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' FEDERAL . . i r ^ E R V ^ ^ A N k OF ST LOUiS 1.96 A N N U A L ..EPORT Will Social Security be here for future generations? The Federa! Reserve Bank of St. Louis T i i e Federal Resen e B a n k o f St. Louis is o n e o f 12 regional Reser\ e Banks, w h i c h t o g e t h e r w i t h the B o a r d o f Governors make u p the nation's central bank. T h e Fed carries o u t U.S. m o i i e t a i y policy, regulates certain depositoiy institutions, p!()\ides wholesale-priced se!'\ices to banks a n d acts as fiscal agent R)r the U.S. Treasuiy. T h e St. Louis Fed serves the E i g h t h Federal Reserve District, w h i c h includes all o f Arkansas, eastern Missotn i, s o u t h e r n h i d i a n a , s o u t h e r n Illinois, western Kentucky, western Tennessee a n d n o r t h e r n Mississippi. B r a n c h oHices are located i n L i t t l e Rock, Louisville a n d M e m p h i s . As we approach o u r g o l d e n years, we all h o p e a n d p l a n f o r f i n a n c i a l security i n retirement. For generations, such hopes were f u l f i l l e d i n part by Social Security, w i t h each generation d e p e n d i n g o n the n e x t f o r funding. This chain o f succession forms the basis f o r public pension systems t h r o u g h o u t the w o r l d - b u t as o u r populations a n d o u r economies change, so must the system. [ T H E FEDERAL RESERVE BANK OF ST. LOUIS ] How It AR Started T h e pace w i t h w h i c h public pension systems -yyi^^m-y M m spread t h r o u g h o u t the w o r l d can be tied to the t^^Az/^ demographic transformations taking place d u r i n g the late 19th a n d early 20th centuries. As life expectancies began to increase, so too d i d the p o p u l a t i o n o f the elderly. Meanwhile, migrations o f people f r o m farms to cities reduced the ties a m o n g extended families and, thus, the family support system that the elderly traditionally relied u p o n . C o m b i n e d w i t h the usual e m p l o y m e n t difficulties faced by older workers, these transforma- The Origins of Sociat Security tions o f t e n p l u n g e d the elderly i n t o poverty. C o n c e r n e d about their own financial security i n o l d age, wage earners pressured their governments to G e r m a n y established the first national public create public pension systems. I n the U n i t e d States, p e n s i o n system i n 1889. By the t i m e the U n i t e d States the Great Depression was the catalyst: O l d e r workers established its p r o g r a m ( c o m m o n l y referred to as were o f t e n the first to be laid o f f a n d the last to be Social Security) i n 1935, such systems were well established i n most m ^ o r industrialized countries. At the start The first nationat pubtic pension system is Fotiowing Worid With postwar pros- War it, birth perity, the goat of rates rise worid- pension systems U.S. citizens wide, causing a woridwide shifts tive in rura! baby boom that from etiminating wi!! affect the poverty to maintain- coming decades ing pre-retirement dramaticaity. standards of iiving. areas; by 1920, the majority The U.S. piunges tive in urban into depression. areas. estabiished in Germany. By 1933,25% of the woridorce is unemptoyed. The U.S. estabtishes its pubiic pension Pubiic pension systems in the seven major industriaiized countries offer system — commoniy benefits to neariy referred to as Sociat 100% of retirees. Security. Payrott tax rate is set at 2%. [ 1996 A N N U A L R E P O R T ] h i r e d at a new j o b . Even worse, the stock m a r k e t K i n g d o m a n d the U n i t e d States) have b e e n e x t e n d e d collapse w i p e d o u t m u c h o f their r e t i r e m e n t savings. to cover nearly all workers, a n d redree benefits have been expanded. Today, almost 100 p e r c e n t o f retirees The Success of Pub!ic Pension Systems i n these seven countries receive p u b l i c pensions. I f such programs were established p r i m a r i l y to I n most countries, poverty rates f o r retirees are n o w reduce poverty a m o n g the elderly, they have been lower than they are a m o n g the rest o f the p o p u l a d o n a huge success. I n the past 40 years, p u b l i c pension (see U.S. example at left). Pensions are n o w the most systems i n the seven m ^ o r industrialized countries i m p o r t a n t source o f i n c o m e f o r the elderly, a n d t h e i r (Canada, France, Germany, Italy, Japan, the U n i t e d importance is growing. T h e prevalence o f p u b l i c pensions also has b e e n R!S!NG FROM THE ASHES: U.S. Poverty Rates l i n k e d to a r e d u c t i o n i n l a b o r force p a r t i c i p a t i o n rates 35 Ages 65 and Over g 30 o f the elderly. O n e goal o f the 1935 U.S. Social Security 25 A c t was to encourage elderly workers to retire, creating o Q^ vacancies f o r younger workers a n d r e d u c i n g u n e m p l o y - 20 e m e n t . Programs i n o t h e r countries have shared the 15 same goal t h r o u g h o u t the years. I n E u r o p e , however, 10 1959 1966 1970 1975 1980 1985 " 1990 1996 tn 1959, more than one-third of the eiderty were tiving in poverty. Today, the etderty are weatthier than the genera! poputation. this goal took o n increasing i m p o r t a n c e i n the 1980s, w h e n