COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

"The Future of Social Security: One Economist’s Assessment"

James Tobin

January 1987

Three interrelated issues must be faced in assessing the future of OASI. I shall discuss each in turn. Balancing Contributions and Benefits. The overriding long-run issue about OASI is the balance between the tax contributions of the young and the benefits of the old. The system is now geared to scale up benefits automatically so as to maintain the ratio of benefits to contemporaneous wages, the replacement ratio, at its historical level of roughly 40 percent. Payroll tax rates are the residual balancing item in the OASI financial equation. They have been raised steadily for years, and according to current projections they will have to be raised substantially next century if the replacement ratio is to be maintained. The generations involved, however, may at some point prefer to move to or toward a different option-freezing the tax rates and adjusting future benefits instead. This would mean that in the 21st century the benefit/wage ratio would fall; OASI benefits would still be rising in absolute purchasing power, but they would decline relative to the wages of active workers. It is not too soon to begin serious consideration of the options.

Erosion of Confidence. The confidence of young workers in Social Security has eroded in recent years. Some are worried that the system will go broke. Others perceive that their rate of return on the payroll tax contributions they and their employers make will be quite low, in contrast to the interest rates they observe in financial markets today. They wonder why participation itself should be compulsory. The link between the contributions of, or on behalf of, any individual participant and his or her eventual benefits is quite loose, and quite mysterious. The system is a hybrid, mixing social retirement insurance with some intragenerational redistribution in favor of workers with low earnings. This is bound to diminish the rates of return high wage workers perceive they can earn through OASI. Old issues return anew: Should OASI be made more purely an insurance program, letting the general federal budget handle redistribution via needs-tested transfers? Should the link between contributions and benefits be actuarially fair for individual participants? Should the benefit entitlements earned by past contributions be reported regularly and clearly to participants throughout their careers? Should compulsory participation be limited to defined levels of contributions and benefits? As Robert Ball recounts in Chapter 1 of this volume, the founders of Social Security confronted these questions and compromised. Compromises, even theirs, are not graven in stone. Times, circumstances, and attitudes change. At the end of this chapter I shall sketch, as an option worth considering, a system that links contributions and benefits more explicitly and tightly.

Financing Social Security. The issues just raised regarding the links between contributions and benefits for individual participants are related to questions about the financing of the system as whole. Until now Social Security has been mainly a pay-as-you-go system, using its current receipts from workers’ contributions to pay its current benefits. Its trust fund, as its reserves are called, has been deliberately kept small. Under the 1983 legislation, this fund will grow to unprecedented heights relative to annual outlays over the next 15 to 20 years. Thereafter it is projected to decline, and to vanish after midcentury. A case can be made on macroeconomic grounds for a funded system in preference to pay-as-you-go. Full funding would mean a trust fund commensurate to OASI’s liabilities for the future benefits accumulation of such a fund, it can be argued, would add to national saving and investment enough productive capital to yield the promised benefits. That yield might well be a higher rate of return than pay-as-you-go can offer. History cannot be rerun. A shift to funding would take nearly a half century to accomplish. Moreover, the proposal inevitably raises the question of the relation between Social Security trust funds and the overall federal budget. I shall discuss these financial issues, and in my sketch of possible reforms for the next century I shall describe how the long transition to a funded system might be managed.

JEL Classification: 915, 918, 914, 913, 921

Keywords: Social security, government expenditures, OASI, old age, elderly