Full text of Inside the Vault : Fall 1997

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

2/20/2020

Social Security: Who Will Fund Your Nest Egg?

I N S I D E T H E VA U LT | FA L L 1 9 9 7
https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/social-security-who-will-fund-your-nest-egg

Social Security: Who Will Fund Your Nest Egg?
An issue that has captured the attention of baby boomers, Generation Xers and retirees is that of Social
Security. Will it be there for you? Who will pay for it? To answer these questions, let's take a look at why the
current public pension system was established and how it operates. Then we'll explore some of the proposed
changes that meet the challenges of the Social Security System.

Feathering Your Own Nest
Prior to the creation of a public pension system, individuals relied on their savings or family and community
members to help them during their retirement years. Demographic changes during the early 20th century,
such as increasing life expectancies and migrations of workers from farms to cities, contributed to the
declining support from family and community. These factors and employment difficulties faced by older
workers increased pressure on the federal government to create a public pension system. The Great
Depression of the 1930s in which older workers were often the first to be laid off and the loss of retirement
savings due to the stock market collapse precipitated the establishment in 1935 of the U.S. public pension
system—commonly referred to as Social Security. In addition to providing relief to the elderly, a goal of the
1935 U.S. Social Security Act was to encourage elderly workers to retire, creating vacancies for younger
workers and reducing unemployment. In this way, younger workers as well as older workers benefited.

Building the Birdhouse
The U.S. public pension system operates as an inter-generational transfer. This pay-as-you-go system means
that contributions by current workers are used to pay the benefits for current retirees. Each generation of
workers supports the previous generation with the implicit understanding that the next generation of workers
will support their retirement, forming a chain of inter-generational transfers. To qualify for a public pension, a
worker must have reached a certain age and have contributed to the system for a minimum number of years.
Individuals may retire early, but with a reduction in benefits. Benefit payments increase with the number of
years worked.
The pension program is financed through payroll taxes. Current employees and employers each pay a payroll
tax, with an upper limit on taxable earnings. Currently these tax revenues exceed payments to beneficiaries,
and the surplus is placed in a trust fund invested in government securities. According to the 1997 Annual
Report of the U.S. Social Security Board of Trustees, contributions from workers will cover payments to
retirees until 2012. After this date, monies from the trust fund will be used to finance the shortfall in
contributions. At this rate, the trust fund will be depleted by 2029, and contributions will cover only 75 percent
of payments to beneficiaries. Without an increase in taxes or a reduction in benefits, government revenues
will have to be reallocated from current programs to make up the Social Security deficit.
One of the major factors creating the projected shortfall is the ratio of contributors to beneficiaries. In 1950,
there were approximately 7 contributors per beneficiary.
https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/social-security-who-will-fund-your-nest-egg?print=true

1/2

2/20/2020

Social Security: Who Will Fund Your Nest Egg?

That number will drop to about 5 contributors per worker in 2000 and 2 contributors per worker in 2050. In
addition to the number of workers paying into the system and the number of retirees, other components that
affect the balance of revenues and payments are payroll tax rates, wages and the level of benefits. Because
payments are indexed—adjusted for inflation—price levels also affect the balance.

Protecting the Nest Egg
Given the projected deficits and possible depletion of the Social Security Trust Fund in the not-so-distant
future, ideas about how to reform the System are up for debate. One proposal is based on maintaining the
pay-as-you-go structure, with some of the following changes:
Increase the retirement age
Increase the work years required for full benefits
Reduce the incentives to retire early
Reduce monthly benefits to new retirees as life expectancy increases
Increase the taxability of benefits
Reduce the indexation of pensions
Raise the contribution tax or broaden the tax base
An alternative to the current intergenerational transfer is that of moving to a more fully funded, two-tier
system. This type of reform generally includes a portion of the pay-as-you-go system to guarantee a minimum
pension for all retirees—the first tier—but would be supplemented by workers' mandated contributions to a
private pension to fund their own retirement—the second tier. Benefits under the first tier would be assured by
the government; benefits under the second tier would depend upon the return on one's investments. In the
United States, 42 percent of the elderly would have incomes below the poverty line were it not for public
pension benefits. Thus the two-tier system must have a first-tier substantial enough to provide a cushion
against the market risk inherent in the second-tier benefits. At the same time, however, the first-tier must be
modest enough to provide a solution to the problem of the projected shortfall.

