by Mark Schaub
While the debates rage over how to save Social Security, some wonder why no one has called attention to the program's real history. We understand the program is set up for one generation's retirement supplement to be paid by another generation of workers. And we understand the ratio of beneficiaries to workers is about to get way out of whack as the baby boomers start retiring. But what of the program's financial history before this large potential problem got everyone up in arms?
The problems most discuss are
1. People live longer now compared to when the program was first
put in place
2. The baby boomer generation is 78 million strong and soon will
begin drawing benefits
3. The size of the workforce will stay roughly the same while the
retiree population grows by leaps and bounds
4. Inflation will cause benefits to increase at an increasing
rate
How will we handle these potential problems? The same way, I fear, as they have been in the past.
When Social Security began paying benefits, the funding potion of the equation required 2 percent of the first $3,000 of a worker's salary. Over the years, the program expanded and changed until we have the mammoth it is today. The 2 percent of $3,000 funding requirement remained unchanged until 1950, when the tax rate increased to 3 percent.
Since Social Security's inception, the FICA rate has changed 24 times; today it is 12.4 percent. In 1966, the Medicare hospital insurance tax was added as a separate item. It began at .35 percent of a worker's salary and is now at 2.9 percent. So the program that once cost 2 percent of a worker's salary now costs 15.3 percent. Although the worker and employer share these contributions, the employer's share represents additional earnings the worker could be receiving as income.
The tax rates were not the only part of the funding equation that grew. Up to 1950, the FICA tax was only applied to the first $3,000 of income. It was increased periodically via legislation until the 1970s when the automatic cost-of-living adjustment (COLA) was implemented for benefits and for the funding base. As of 2005, FICA taxes are applied to the first $90,000 of income, while the Medicare tax has no funding base ceiling (that is, it is applied to all earnings, no matter how great).
Before boomers' retirement and before the looming funding crisis, a worker's payment into the system has gone from $60 in 1949 (2 percent of $3,000) to $13,770 or more in 2005 (15.3 percent of $90,000). In other words, a middle-income worker's share of funding the program has increased by a compounded rate of 10.2 percent a year since 1949. The stock market has barely kept pace with the increases in the true Social Security contribution rate.
Now, despite the overlooked incredible rate of increase in worker's Social Security contributions, people are worried about the strain that will be put on the program when the retiree population triples over the next 25 years. The costs of converting the program to a "funded" program (that is, personal saving accounts) will be astronomical. Some experts say just a 1 percent increase in the Social Security tax would save the program. Looking at the past increases, this sounds ludicrous. Other experts say we should just increase the contribution base. What a shock—like that's never been done before. If the history of funding increases in this over-grown, vote-buying program gives us "scenes from coming attractions" about Social Security, all I can say is those in their twenties, thirties, and forties had better prepare to pay ten times more into Social Security than they'll ever get out of it when it comes their turn to retire.
Mark Schaub is the Hibernia National Bank Endowed Associate
Professor of Finance at Northwestern State University in Louisiana.
He has published in several journals on topics including consumer
finance and investing. His doctorate in finance was earned from
Mississippi State University in 1998.