persistendy h i g h u n e m p l o y m e n t rates l e d to the sharp expansion o f early r e d r e m e n t incendves. Between 1970 and High unempioy- !n Germany, 81% Great Britain 1975, the U.S. ment rates in the of men retire prior introduces women's movement 1980s tead Europe to age 65; in 1971, tegistation to gains momentum, to expand incen- onty 38% did so. privatize its with the number of tives for o!der pubtic pension women attending workers to teave program. cottege rising by High inftation the workforce 40%. By the end of foiiowing the oit ear!y. tn 1981, U.S. passes tegista the decade, hatf of Medicat advancements and heatthier crisis prompts France reduces tion that wi!t raise at! working-age industriaiized its retirement age the retirement age women are in the countries to from 65 to 60. to 67 by 2027. tabor force. match annua! expectancy in Japan adjustments in has nearty doubted - tifestytes cause peopte to tive ionger. Since 1900, tife their pensions increasing from 43 with increases to 77 years for men in overa!! and from 44 to 82 prices. years for women. [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] How It lAbrks The Operation of Pubtic Pension Systems are two types: a universal Hat rate system a n d an T h e p u b l i c p e n s i o n systems i n these seven coun- earnings-related system. U n d e r the f o r m e r system, tries operate essentially o n a pay-as-you-go basis. This workers w h o are eligible f o r f u l l pensions receive the means that c o n t r i b u t i o n s by c u r r e n t workers are used same m o n t h l y benefit as everyone else. U n d e r the latter, workers' pensions vary d e p e n d i n g to pay the benefits f o r c u r r e n t retirees. Each g e n e r a t i o n o f workers supports the previous g e n e r a t i o n w i t h the i m p l i c i t u n d e r s t a n d i n g that the n e x t g e n e r a t i o n o f workers w i l l support their retirement, f o r m i n g a c h a i n o f i n t e r g e n e r a t i o n a l transfers. T h e table below gives a n overview o f the c u r r e n t p u b l i c At! of Europe's systems are in deficit: Worker contributions do not cover payments to retirees. p e n s i o n system i n each o f the seven o n the wages they receive d u r i n g their w o r k i n g life. Most countries also provide supplemental pensions for the poorest retirees, w h i c h are financed f r o m general government revenues. To qualify f o r a public pension, a w o r k e r must have reached a certain age a n d have contributed to the system f o r a m i n i m u m n u m b e r o f years. countries. Since t h e i r i n c e p t i o n , most o f these T h e n o r m a l r e t i r e m e n t age varies across countries, systems have b e e n revised dramatically. Today, there w i t h 65 as the c u r r e n t m a x i m u m . I n Italy, Japan a n d !N THE S A M E BOAT: A Gtobat Comparison of Sociat Security Programs, 1996 First Legistation Benefit Type Work Years For Pension Retirement Age Dependents' Supp!ement Mateini) Femate (f) Minimum Fu!t 10 (residency) 1 40 (residency) 40 CANADA 1927 UF ER 65 65 65 65 FRANCE 1910 ER 60 65 60 60 (mother) 60 60 [65] 65 38.5 [40] 15 37.5 15 with 12/iast 18 mos. unemployed 35(m); 15 with 10 after age 40(f) 40 5 Yes No Yes GERMANY 1889 ER 60 63 [65] 65 !TALY 1919 ER Any Age [65] 62 [65] Any Age [65] 62 [65] 15 [5] 40 JAPAN 1941 UF ER 65 60 65 59 [60] 25 25 40 40 No Yes UNtTED K!NGDOM 1908 UF/ER 65 60 [65] 12(m) 11(f) 49(m) 44(f) Yes UNtTED STATES 1935 ER 65 [67] 65 [67] 10 40 Yes Refers to changes that have been approved but are not yet in effect. 36 ER = Earnings Related UF = Universal Fiat Benefit No No [ l 9 9 6 ANNUAL REPORT] countries c o u n t a p o r t i o n o f the years the U n i t e d K i n g d o m , w o m e n may retire at an earlier age t h a n m e n , spent o u t o f the labor force w h i l e b u t these gender diHerences are caring f o r c h i l d r e n . A l l countries except G e r m a n y a n d Italy increase b e i n g eliminated. A l l countries the pension i f a spouse is i n e l i g i b l e f o r allow individuals to retire early, w i t h his or her o w n p e n s i o n a n d i f there are varying restrictions. France, Germany a n d Italy allow individuals w i t h l o n g w o r k expe- dependent children. rience to retire early w i t h n o penalty ( a l t h o u g h they Redree benefits i n these seven countries are are phasing o u t these provisions). Canada, France, ac^usted as o f t e n as quarterly a n d as seldom as annu- Japan a n d the U n i t e d States allow individuals to retire ally, i n accordance w i t h changes i n consumer prices. early, b u t w i t h a r e d u c t i o n i n benefits. Most countries T h e excepdon is Germany, where the adjustment is allow retirees to increase their benefits by delaying based o n changes i n average after-tax wages. r e t i r e m e n t f o r a few years. I n some countries, the g o v e r n m e n t finances p a r t I n all countries, benefit payments increase o f the pension p r o g r a m t h r o u g h its general revenues. w i t h the n u m b e r o f years worked, u p to a m a x i m u m . I n all countries, at least part o f the cost o f the pensions I n c o m p u d n g the eligibility r e q u i r e m e n t , many is f u n d e d t h r o u g h payroll taxes