 65, $160,000 at a zero percent rate of return. That worker would accumulate $290,000 at a 2.7 percent rate. And $460,000 at a 4.5 percent rate.
The status quoists seem to argue that most Americans must get a lousy deal in order for some to get a good deal. So let's be clear: Low-earners will be big market losers too. Consider the case of workers who spend a lifetime laboring at the minimum wage. Those retiring next year, if single and male, will do worse under Social Security than if they had invested their FICA in Treasury bonds. The same will eventually be true for the great majority of other low-earners as well.
Let's Stop Lying
No one doubts that Social Security provides a vital safety net that must be preserved. But let's not pretend that the cost of subsidies to low-earners or widows or children is the reason most younger Americans are due to suffer catastrophic losses. The reason lies elsewhere -- in Social Security's pay-as-you-go structure.
This structure allowed early cohorts of beneficiaries, rich and poor alike, to receive windfall paybacks far in excess of the market value of their lifetime contributions. But there was a trade-off: The decision not to establish a funded system inevitably meant that later cohorts of beneficiaries would suffer market losses.
At some level, nearly everyone understands what's going on, which is why so many are now talking about investing FICA contributions in private markets. A growing number of voices advocate a partial or complete transition to a funded system of personal retirement accounts. Even some status quoists want to get higher-octane returns by authorizing Social Security to invest some portion of trust-fund surpluses in equities.
In the end, society may decide it's unwilling to pay the enormous cost of transitioning from a pay-as-you-go to a funded system. But whatever we decide, let's stop lying to younger generations. It's wrong to tell them they're getting their money's worth from Social Security when they're not -- and it's offensive to question their civic spirit just because they want a straight answer.
FACING FACTS AUTHORS: Neil Howe and Richard Jackson CONCORD COALITION EXECUTIVE DIRECTOR: Martha Phillips