“The Social Security program plays an important part in providing for families, children, and older persons in times of stress. But it cannot remain static. Changes in our population, in our working habits, and in our standard of living require constant revision.”
No, this quote is not from 2012 (although one could certainly imagine a contemporary politician calling for Social Security reform with these words). Rather, this is an excerpt from President Kennedy’s signing statement for the Social Security Amendments of 1961. That particular bill amended the Social Security law to, as the Social Security Administration describes, “permit male workers to elect early retirement age 62; to increase minimum benefits payable; to liberalize the benefit payments to aged widow, widower, or surviving dependent parent; and to liberalize the retirement test and eligibility requirements.” (A more detailed description of the bill is also available on the SSA’s website.)
Oh how things have changed.
When President Kennedy signed that bill in 1961, federal spending was at about 18.4 percent of GDP, with a deficit of -0.6 percent. Last year (2011), federal spending was 24.1 percent of GDP, with a deficit of -8.7 percent.
Of course, it is important to recognize that the 2011 budget levels are also the result of the Great Recession. Plummeting tax receipts (as a result of a rapid contraction in GDP and a slow subsequent recovery) and the efforts of the government to stop the freefalling economy (large tax cuts and stimulus packages) resulted in a much bigger deficit. Yet throughout the 2000s (but before the recession began in December 2007), federal spending accounted for around 19 to 20 percent of GDP, with deficits ranging from -1.2 percent (at the low end) to -3.5 percent (at the high end).
In contrast 1961 was the first year in the second longest economic expansion in U.S. history, which lasted from February 1961 to December 1969.
So part of the deficit is cyclical, meaning that it is due to the effects of the economic cycle. The economy in 1961 was expanding, providing more revenues for the government, while the economy of late has been slowly recovering from a complete financial meltdown and high unemployment that has seen tax revenues fall precipitously. The government, by maintaining spending levels, prevented an even larger fall, but also ran up high debts that will need to be paid off once the economic recovery is less fragile. Cyclical deficits are thus temporary. The stimulus package, at around $1 trillion, has been a main contributor to our cyclical deficit. It helped sustain spending at all levels of government, but only in the short term. Once the money appropriated it for it is used up, that’s it. It will not continue creating deficits indefinitely.
Even so, part of the deficit is structural. Unlike cyclical deficits, structural ones will exist whether the economy is expanding or contracting. That is, it is not dependent on the economic cycle. The main structural elements in our current deficit are the Bush tax cuts and entitlement spending. Because the Bush tax cuts were not offset by spending cuts, but rather by spending increases, the debt and deficit ballooned. Indeed, the Bush cuts were accompanied by a huge increase in military spending because of the Afghanistan and Iraq Wars, as well as the enactment of an expensive prescription drug entitlement that U.S. Comptroller David Walker called “the most fiscally irresponsible piece of legislation since the 1960s.”
So the structural portion of our deficit is mainly characterized by strong demand for services and weak desire to actually pay for them. Legislators usually face little personal downside to enacting politically popular programs (like Bush’s Medicare expansion), but strong opposition in funding them (which occurs through taxes). The result is that new programs are funded mainly through higher debt. Furthermore, since the Republican Party has effectively abandoned its dedication to balanced budgets in favor of tax cuts at all costs, funding for these programs has actually decreased. The result is an untenable fiscal situation in which high demand for government services is met, but the services are funded through debt.
Now that we’ve established all that, let’s return to Social Security and Medicare.
Social Security, when Kennedy signed the Social Security Amendments of 1961, was about 12.8 percent of all federal outlays and about 2.35 percent of GDP. By last year (2011), those portions had risen to 20.3 percent of federal spending and 4.89 percent — and it is continuing to climb. Medicare is likewise growing at a fairly rapid pace. In 1967 (the year after it was first implemented), Medicare spending was 1.7 percent of the federal budget. In 2011, it was 13.5 percent of the federal budget and 3.25 percent of GDP.
These two programs make up a very large part of the federal government, and they are only set to grow in the future. Why? Well, both are entitlement programs, which means that anyone can claim benefits as long as they meet criteria laid out in the law. The main criteria for both of these particular programs is age. Social Security and Medicare provide pensions and health insurance for elderly Americans, respectively.
Like any government program, these two are funded through taxes, which are taken from American workers. The larger the pool of workers, the greater the economic activity, and the higher the tax revenue. The smaller the pool of retirees and the later people retire, the lower the benefit payments.
The baby boom that followed World War II provided the American economy with a large pool of workers, which boosted the American economy. As the Economist succinctly describes:
Basically, economic growth comes from having more workers, making them more productive or a combination of the two. If a country has fewer workers, productivity has to do all the work, and even then real growth is likely to be slow.
In 1965, a few years after Kennedy expanded Social Security coverage, there were about 4 workers to every 1 retired beneficiary. That had fallen to about 2.9 workers per each beneficiary in 2010, and will fall even further as the baby boomers begin retiring in larger numbers. The elderly population (over 65) will increase by about a third over the next decade. (Though, as an aside, this lower population growth still puts the U.S. ahead of many European nations, which will have to deal with the combination of more drastic population declines and more generous government programs.) At the same time, people are living longer, which increasing the amount of benefits that must be paid out.
Something has to give. Either the future holds higher taxes on a worker population that is shrinking relative to beneficiaries, or retirees will have to take a benefits cut to maintain the current taxation levels, or some combination of the two. Consider also that the growth of Social Security and Medicare as portions of the entire federal government have implications for other government services, as well. The more resources it dedicates toward these two programs, the less it can dedicate to others (like defense). Keep in mind that raising revenue through higher taxes is always very difficult politically and that existing law mandates that Social Security and Medicare benefits must be paid out to those that qualify. So, even if the dedicated payroll taxes that fund Social Security and Medicare fail to cover the program’s expenses, the government must continue to pay out benefits, or change the law.
Of course, both programs are quite popular among Americans (especially among older Americans, who voter often), which makes it very difficult to simply ‘change the law.’ Nevertheless, the graying of America’s population and longer life expectancies necessitate reforms that combine slower benefits growth with greater revenue. Increasing retirement and eligibility ages, paring back benefit increases, and raising new revenue will be the order of the day. Americans should take a serious look at policies to deal with these fiscal realities, like linking Social Security payment increases to the price index instead of the wage index, increasing cost-sharing in Medicare, raising new taxes (perhaps by allowing the Bush tax cuts to expire) and eliminating tax expenditures and deductions (like that for mortgage interest).
None of this will be easy. Debate over how to amend Social Security and Medicare will be heated. But better to have that debate now and on our own terms than to ignore it until the effects of a graying population and the bond markets force it upon us.