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Friday, March 28

The social-security system has come
under a barrage of criticism in the
past several years. The tone of the
debate occasionally has become
rather shrill— "chain-letter scheme"
is a favorite epithet— so much so
that a group of senior statesmen
(including five former HEW secre­
taries) recently felt compelled to
issue a lengthy statement defending
the program against its critics at
both ends of the political spectrum.
The controversy centers around the
financing of a $70-billion program
which protects American workers
and their families against the loss of
income resulting from death, dis­
ability or retirement. Controversy
has frequently swirled around the
hybrid social-insurance system since
it was first introduced into this
country a generation ago, but at­
tacks may be stepped up in coming
months, as Congress turns its atten­
tion to recent reports which indi­
cate a sudden worsening of program
finances under the double-barreled
impact of inflation and recession.
Where money comes from
The Old-Age, Survivors and Disabil­
ity Insurance program (OASDI) is
financed largely by a 9.9-percent
payroll tax. (Medicare financing,
which is ignored in this analysis,
pushes the total tax rate to 11.7 per­
cent.) The rate is split evenly be­
tween employers and employees—
a minor distinction, since most
economists believe that employees
bear the entire burden of the tax.
This year, the tax is payable on the
first $14,100 of earnings. Until 1950,
the tax rate was 2 percent on the

first $3,000 of earnings, but in the
ensuing quarter-century Congress
has legislated many social-security
tax increases, generally at the same
times that it boosted benefits.
In 1972, Congress modified its ad
hoc approach and adopted an in­
dexing system for financing the
program. Under the new plan, an­
nual benefit increases are based
upon changes in the consumer price
index, with the first such increase
due this midyear. Similarly, the tax­
able wage base now rises auto­
matically each year in accordance
with increases in average wages.
But whatever its virtues, the index
approach creates difficulties for
evaluating the future health of the
program, because its financial status
now depends not only on current
benefit schedules and demographic
prospects, but also on far-distant
changes in prices and wages.
Another important feature of the
plan is a pay-as-you-go ("current
cost") method of financing. Under
this approach, there is no fund cre­
ated during a worker's life to serve
as a source of his ultimate benefits.
The social-security taxes he pays are
immediately distributed to persons
who are already beneficiaries, while
his own benefits will be paid from
taxes collected in the future from
persons then working. In other
words, the benefits paid this year—
to the aged, to the disabled, to re­
tirees' dependents, and to the sur­
vivors of deceased workers— are
derived mostly from this year's con­
tributions by workers and their
(continued on page 2)


Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.

The system has consistently main­
tained a reserve fund, but nothing
comparable to the type maintained
by private insurance firms— whence
comes the charge that it has un­
funded liabilities running into the
trillions of dollars. However, any
system whose future income is as­
sured by the government's taxing
power has no need to build up the
huge sums that private insurers
would require if they underwrote
similar liabilities. The major purpose
of the trust fund rather is to serve
as a contingency reserve large
enough to tide the system over any
temporary changes in income and
outgo. Thus, during the past decade,
trust-fund assets generally have
been kept equal to about one year's
expenditures. In dollar terms, trustfund assets have varied over time>
rising from $7 billion to $22 billion
between 1945 and 1955, declining
slightly by 1965, and then rising
further to $46 billion in 1974.
Long-term deficit
Current fears about the long-term
health of the program center around
the wide gap expected to develop
between income and outgo after
the first decade of the 21 st century.
These fears first surfaced last year in
several Administration and Con­
gressional documents, primarily the
annual Trustees Report, and are
bound to grow because of the in­
creasing gloominess of more recent
official reports.
The assumptions cranked into last
year's projections for the 1974­
2048 period include a 5.0-percent

annual rate of increase in
wages, a 3.0-percent rate of in­
crease in consumer prices, and a 2.1
total fertility rate after 1985. (The
latter is the average number of
babies borne by each woman dur­
ing her lifetime.) Given these as­
sumptions, the cost of scheduled
benefits would average 13.9 percent
of the total taxable payroll over the
75-year period, but the tax rate
would average only 10.9 percent
over the same time-span. The dif­
ference between the average cost of
the program and the average tax
rate represents a financing deficit
equivalent to 3.0 percent of total
payroll— even greater when allow­
ance is made for the benefit in­
crease scheduled this year.
a v e ra g e