o n c u r r e n t workers tndexation of Pension Payrot! Tax Rate Taxabte Wages Trust Fund Operating Status Fioor Ceiting 100% 0 NA Yes NA Yes No Yes SURPLUS 7.96% Cover Deficit No Yes No DEHCtT 9.3% 9.3% 20% Yes Yes Yes DEHCtT 8.34% 21.3% Cover Deficit Yes No [Yes] No DEHCtT 33.33% pius administrative cost Yes Yes Yes BALANCE Empioyee Emptoyer Prices 0 2.925% 0 2.925% Prices 7.96% Net W a g e s Prices Prices Government Contribution 8.675% and 0.5% of bonuses NA Prices 2-11.1% 2-10.2% Cover Deficit Yes Yes No DEHCtT Prices 6.2% 6.2% 0 No Yes Yes SURPLUS [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] Keeping It Going a n d t h e i r e m p l o y e r s . Wages b e l o w a m i n i m u m level t h e s h o r t f a l l i n c o n t r i b u t i o n s . By 2029, t h e f u n d w i l l are e x e m p t f r o m taxes i n all c o u n t r i e s , except France be d e p l e t e d , a n d i n the f o l l o w i n g year c o n t r i b u t i o n s a n d t h e U n i t e d States, r e d u c i n g t h e actual tax paid. w i l l cover o n l y 75 p e r c e n t o f payments. W i t h o u t an I n t h e U n i t e d K i n g d o m , t h e t a x rate p a i d by t h e increase i n taxes o r a r e d u c t i o n i n benefits, govern- e m p l o y e e a n d e m p l o y e r is g r a d u a t e d : Wages below m e n t revenues w i l l be necessary to pay t h e r e m a i n i n g a n established level are t a x e d at o n e rate, w h i l e wages 25 p e r c e n t . T h i s s h o r t f a l l w i l l c o n t i n u e to g r o w above are t a x e d at a h i g h e r rate. A l l , except Italy, t h r o u g h t h e m i d d l e o f t h e n e x t century, as w i l l the place a n u p p e r l i m i t o n taxable earnings, a n d Italy deficits i n t h e o t h e r six countries. w i l l s o o n f o l l o w suit. I n m o s t c o u n t r i e s , however, this Keeping The System Af!oat l i m i t is h i g h : M o r e t h a n 90 p e r c e n t o f all workers f a l l T h e f i n a n c i a l stability o f a pay-as-you-go system b e l o w it. requires t h a t c o n t r i b u t i o n s k e e p pace w i t h b e n e f i t F o u r o f the seven c o u n t r i e s m a i n t a i n trust f u n d s payments. To u n d e r s t a n d t h e p r o b l e m s faced by these f o r t h e i r p e n s i o n systems. I n C a n a d a a n d Germany, systems, consider t h e factors t h a t affect c o n t r i b u t i o n s these f u n d s are used p u r e l y f o r h a n d l i n g cyclical a n d those t h a t affect payments. fluctuations i n c o n t r i b u t i o n s a n d payments. I n J a p a n a n d t h e U n i t e d States, such f u n d s are i n t e n d e d as a f o r m o f insurance, to c o u n t e r a c t t h e effects o f l o o m i n g d e m o g r a p h i c changes. T h e last c o l u m n i n t h e table indicates the finan- CONTRtBUHONS PAYMENTS What determines contributions made to the system What determines payments made by the system * tax rates * the number of retirees cial h e a l t h o f each c o u n t r y ' s p r o g r a m . A l l o f E u r o p e ' s wages * the cost of living systems are c u r r e n t l y i n d e f i c i t : C o n t r i b u t i o n s firom the number of workers paying into the system * the generosity of the system H workers d o n o t cover t h e payments t o c u r r e n t retirees. Canada's a n d Japan's systems are r o u g h l y i n balance, T h e factors d e t e r m i n i n g c o n t r i b u t i o n s a n d w i t h c o n t r i b u t i o n s j u s t c o v e r i n g payments to retirees. payments all have risen r a p i d l y since W o r l d W a r I I . I n t h e U n i t e d States, c o n t r i b u t i o n s exceed payments Suppose o u r goal is to m a i n t a i n the c u r r e n t systems a n d t h e t r u s t f u n d is g r o w i n g . A c c o r d i n g to t h e latest w i t h o u t raising taxes o r r e d u c i n g t h e benefits. Is such a n n u a l r e p o r t o f t h e U.S. Social Security B o a r d o f a goal achievable? I t is i f we can m a i n t a i n the r a t i o Trustees, c o n t r i b u t i o n s f r o m w o r k e r s w i l l cover o f c o n t r i b u t o r s to retirees o r boost t h e g r o w t h o f p a y m e n t s to retirees u n t i l 2012. A f t e r this date, real wages substantially. B u t h o w likely is e i t h e r o f m o n i e s f r o m the t r u s t f u n d w i l l b e used to f i n a n c e these conditions? H ) What would my retire like without Social Sec rtt be ty? [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] Wit! W e Have Enough Contributors By the year 2000, there will be only f o u r possible to Support the Beneficiaries? workers per retiree, and this n u m b e r is expected to T h e n u m b e r o f contributors relative to retirees decline to two workers by 2050. can be r o u g h l y a p p r o x i m a t e d by the working-age T h e eHect o f these declines m i g h t be mitigated p o p u l a t i o n relative to retirement-age population. i f employment rolls were to expand m o r e rapidly L o o k i n g at the changes i n these populations since 1950 than projected, or i f workers were Onty Canada and the a n d the projected changes t h r o u g h the m i d d l e o f the n e x t century w i l l give y o u the U S- have !abor force participation rates that Rrst i n d i c a t i o n o f the problems c