Academic journal article Federal Reserve Bank of St. Louis Review

Social Security versus Private Retirement Accounts: A Historical Analysis

Academic journal article Federal Reserve Bank of St. Louis Review

Social Security versus Private Retirement Accounts: A Historical Analysis

Article excerpt

This paper compares Social Security benefits relative to those paid from private investments: specifically, whether 2003 retirees would gain more retirement income if they had invested their payroll taxes in private accounts during their working years. Three different retirement ages and four possible earnings levels are considered for two private investments--6-month CDs or the S&P 500. On average, the results suggest less than 5 percent of current retirees would receive a higher monthly benefit with Social Security. Several Social Security reform proposals are described.

INTRODUCTION

The Social Security Act of 1935 remains one of the largest and most enduring mandates of federal government activity. (1) Although the term Social Security is commonly used to refer to retirement benefits, the Social Security system has evolved over time to include other social welfare programs as well. Initially, the Act provided for only old-age retirement benefits (also called Old Age Insurance, or OAI). Benefits for survivors were added in 1939, and the system became known as OASI. Disability benefits were added in 1954 (OASDI). The final addition came in 1965, when Medicare was enacted, giving the present-day program the name OASDHI. As seen in Figure 1, Social Security, disability, and Medicare benefits are the largest expenditures of the federal government, with nearly $725 billion (7 percent of gross domestic product, 34 percent of total federal spending) spent on OASDHI in 2003. (2) We focus specifically on OASDI and simply refer to this as Social Security throughout the remainder of the paper, unless noted otherwise.

[FIGURE 1 OMITTED]

Social Security (OASDI) is commonly referred to as a pay-as-you-go pension system. (3) Rather than paying an individual benefits from a fund that they have built up over time (called a fully funded pension system), a pay-as-you-go system relies on tax revenue from current workers to fund the benefits of current recipients. Over 47 million Americans received benefits through the OASDI system in 2003 (roughly 16 percent of the U.S. population). (4) Considering only retirees and their dependents, nearly 33 million Americans received OASI benefits in 2003 (roughly 11 percent of the U.S. population and 91 percent of the U.S. population over age 65). The system is funded by payroll taxes levied equally on employees and their employer up to a maximum income level ($90,000 in 2005). (5) The current tax rate for each employee and his employer is 6.2 percent (for a total rate of 12.4 percent). Payroll tax rates have increased since the 1930s, as seen in Table 1. (6)

Since the inception of Social Security in 1937, for most years revenues coming in have been greater than expenditures going out. In 2003, for example, OASI trust fund revenues from payroll taxes totaled $544 billion, while benefits summed to $406 billion. (7) By law, any surplus revenue must be credited to the Social Security trust fund. Trust fund monies are invested in federal government securities (Treasury securities) to earn a rate of return. There are no actual funds held in the trust fund; the federal government regularly uses these monies for both mandatory and discretionary purposes. The size of the Social Security trust fund was roughly $1.4 trillion at the end of 2003. Revenues, expenditures, and the trust fund balances for selected vears are shown in Table 2.

Prelude to a Crisis

The Social Security system remains quite solvent today, despite an increase in the number of benefit recipients and increasing expenditures as a percentage of total federal spending. As seen in Figure 2, the number of OASDI beneficiaries has increased from nearly 26 million in 1970 to over 47 million in 2003, which is an average annual increase of 1.86 percent. In terms of the entire U.S. population, 12.6 percent received some OASDI benefit in 1970, compared with 16.2 percent in 2003. OASDI expenditures as a percentage of total federal spending rose from roughly 10 percent in 1957 to 22 percent in 2003, as seen in Figure 3. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.