Different values for the wage and
price variables of course would pro­
vide different results. Still, the bulk
of the expected deficit arises from
increasingly conservative demo­
graphic assumptions, which indi­
cate that the number of benefi­
ciaries per 100 workers will rise
from 30 to 45 between now and the
year 2030. This reflects the expec­
tation that, with low birth rates,
relatively few workers will be avail­
able to support the very large num­
ber of people who were born soon
after World War II and who will
retire in the 21st century.
Short-term deficit
Despite the importance of the de­
bate over the long-run health of the
social-security program, the sys­
tem's short-run financing problems

w ill undoubtedly dominate the
headlines in coming months. Last
year, the Trustees' worst-case pro­
jection showed a near-balance in
the program over the next several
years, leaving $44 billion in trustfund assets at the end of 1978. In
contrast, the Trustees' forthcoming
report— reflecting the gloomy eco­
nomic projections of the President's
Council of Economic Advisers— may
show a severe drain capable of w ip­
ing out trust-fund assets by the end
of the decade.
The sudden worsening of the pro­
gram's short-term financial outlook
reflects the same combination of
factors that has created such havoc
in the nation's overall economy. Un­
employment has eroded payroll-tax
revenues, and has also speeded the
drain on the trust fund because of
more workers seeking retirement or
disability benefits. Inflation mean­
while has increased social-security
outlays under the automatic benefit
formula; this is expected to lead to
an 8.7-percent benefit increase this
June and a further 9.2-percent in­
crease in June 1976. To be sure, the
sluggish economy will get a boost
from this year's $2.5-bilIion socialsecurity deficit, but we can't assume
that a projected $6.1-billion deficit
in 1976 (or a $9.6-billion deficit in
1980) w ill be equally appropriate.
Congressional hearings are likely
soon, at which point a number of
proposals w ill be advanced to deal
with the suddenly increased OASDI
deficit. The administration has al­

ready rejected a proposal contained
in a recent Advisory Council re­
port, which would have shifted $7
billion of Medicare financing from
the OASDI program to the shoulders
of the general taxpayer, and it cer­
tainly would reject the AFL-CIO
view that at least one-third of
OASDI program costs should even­
tually be met from general tax
One financing possibility, advanced
by the Advisory Council, would be
an immediate increase in the socialsecurity tax rate from 9.9 percent to
10.9 percent (exclusive of Medi­
care), and further increases rising to
16.1 percent in the year 2025. An­
other possibility would be a further
expansion in the taxable wage base,
which under the automatic formula
has reached $14,100 this year and
might reach $15,300 next year. The
AFL-CIO argues that Congress
should raise the base to roughly
$28,000, at which point 97 percent
of all workers would have their full
wages taxed— the same situation
prevailing at the outset of the pro­
gram in the 1930's. (Insuranceindustry spokesmen have consis­
tently attacked proposals of this
kind / on the grounds that the pro­
gram would then usurp private sav­
ings and leave room for no other
type of individual financial plan­
ning.) But whatever proposal is
chosen, the latest financial estimates
indicate that the total cost of the
OASDI program w ill double be­
tween 1974 and 1980, to $120 bil­
lion, so that steps must be taken
soon to find more money.
William Burke

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ZSZ ON llW H d
a iv d
3D VlSOd s n

(D ollar amounts in m illions)

Selected Assets and Liabilities
Large Commercial Banks

A m ount


3 /1 2 /7 5

Loans (gross, adjusted) and investments*
Loans (gross, adjusted)— total
Security loans
Commercial and industrial
Real estate
Consumer instalm ent
U.S. Treasury securities
O ther securities
Deposits (less cash items)— total*
Demand deposits (adjusted)
U.S. G overnm ent deposits
Time deposits— to ta l*
States and p o litica l subdivisions
Savings deposits
O ther tim e deposits^
Large negotiable CD's


Weekly Averages
of Daily Figures

W eek ended
3 /1 2 /7 5

Change from

„ „

year a§ °

3 /5 /7 5

D olla r


+ 6,242
+ 5,945
+ 1,144
+ 2,262
+ 1,157
+ 676
+ 710
- 413
+ 9,652
+ 1,039
+ 8,352
+ 294
+ 1,084
+ 6,119
+ 5,690






W eek ended
3 /5 /7 5


+ 101.42
+ 10.61
+ 11.54
+ 12.91
+ 26.22
+ 16.29
+ 25.00
+ 50.26

year-ago period

Member Bank Reserve Position
Excess Reserves
Net free ( + ) / Net borrow ed ( - )







Federal Funds— Seven Large Banks
Interbank Federal fund transactions
Net purchases ( + ) / Net sales ( —)
Transactions of U.S. security dealers
Net loans ( + ) / Net borrow ings ( —)

+ 2,004

+ 1,677

+ 1,582

+ 1,573





*lncludes items not shown separately. Jln dividu als, partnerships and corporations.

Information on this and other publications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
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