o n f r o n t i n g public are higher today than pension systems. As the figure they were in 1950. below shows, the n u m b e r o f to delay their retirements. B u t the trends are n o t encouraging. O n l y Canada and the U n i t e d States have 1a o or e p a r d ipati n rates that are higher today than they were i n 1950. I n the U n i t e d K i n g d o m , the labor force participation rate has remained nearly steady over the last working-age individuals s u p p o r t i n g each retiree 40 years, while i n the f o u r other countries, the rate has fallen i n all seven countries i n the past 50 years has fallen. a n d is projected to c o n t i n u e falling. I n all countries, the labor force participation rates o f m e n have fallen. Young m e n are delaying W h i l e the pace o f aging varies across countries, all are facing sharp declines i n their working-age their entry i n t o the labor force, spending m o r e time p o p u l a t i o n relative to the retirement-age population. i n f o r m a l education, while older m e n are exiting the T h e most extreme example is Japan, where i n 1950 workforce earlier, either by taking early retirement there were 10 people o f w o r k i n g age f o r each retiree. or by simply n o t w o r k i n g past age 65. FROM FULL TO FRAGtLE SUPPORT: N u m b e r of W o r k e r s Supporting Each Retiree Canada and United States M M t i i TTTTT M 1950 France # T t M M 2000-^2050 ttaiy # T TTTf # T TT 1950^2000-^2050 Japan T TTT^ft fTT f t 1950^^2000^2050 Germany and United Kingdom t T t TTTTTT Titt TT 1950 2000^2050 As birth rates decfine and tife T expectancy rises, fewer workers TTff^fffif TTTT T^ 1950 2000^2050 e wi!) be avaiiabie to finance retirement benefits. How we ca F [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] Witt Reat Wages Grow Fast Enougti? Y o u n g a n d older women's labor force participat i o n rates have fallen i n accordance w i t h men's, but T h e a m o u n t o f revenue an individual worker these declines have been dwarfed by the rise i n the generates f o r the public pension system i n a given year depends o n the worker's wages and labor force participation rates o f prime-age the rate at w h i c h these wages are taxed. w o m e n . O n l y i n Canada a n d the H o l d i n g tax rates fixed, an increase i n U n i t e d States, however, have women's labor force participation the wage results i n higher revenues rates g r o w n fast e n o u g h to offset f o r the public pension system. the d e c l i n i n g rates o f m e n . A rise i n wages that is l i n k e d to infladon, however, doesn't help m u c h . Most o f the seven countries are Public pension benefits are also l i n k e d to taking steps to reverse the declines i n inflation, so retiree benefits are rising at the their labor force p a r t i c i p a d o n rates, either by increasing the n o r m a l r e t i r e m e n t same rate. Thus, the only way to generate an increase age or by increasing the w o r k requirement for f u l l i n public pension revenues w i t h o u t a simultaneous pension benefits. rise i n expenditures is t h r o u g h a rise i n wages. (Even this is n o t possible i n Germany since pension L o n g phase-in periods f o r these changes — benefits are i n d e x e d to wages.) i n some cases u p to 30 years — w o n ' t do m u c h to affect the near-term health o f public pension systems, Growth i n real wages is driven primarily by however. F u r t h e r m o r e , these changes may have little increases i n productivity — how m u c h o u t p u t each effect o n early retirement, w h i c h at present is taken worker produces. W h e n the o u t p u t o f a worker rises, by a m ^ o r i t y o f individuals i n all seven countries. the real earnings o f that worker also rise. A n o t h e r t r o u b l i n g factor f o r the viability of public I n all seven countries, productivity growth i n the pension systems has been the rise i n unemployment past two decades has d r o p p e d sharply below that o f rates since the 1950s. O n e has to be w o r k i n g i n order previous decades. I n Japan, f o r example, manufactur- to contribute to the coffers o f the public pension i n g o u t p u t per h o u r grew by an average o f 7.9 percent system (although Germany requires individuals a year f r o m 1955 to 1973; since then, it has fallen to receiving u n e m p l o y m e n t payments to contribute). 3.9 percent a year. I n the U n i t e d States, labor produc- Thus, the higher the u n e m p l o y m e n t rate, the greater tivity i n n o n f a r m businesses grew at an average o f the deviadon between potential a n d actual social 2.8 percent a year f r o m 1960 to 1973, b u t declined security revenues. to 1.1 percent a year since. W h i l e many economists do expect productivity growth to improve, few expect improvements large enough to restore the health o f public pension systems. e H ) T m just getting started. Should I worry about retirement already? [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] What We Can Do n u m b e r o f workers paying the pension benefits o f Fixing the Socia! Security Probiem each retiree declines as expected, t h e n real wages Given the g r i m o u t l o o k f o r public pension systems, what can be done to ensure that