Social Security and Economic Growth (Case Study)

1. The Social Security system - also known as Old Age, Survivors and Disability Insurance (OASDI) - is not paid for by people paying taxes now to accumulate assets that people in the future spend when they get SS benefits. It's a "pay as you go" system. In the simplest case, the SS benefits received now (by the retired - or their surviving widows or children - or the disabled) = the SS tax revenues collected now (from payroll taxes).

The current system is more complicated: the SS system is currently running a surplus, so that any SS tax revenues not spent go to buy government bonds, which are held in the Social Security "Trust Fund." (It also contributes to the overall government budget surplus, which means it can go to increase government spending, to cut taxes, or to buy government bonds from the public. The last is also called "paying down" the government's debt.) This Trust Fund would be used to pay benefits in the future if and when the SS system runs a deficit (benefits exceed tax revenues). The system thus looks as follows:

The system could also be helped by using Federal "general revenues" (income tax revenues, etc.), if Congress and the President decide to do so. At this point, no general revenues are used to help the SS system: that's why the use of general revenues is drawn with a dotted line. Similarly, the use of the Trust Fund to help the system is drawn as a dotted line, because it's never happened. The Trustees of the system don't expect it to happen soon.

One proposal being considered - called "partial privatization" - is that SS revenues be used to finance individual accounts that people could put into the stock market and similar places. If this system were set up, it would look as follows:

Note that this type of system would hurt the ability of the system to pay for the SS benefits of the current and future recipients. It also moves money into more risky financial markets (that aren't protected from inflation and stock market crashes, the way the SS system is). In the next decade or so, these financial markets are not likely to pay as well as they did back during the "bubble years" of the late 1990s. Thus, many economists think that this also goes against the SS system's role of providing insurance (rather than being an investment or speculative account). It also makes the SS system more complicated and more expensive to administer, while adding new costs (brokerage fees) to take money out of retirement accounts.

2. To analyze the future of SS, assume for simplicity that the system will not be partially privatized and does not run a surplus or deficit (as in the simple case above, so that SS tax revenues = SS benefits). This means that the future of the system depends on the growth of :

  1. the number of people who have paying jobs and contribute to SS by paying taxes,
  2. the wages & salaries these workers are paid,
  3. the tax rate on these wages & salaries and the "cap" on increases in SS tax obligations, plus also
  4. what kind of benefits SS pays, including the age at which people become eligible for benefits and the rules of eligibility for the disabled and survivors.

This list suggests what can be done to make sure that the SS system doesn't run a deficit. Some of these are:

  1. instead of being paid for out of wages, SS taxes could be put on all income (including dividends and interest), or out of "general revenues."
  2. instead of taxing only the first $70,000 or so of wage income, this "cap" could be removed.
  3. the SS tax rate could be raised. This could be justified, since with people living longer will get more benefits, they ought to put more into the system while working. Many observers have noted that a relatively small tax hike (maybe 2 percent) would solve any problems that have been predicted for the SS system.
  4. benefits received by retirees (and the disabled and survivors) could be reduced - or the retirement age could be raised.
  5. wages of employed workers (and thus the tax base) could rise a lot.

But note that since SS is a "pay as you go" system, we don't have to raise taxes or cut benefits until the system starts running a deficit. The SS system's trustees predict that this will occur decades from now in the future. But will this prediction work out? Do we really need to raise taxes or cut benefits? Do we need a radical reform, such as partial or total privatization?

3. Probably not. The list of "solutions" above ignores the key issue: when there are people who are not working (the retirees), they must be supported by those who are working. This is true whether the retirees are supported by SS or by direct payments from their children or by interest or dividend payments on the wealth the retirees themselves own. So the benefits that the retirees in the future get depend on:

  1. how many retirees and other non-workers there are relative to the employed workers,
  2. how much each employed worker produces (labor productivity), and
  3. how generous the employed workers are to the non-workers.

The scare about the SS system going broke depends on (a): there will be too many old folks in the year 2025 compared to the number of retired people, because people are living longer than they used to be. The fear is that the large number of old folks then will imply that the employed workers will have to pay an outrageous percentage of their income to pay for the retirees - or be less generous.

There's a lot of doubt about the "aging of America" story. Focusing on retirees ignores the fact that adults also have to support children and that people in the US are having fewer children than they used to. That means that resources can be shifted from support of the young to help support the retired. Further, immigrants are typically younger and can support the old via SS taxes.

Further, look at (b). The growth of labor productivity is crucial to future prosperity: The potential ability to consume of both workers and non-workers = employed workers times labor productivity.

4. One way to help pay for SS is to keep unemployment low, to avoid wasting our labor and other resources. Assume that this happens, so that only supply-side growth is relevant. Thus, the actual and potential real GDP (and our ability to pay retirement and other benefits) grows with the labor force and labor productivity. For example, if the labor force grows 2 percent per year and labor productivity grows 3 percent per years, we see the following changes:


Labor force

Labor productivity

Real GDP

Year #1




Year #2




Year #3




Year #4




This means that the growth of our ability to distribute benefits to both the employed and the retired grows according to the following formula:

Growth rate = growth rate of the labor force + the growth rate of labor productivity.

The SS scare is based on the usually-unmentioned assumption that both the labor force and labor productivity will be growing very slowly in the future. The SS Trustees assume a 1.4% annual growth rate during the next 75 years. (Other government agencies have more optimistic predictions. The 2001 tax cut was justified partly by predictions more than twice as optimistic.) The Trustees' assumption implies that the economy will be growing much more slowly than during the last 75 years (3.3 percent). In other words, it assumes that the economy is going to be in disastrous straits for the next 75 years. This doesn't simply hurt the SS system. If the economy is growing at only 1.4 percent per year, the stock market will do very poorly, too. With slow growth of the economy, businesses can't reap high profit rates, while in the long run, stock prices reflect profitability. All of our incomes will be growing slowly, creating all sorts of problems.

You can see how growth rates work using the following table:


Growth rate = 1.4%

Growth rate = 2%

Growth rate = 2.5%

1999 real GDP




2000 real GDP




2001 real GDP








2025 real GDP




The SS Trustees assume the first column applies, where our ability to support both the employed and the retired (and other non-workers) will be quite low compared to a more reasonable growth rate given historical experience in the US. Also, we can raise the rate of growth of productivity using government policies that involve or encourage investment in factories, machines, technology, infrastructure, public health, and education.

Thanks to Doug Henwood's Left Business Observer for the above diagram. Thanks also to Max Sawicky for his comments.

For more on this topic, see LBO and an article by Richard duBoff, Professor of Economics, Bryn Mawr College. Also, see Social Security: The Phony Crisis, by Dean Baker and Mark Weisbrot (1999: University of Chicago Press) and Social Security: More, Not Less by Robert Eisner (1998: Century Foundation Press).