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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 employers. (continued on page 2) o 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 revenues. 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 uo}8 u !L|sb/V\ MBM BH • • qejfi • uoSojo • epeA3|\| . oi]ep| B IU J O p |E 3 • EUOZUV • |! | B J '0 3 S p U B J j U B S ZSZ ON llW H d a iv d 3D VlSOd s n 1IVW SSV1D JLSMIdi BANKING DATA— TWELFTH FEDERAL RESERVE DISTRICT (D ollar amounts in m illions) Selected Assets and Liabilities Large Commercial Banks A m ount Change oSo'JSc"8 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 85,824 66,274 2,272 23,590 19,780 9,831 6,860 12,690 84,394 23,015 438 59,618 6,723 18,986 30,591 17,010 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 + 91 + 8,352 + 294 + 1,084 + 6,119 + 5,690 — — — + + + + — + - + + + 99 743 330 214 25 13 758 84 533 496 12 509 52 172 207 403 W eek ended 3 /5 /7 5 Percent + 7.84 + 9.85 + 101.42 + 10.61 + 6.21 + 7.38 + 11.54 3.15 + 12.91 + 4.73 + 26.22 + 16.29 + 4.57 + 6.06 + 25.00 + 50.26 Comparable year-ago period Member Bank Reserve Position Excess Reserves Borrowings Net free ( + ) / Net borrow ed ( - ) + 41 0 41 + 66 4 62 - 29 243 214 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 + - 912 21 *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 Digitized for FRASfeRh0ne (41S) 397' 1137’ • B>|SE|V