individuals w o u l d have to rise m u c h faster than they have i n entering the workforce today will have adequate the p2LSt 25 years i n order to compensate. Those w h o income i n retirement? T h e first step is to ensure that espouse economic scenarios that w o u l d allow the sys- economic conditions are o p t i m a l f o r m a x i m i z i n g tems to f u n c t i o n free o f problems t h r o u g h the m i d d l e contributions to the system. This requires that the o f the next century are i g n o r i n g the prevailing trends, economy grow f i ^ t e n o u g h to provide j o b o p p o r t u n i - b o t h economic and demographic. ties f o r those i n the labor force and that productivity Reform Propose!s grow fast enough to p r o m o t e growth i n real wages. Proposals to r e f o r m public pension systems are Governments can help achieve these goals best abundant. Generally, these proposals fall i n t o two by enacting policies that p r o m o t e economic growth. categories: those that m a i n t a i n the pay-as-you-go Thus, government polices that provide incentives f o r structure o f the c u r r e n t systems and those that move working, saving and investing will t e n d to stimulate toward a fully f u n d e d system. growth. Increases i n the level o f education o f the Maintain the Pay-as-you-go Structure workforce and improvements i n the quality o f Proposals that w o u l d m a i n t a i n the pay-as-you-go education will also help. structure typically look f o r ways to raise contributions Central banks, like the Federal Reserve, can or decrease benefits. Seven proposals are listed below: help promote growth by m a i n t a i n i n g price stability. Inflation — even at moderate rates — and i n f l a t i o n SEVEN WAYS TO RETAtN THE CURRENT SYSTEM uncertainty impose substantial costs that h i n d e r 1. economic activity. While economic growth a n d productivity are important, however, they cannot by themselves elimi- ^^ nate the problems caused by an aging population. Increase the retirement age or make planned increases in retirement age effective earlier. Increase the work years required for full benefits. Given the sweeping demographic trends discussed 3. Reduce the incentives to retire early or increase the incentives to retire late. earlier, it is highly unlikely that the public pension systems o f these seven countries can maintain the current level o f benefits w i t h o u t raising taxes or r u n n i n g substantial deficits. Put simply, i f the O Reduce monthly benefits to new retirees as life expectancy increases. 5. 6. 7 Increase the taxability of benefits. Reduce the indexation of pensions. Raise the contribution tax rate or broaden the tax base. Hj W i l l Social Security provide ) for my child's retirement? [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] Interestingly, w h e n public pension systems were W h i l e the Hrst f o u r proposals w o u l d affect only established, most workers were n o t expected to reach f u t u r e redrees, the Rfth a n d sixth proposals w o u l d retirement age. W h e n Germany established its system affect c u r r e n t as well as future redrees. I n the U n i t e d i n 1889, f o r example, only 20 percent o f workers lived States, some have suggested that we treat Social u n t i l age 70, the m i n i m u m age f o r receiving benefits. Security i n c o m e the same way we treat private pension i n c o m e f o r tax purposes; benefits i n Even after the r e t i r e m e n t age was Some countries reduced to 65 i n 1916, most have considered German workers still d i d n o t live c o n t r i b u t i o n s w o u l d be treated as o r d i n a r y i n c o m e a n d taxed to collect a pension. As lifespans adjusting pension have risen (see figure below), a higher percentage o f workers is excess o f a worker's previously taxed b e n e f i t s b y ! e s s t h s n living to collect r e t i r e m e n t benefits — a n d they are collecting f o r a the inftation rate. m u c h longer time. Legislation that made i t easier accordingly. Taxes applied to Social security i n c o m e w o u l d be r e t u r n e d to the coffers o f the system, reduci n g the overall cost o f benefits. Some countries have considered ac^usdng to retire early has only c o m p o u n d e d the p r o b l e m . pension benefits by less than the i n f l a d o n rate. For Reducing the effect that increases i n life example, i f the i n f l a d o n rate were 3 percent, benefits expectancy have o n the cost o f public pension systems m i g h t increase by only 2 percent. This w o u l d reduce is the goal o f the first f o u r proposals m e n t i o n e d earlier. the real pension income o f redrees. A l l o f these w o u l d reduce the total benefits a worker T h e last proposal attempts to increase revenue can expect to receive i n redrement. T h e first three rather t h a n cut costs. This can be d o n e by increasing w o u l d d o this by delaying redrement, while the taxes o n workers directly o r by increasing the taxable f o u r t h proposal reduces the m o n t h l y benefit a wage ceiling, thus increasing the tax rate p a i d by redree w o u l d receive. h i g h wage earners. L A S U N G A LOT LONGER: Life Expectancy [Mate nFemaie 1950 2000 2050 1950 2000 2050 1950 