Reforming Social Security in the US.: An International Perspective

Business Economics, Jan, 2001 by Estelle James

where C is the required contribution rate as a percentage of wages, B is the average benefit as a percentage of average wage, S is the support ratio (the number of workers per retiree), and D is the dependency ratio (the number of retirees per worker). As the PAYG system matures and the population ages, which is currently happening almost everywhere, the dependency ratio (D) grows (and S declines). Thus, either B must go down or C must go up.

Parametric changes in the system--raising the contribution rate or the retirement age, reducing the pension, modifying the indexation formula--could make these systems solvent. However, it is very difficult for politicians to inflict short-run pain in order to gain long-run sustainability. Moreover, they would have to inflict the pain not once, but repeatedly, as changes continue to occur--hardly a self-equilibrating system. For example, every time the trustees of the U.S. social security system have assessed its fiscal soundness, they have found that people are living longer than expected the previous time, and therefore some adjustment to the benefit formula or contribution rate is needed to keep the system solvent.

Growth. In addition to these sustainability problems, PAYG systems have negative effects on economic growth:

* high and rising payroll taxes for pensions (exceeding twenty-five percent of wages in many countries) may increase unemployment or evasion and decrease revenues available for other public goods

* early retirement on actuarially unfair terms (often below the age of sixty) reduces the supply of experienced labor

* private saving may be discouraged by the gift of benefits to the first generation of retirees and the continued provision of public annuities to future generations In the U.S. the payroll tax is relatively low, the retirement age is relatively high, and early retirement is penalized. However, even though our national savings rate is considered too low by many economists, we have not used our old age security program as a way to raise it: quite the contrary. [1]

Equity. Finally, empirical evidence has cast doubt on the equity of many traditional systems. In many countries, rich people gain at the expense of the poor, since rich people live longer and therefore collect benefits for more years. Although the U.S. has a relatively progressive benefit formula, this tends to be offset by the greater life expectancy of the rich, a disparity in life span that has been increasing. Under the defined benefit formula in effect in most countries, workers whose wages increase toward the end of their careers receive a larger future pension that, in effect, is financed by others. Moreover, workers who retire before the age of sixty receive benefits that are subsidized by a tax on the labor of those who work longer. These are not big problems in the U.S., but the U.S. has other surprising and questionable winners and losers. For example, single career married families fare better than unmarried households, while dual career families fare worst of all in terms of the benefit/tax ratio .