Who's Minding the Nest?
In 1965, the U.S. Congress amended the Social Security Act to require that an Advisory Council be
established every four years to analyze the long-term health of the Social Security System. The 1994-96
council was asked to focus on the long-range financial status of the program, the adequacy and equity of the
benefit structure across generations, income status and family situation, and the roles of the public and
private sectors in providing retirement income. Council members reportedly agreed that the system needs to
move away from a pay-as-you-go approach toward a more fully funded system of financing retirement.
Members were unable, however, to develop a single proposal to which all could agree.
Clearly, the current balance between costs and benefits of our public pension system is unsustainable. The
sooner policymakers reform the System, the greater the ease of transition for the System as a whole, as well
as for the individual in building his nest egg.

https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/social-security-who-will-fund-your-nest-egg?print=true

2/2

2/20/2020

Q&A

I N S I D E T H E VA U LT | FA L L 1 9 9 7
https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/q--a

Q&A
What effect do immigrants have on the wages of native-born Americans?
The basic principle of supply and demand would suggest that increases in the labor supply would decrease
the price of labor, that is, wages. This principle holds true if all workers possess the same skills. In fact,
workers have different skills, and studies have shown that over the past 20 years only native high school
dropouts have experienced a decline in their wages because of immigration.
What impact do immigrants have on government budgets?
The most striking difference between immigrants and natives is not in benefits received, but rather in taxes
paid. Both immigrants and natives get about the same amount of government benefits during childhood and
retirement, when most benefits are received. During the working years, however, the amount of taxes each
group pays is quite different. Recent immigrants pay the least, but their children—who tend to make more
money and live in high-income/high-tax states—pay the most. Thus, although some immigrants may pose an
initial fiscal burden, the U.S. economy, in the long run, benefits from immigration.
What effect do immigrants have on the U.S. economy?
A recent National Research Council report, authored by a panel of economists and sociologists, shows that
Americans are generally not losing jobs because of immigrants. Actually, immigrants are increasing economic
growth by bringing with them skills that widen the variety of goods the economy can produce. Each year, new
immigrants add between $1 billion and $10 billion to total U.S. output.
Are more immigrants entering the United States now than ever before?
That depends on whether one is counting absolute numbers or looking at the percentage of population. The
number of immigrants entering the United States legally is greater today than it was in the early 1900s. The
current rate of U.S. immigration—the level of immigration adjusted for population—however, is much lower
today than it was a century ago. Between 1900 and 1910, about 11 immigrants per thousand residents
entered the United States legally. The current rate is about five per thousand, but rising.

https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/q--a?print=true

1/1

2/20/2020

Economic Snapshot

I N S I D E T H E VA U LT | FA L L 1 9 9 7
https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/economic-snapshot

Economic Snapshot
3rd Quarter 1997
Q4-96 Q1-97 Q2-97 Q3-98
Growth Rate—Real Gross Domestic Product

4.3%

4.9%

3.3%

3.5

Inflation Rate—Consumer Price Index

3.3%

2.4%

1.1%

2.0%

Civilian Unemployment Rate

5.3%

5.3%

4.9%

4.9%

SOURCE: National Economic Trends, Federal Reserve Bank of St. Louis, October 1997, p.3

What does Real GDP measure?
Real Gross Domestic Product measures the value, adjusted for inflation, of a country's output of final market
goods and services during a year. In contrast, Nominal GDP is expressed as a dollar value not adjusted for
inflation. "Final" goods and services ensures that an item is counted only once For example, tires that are on
an automobile produced in 1997 are included in the dollar value of the car. If the tires were counted first as
tired production and then as part of the car's value, GDP would be overstated.
Economists measure real GDP as a money amount in base-year dollars. They choose some past year, such
as 1992, to calculate the value of the economy's current output. Real GDP in base-year dollars show what the
https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/economic-snapshot?print=true

1/2

2/20/2020

Economic Snapshot

money value of the current output would be if prices had not changed since that base year, and enables us to
compare real output over time.

https://www.stlouisfed.org/publications/inside-the-vault/fall-1997/economic-snapshot?print=true

2/2