2000 2050 1950 2000 2050 1950 2000 2050 1950 2000 2050 1950 2000 2050 Canada France Germany tta[y Japan United Kingdom United States Across the gtobe, peopte are tiving to riper otd ages, threatening to toppte pubiic pension systems atready heavy with retirees and tight on money to support them. e [ 1996 A N N U A L R E P O R T ] The U.S. Advisory Counci! on Socia! Security: A Group Divided tn 1965, the U.S. Congress amended the Sociat Security tNDtV!DUAL ACCOUNTS PLAN Act to require that an Advisory Councii be established This plan gets its name from the proposal to add a 1.6 per- every four years to anaiyze the !ong-term health of cent earnings tax to the employees' contribution rate, the Sociai Security program. The 13 members of the with these funds to be invested by individual workers Advisory Counci! are chosen to represent the generai in retirement accounts. The contributions would be pubiic, business, workers and the se!f-empioyed. The collected by the Social Security Administration, and indi- 1994-96 counci! was as!(ed to focus on three things: the viduals would be offered a small range of bond or equity !ong-range financial status of the oid-age survivors and index funds among which to invest their contributions. disabiiity insurance program (OASDi); the adequacy Thus, the money goes toward the individual's own retire- and equity of the benefit structure of the OASDi program ment rather than the retirement of a previous generation. across generations, income status and famiiy situation; Upon retirement, these funds would be converted into and the roies of the public and private sectors in provid- annuities indexed to provide protection against inflation. ing retirement income. Councii members agreed that the system needs to move PERSONAL SECURtTY ACCOUNTS PLAN away from the pay-as-you-go approach toward a more The third plan would move the Social Security system fully funded system of financing retirement. Members closest to a fully funded system. The key to this system were unable, however, to develop a single proposal to is the movement to a two-tiered pension system. The first which all could agree. Thus, their final report highlights tier would consist of a flat monthly benefit designed to three different proposals, each of which was advocated equal 76 percent of the monthly benefit currently payable by a council subgroup. All of the proposals include to low-wage workers, which would increase along measures designed to raise revenue and reduce benefits with inflation. along the lines of those highlighted in the text. The Tier two would consist of mandatory contributions to proposals' key differences are the extent to which they private retirement accounts. These accounts would would change the nature of the current system from an be held and managed by private investment firms, and intergenerational transfer system to a fully funded one. individuals would have a wider range of investment These differences are detailed below: opportunities than under the individual accounts plan. Furthermore, individuals would not have to convert their MAtNTENANCE-OF-BENEHTS PLAN funds to annuities upon retirement. One of the elements of this plan is to raise the Social Workers over 55 would continue to be covered by the Security tax rate in 2045 from 12.4 to 14 percent. But the existing system. Workers between the ages of 25-54 plan's key element is the proposal to invest a portion would receive retirement benefits based on benefits (approximately 40 percent) of the Social Security trust fund in equities. Historically, the rate of return on equities has been higher than the rate of return on U.S. govern- accrued under the old system and contributions to the new system. Those under the age of 25 would be covered solely by the new system. ment securities, where the fund is currently invested. By phasing in this plan beginning in 2010, supporters The current payroll tax would finance contributions to hope that the fund's depletion date wil! be delayed from both tiers. To continue to finance benefits paid to current 2029 to 2050. Thus, the changes under this plan would and future retirees covered under the old system, a do little to alter the structure of the current system. transition payroll tax would be added to the current tax. O [ T H E FEDERAL RESERVE BANK OF ST. LOUIS ] Looking A t Reform the absence o f f u r t h e r legislation, the contributions Move to a More Fu!ty Funded System A more radical set o f reforms w o u l d require o f young and future U.S. workers ( i n c l u d i n g i m p l i e d each generation to finance m o r e o f its own retire- accrued interest) are projected to exceed the benefits ment. Proponents o f a m o r e fully f u n d e d system base they could earn i n retirement. their proposals o n the belief that we can n o longer Often, r e f o r m proposals o f this type will maintain sustain a pay-as-you-go system given the demographic a p o r t i o n o f the pay-as-you-go system to guarantee a changes affecting most countries. W h i l e we could m i n i m u m pension for all retirees. This m i n i m u m devise a theoretical c o m b i n a t i o n o f benefit cuts then w o u l d be supplemented by workers' mandated and tax increases to keep a pay-as-you-go system contributions to a pension to f u n d their own retire- i n balance, such changes are probably n o t politically ment, f o r m i n g a two-tier system. viable. As contribution rates rise and benefits are cut, the system's value to a young worker lessens. Even i n T h e first tier could f u n c t i o n like the Canadian, British and Japanese universal flat-rate systems. T h e !N A NUTSHELL: A Generationa! Profite of Socia! Security Severat trends are converging in a way that speiis troubie for the U.S. Socia! Security system: Peopie are iiving ionger, and the number of workers per retiree is on the way down. AGE 70 UFE EXPECTANCY AT BtRTH RETtREMENT AGE TAX WHEN ENTERtNG WORKFORCE WORKERS PER RET[REE WHEN ENTERtNG WORKFORCE WORKERS PER RETtREE WHEN EXmNG WORKFORCE Assumes that worker Digitized forNOTE: FRASER enters workforce at age 20. AGE 45 AGE 25 AGE 5 [ l 9 9 6 ANNUAL REPORT] second tier w o u l d operate like the d e f i n e d contribu- Conc!usion t i o n private pension plans that many individuals Public pension systems were established to currently participate in, except that workers w o u l d be guarantee r e t i r e m e n t i n c o m e f o r the elderly. These r e q u i r e d to invest a f i x e d percent o f their salaries i n systems have been h i g h l y successful at r e d u c i n g these plans. A t retirement, these benefits c o u l d be poverty rates a m o n g the elderly a n d allowing many converted i n t o annuities (investments that provide a to ei^oy a comfortable r e d r e m e n t . stream o f i n c o m e f o r as l o n g as an i n d i v i d u a l lives). Unfortunately, increases i n the generosity o f Benefits u n d e r the first tier w o u l d be assured by pension benefits, slowing economic g r o w t h a n d the government; benefits u n d e r the second tier w o u l d changes i n demographics worldwide have made these d e p e n d o n the r e t u r n o n y o u r investments. Thus, the systems increasingly cosdy to m a i n t a i n , causing con- first tier w o u l d provide some insurance i n the face o f cern a m o n g workers about the ability o f their system adverse m a r k e t conditions. to finance their a p p r o a c h i n g r e d r e m e n t . To address Such a system c o u l d even be supplemented these concerns, policymakers are f o r m u l a t i n g r e f o r m w i t h a t h i r d tier o f incentives f o r additional voluntary proposals i n each o f the seven m ^ o r industrialized savings. T h e t h i r d der w o u l d provide tax incendves nadons. to encourage individuals to increase their savings f o r T h r e e approaches to r e f o r m i n g the U.S. Social r e d r e m e n t b e y o n d the m a n d a t o r y c o n t r i b u d o n s o f Security system are currently b e i n g debated. T h e par- the second tier. dcular r e f o r m soludon one favors depends o n the goals For a m u l t i - d e r system to work, the benefits one wants the system to achieve. B u t i f we make realise u n d e r the first tier must be modest e n o u g h to sustain dc assumpdons about u p c o m i n g trends i n the econo- i n the face o f prc^ected d e m o g r a p h i c changes, b u t my a n d demographics, i t is clear that the c u r r e n t substantial e n o u g h to provide a cushion against the balance between costs a n d benefits is unsustainable. m a r k e t risk i n h e r e n t i n the second-tier benefits. This I f we l u l l ourselves i n t o complacency a n d fail is particularly relevant f o r low-wage workers. I n the to act because o u r system is currently healthier than U n i t e d States, 42 percent o f the elderly w o u l d have most, we w i l l only cause f u t u r e r e f o r m to be m o r e incomes below the poverty l i n e were it n o t f o r p u b l i c cosdy. T h e a m o u n t by w h i c h taxes must rise o r pension benefits. Right now, only 6 percent o f the benefits must be cut increases the l o n g e r we wait. elderly i n the U n i t e d States receive public assistance, F u r t h e r m o r e , delaying r e f o r m w i l l reduce the time less than h a l f the p r o p o r t i o n 30 years ago. A r e f o r m workers have to adjust their financial p l a n n i n g to that reduces p u b l i c pension benefits b u t increases any changes. the need f o r p u b l i c assistance provides n o cost saving. T h e clock is ticking. e [ T H E FEDERAL RESERVE BANK OF ST. LOUIS ] Balance Sheet (thousands o f dollars) December 31,1996 December 31,1995 $ $ Assets: Gold Certificates Special Drawing Rights CertiAcates Loans to Depository Institutions U.S. Government and Federal Agency Securities, Net 474,000 484,000 419,000 490,000 28,700 9,165 18,469,573 17,475,302 Items i n Process of Collection 666,154 219,695 Other Assets 727,177 737,949 0 356,727 $20,784,604 $19,772,838 Interdistrict Settlement Account Total Assets Liabitities: Federal Reserve Notes $16,769,048 $18,426,919 Deposits 754,191 908,876 Deferred Credit Items 292,155 195,199 49,562 45,904 2,693,540 0 $20,558,496 $19,576,898 $ $ Other Liabilities Interdistrict Settlement Account Total Liabilities Capita! Accounts: Capital Paid I n Surplus 114,363 $ Total Liabilities and Capital $20,784,604 97,970 111,745 Total Capital 226,108 97,970 $ 195,940 $19,772,838 [ l 9 9 6 ANNUAL REPORT] Statement of Income and Expenses (thousands of dolars) December 31,1996 December 31,1995 $1,099,849 $1,040,741 49,305 52,869 $1,149,154 $1,093,610 $ $ Earnings: Interest o n Government Securities Other Revenue Total Current Income Current Expenses: Current Operating Expenses 95,026 87,470 Less Reimbursables (9,133) (9,189) Current Net Operating Expenses 85,893 78,281 Cost of Earnings Credits 12,101 6,860 13 0 Net Periodic Pension Costs Current Net Expenses $ Current Net Income 98,007 $ 85,141 $1,051,147 $1,008,469 $ $ Miscettaneous Additions and Deductions: Net Additions or Deductions (39,723) 19,445 Cost o f Unreimbursed Treasury Services (2,129) (2,114) Assessment for Expenses by Board o f Governors (4,061) (3,730) (18,499) (18,660) Federal Reserve Currency Costs Net Income Available for Distribution $ 986,735 $1,003,410 Distribution of N e t income: Dividends Paid to Member Banks $ Payment to the U.S. Treasury (6,431) $ (963,911) (5,344) (984,871) Transferred to Surplus 16,393 13,195 Surplus, January 1 97,970 84,775 Statutory Surplus Transfer to Treasury, October 1 (2,618) Surplus, December 31 $ 111,745 0 $ The Balance Sheet and Statement o f Income and Expenses are prepared by Bank management. Copies o f fuH financial statements complete with footnotes are available by contacdng the Public Affairs Department o f the Federal Reserve Bank of St. Louis, Post OSice Box 442, St. Louis, Missouri 63166. e 97,970 [ T H E FEDERAL RESERVE B A N K OF ST. LOUIS ] Economic Advisory Councii/Bank Officers ADVtSORY COUNCtL Agricutturat Joan P. Cronin Richard G. Anderson James B. Buttard Senior Vice President Assistant Vice President Research Officer Bruce Brumfietd Wittiam G. Dewatd Dennis W. Btase Diane B. Camerto Partner B r u m f i e l d Plantation a n d FTB Farms Inverness, Mississippi Senior Vice President Assistant Vice President Assistant Counsel Mary H. Karr Martin J. Coieman Michaet W. DeCtue Senior Vice President, General Counsel & Secretary Assistant Vice President Supervisory Officer Judie A. Courtney Eiizabeth A. Hayes John P. Baumgartner Assistant Vice President Supervisory Officer Dr. Bert Greenwatt Partner Greenwait Company Farm Hazen, Arkansas Vice President John W. Biock James L. Laird Timothy A. Bosch Marityn K. Corona Lowett Guthrie President Trace Die Cast, Inc. Bowling Green, Kentucky Witiiam A. Hatey President/CEO Haley Family C o r p o r a t i o n St. Louis, Missouri Hittary B. Debenport Kathteen 0. Paese Assistant Vice President Operations Officer Edward A. Hopkins Joseph A. Ritter Assistant Vice President Research Officer Vice President Sturgis, Kentucky Sma!! Business W . Scott M c B r i d e Assistant Counsel Vice President Waltonville, Hlinois Wittiam Sprague Jeffrey M . Date Assistant Vice President Vice President Cietus C. Coughtin Vice President Patricia A. Marsha!! Harotd E. Stingertand Assistant Vice President, Assistant General Counsel & Assistant Secretary Credit O f f i c e r Vice President Jerome J. McGunnigte Assistant Vice President President Shuler Drilling Company, Inc. El Dorado, Arkansas Vice President John P. Merker Assistant Vice President Principal Trust Marketing Communications Consortium, Inc. Memphis, Tennessee Frances E. Sibtey Assistant Vice President W i t i i a m C. Lestie St. Louis Office Thomas C. Metzer President and Chief Executive Officer Steven N. Siivey Jean M . Lovati Robert J. Taytor Assistant Vice President Michaet J. Mueiier Daniei L. Thornton Assistant Vice President Cart K. Anderson Supervisory Officer General A u d i t o r Barktey E. Baitey Supervisory Officer Vice President Bernard E. Berns Public Affairs Officer W.LeGrande Rives Vice President W i i t i a m J. Sneed M e m p h i s Branch Martha L. Perine Daniei P. Brennan Public Affairs Officer Vice President and Manager John W. Mitcheit Timothy C. Brown Operations Officer Henry H. Bourgaux Senior Vice President Thomas 0. Short Assistant Vice President David A. Sapenaro Senior Vice President Ronaid L. Byrne Vice President Michaet D. Renfro Randait C. Sumner Thomas A. Boone Vice President and Manager Vice President Kari W. Ashman Operations Officer Louisvi!!e Branch Vice President Vice President Assistant Vice President Andrea S.Eddy Vice President First Vice President a n d Chief Operating Officer Vice President a n d Manager Thomas R. Catiaway Vice President Kim D. Neison OFHCERS Litt!e Rock Branch Robert A. Hopkins Vice President Assistant Vice President Beveriy Robertson David C. W h e e t o c k Research Officer R. Atton Gitbert N. Lynn Greenwood Robert Reynoids Leisa J. Spatding A u d i t Officer W i t i i a m T. Gavin e Operadons Officer / N O W \ /^ON THE \ tNTERNET SOURCES: U.S. Poverty Rates, page 5 U S Dept. of Commerce, Bureau of the Census A Gtobat Comparison of Sociat Security Programs, 1996, page 6 U.S. Sociat Security Administration. Organization for Economic Cooperation and Devetopment, Bank of ttaiy, Canadian Department of Finance. German Federai Ministry of Labor and Sociat Affairs Number of Workers Supporting Each Retiree, page 10 1950: Nathan Keyfitz and Withetm Ftieger, tVor/t/Popu/af/on CfOM/^A ant^/!g/ng(1990) 2000 and 2050: Wortd Bank, /St/e/t/ng ^Ae Cr/s/s (1994) Life Expectancy, page 16 U.S. Dept. of Commerce, Bureau of the Census, and United Nations
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