THE Social Security Act in 1935 established
a dual program of protection against old-age dependency--old-age
benefits, a contributory social insurance system covering primarily
industrial and commercial workers; and old-age assistance, a program
administered by the States (but partly financed by the Federal Government)
to give financial assistance to aged persons who were in need. Under
both programs, the "aged" were defined as persons aged
65 and over.
In theory, a broad national social insurance
program should, at least eventually, meet virtually the entire problem
of old-age dependency. A public assistance program should be designed
primarily to help those already aged when the dual program began,
although there may always be some need of assistance for persons
with special needs. The social insurance program would have to be
applicable to all types of employment rather than merely to industrial
and commercial workers. It was believed, when the Social Security
Act was adopted, that extension of coverage would be largely an
administrative problem that could be solved by subsequent legislation
after the system was established and operational experience had
developed. Accordingly, at some future date the social insurance
program would completely, or almost completely, eliminate the need
for old-age assistance.{1}
{1} See Robert J. Myers, "Long-Range
Trends in Old-Age Assistance," Social Security Bulletin,
February 1953.
In 1939 the social insurance system was broadened
to include survivor benefits, and its official name became "old-age
and survivors insurance." At the same time the name of the
fund was changed from "old-age reserve account" to "old-age
and survivors insurance trust fund." In 1950 the law was amended
to cover more workers--chiefly self-employed workers (other than
farmers and professional workers) and certain domestic servants,
certain farm laborers, employees of nonprofit institutions (on an
elective basis), and some Government employees. The amendments also
raised the benefit level about 80 percent to take into account changes
in wage levels and cost of living during the previous decade. In
1952 the program was further amended; the major change was an increase
of 10-15 percent in benefit amounts, again to take into account
the increases in wage levels above those prevailing when the 1950
amendments were being enacted.
This article deals with the financing aspects
of the old-age and survivors insurance program. The actual financial
bases of the system are set forth {2}, as well as the most important
proposals made for financing the program. Methods of financing and
investment procedures are treated separately.
{2} For data showing the actual operations
of the trust fund in each of the calendar years 1940-52,
see the Bulletin, March 1953, p. 28.
Why a Fund Develops
Any discussion of the actual operations and
the financial basis of the old-age and survivors insurance program
should be prefaced by a summary of the reasons for and methods by
which a fund {3} develops under any pension
plan or under any type of insurance system.
{3} Sometimes the word "reserve"
is used to designate the developing fund under a pension plan. From
a strictly accurate, technical standpoint, "reserve" should
be used only to denote an actuarially calculated amount based on
actual and estimated benefit and contribution obligations.
Under almost any pension system, the cost
of the benefits will rise for many years after the program is inaugurated.
There are many factors that produce this result, but not all the
factors are present in every instance. Among such factors are (a)
the increasing proportion of the aged in the population (almost
invariably present as a result of continual improvement in mortality
at all ages in the past); (b) the greater proportion of younger
persons than of older persons covered when the system is established
(partly because of the omission of all or some of the current aged,
who had already retired); and (c) the basing of benefits to a greater
or lesser degree on the length of time that contributions are made
(so that benefits in the early years of operation are smaller than
those that will be paid ultimately).
If the rising benefit cost is to be met by
a level contribution rate, contribution receipts in the early years
of operation will exceed benefit disbursements, and thus a fund
will be built up; after the early years (or perhaps decades) of
operation the reverse situation will occur. If the system Is in
"actuarial balance," with the level contribution rate
properly and precisely determined, interest on the fund developed
in the early years will meet the excess of benefit disbursements
over contribution income in the later years.
As an alternative to financing a pension
plan with a level contribution rate, a schedule providing for a
lower rate in the early years and a series of increases thereafter
can be used. The ultimate rate under such a schedule will, of course,
have to be higher than the level rate mentioned previously. The
size of the fund that develops would depend on the gradation of
the contribution schedule. If there were very little gradation (that
is, if the initial rates were only slightly below the level rate,
and the ultimate rate was attained in a short period and was accordingly
very little above the level rate), then the developing fund would
be almost as large as under the level-rate basis. At the other extreme,
if the contribution schedule started out very low and rose very
slowly but ultimately, of course, to a fairly high level, virtually
no fund might be developed, and yet the system would be in actuarial
balance.
In fact, this situation--in which the contributions
are determined, to all intents and purposes, so that they equal
the estimated benefit payments in each future year--is actually
one form of "Pay-as-you-go" financing. The term also applies
to a situation that involves no definite benefit commitments but
instead the paying of whatever benefits would be possible with the
prescribed contribution income, or conversely raising whatever money
would be necessary to meet benefit obligations determined in advance.
There are, of course, an infinite number
of variations possible in the contribution schedule that, under
the assumptions made, would result in a self-supporting system.
As still another alternative, plans can be
financed by having higher contribution rates in the early years
and lower ones thereafter. This procedure, naturally, produces a
larger fund than financing through the use of level rates and is
fairly common in financing private pension plans. The accrued liability
for service performed before the inception of the plan and the additional
cost arising from the fact that the initial group is older than
future new entrants can both be financed by amortizing them over
a period of years.{4} After this time, the contribution rate would
be relatively low--at the level necessary for new entrants coming
in at the younger ages. Furthermore, at such time the system would
be fully funded and meet the most rigid definition of actuarial
soundness (to be discussed in some detail later). Thus the assets
on hand would be sufficient to meet all the benefit obligations
that have accrued, even if the system were to be abandoned both
as to collection of contributions in the future and crediting of
future service.
{4} In theory, these liabilities could be
paid off in one initial lump sum, but in practice this procedure
is not followed, if for no other reason than tax considerations.
It may be noted further that if, by reason
of the provisions of the plan established, the cost of the benefits
does not rise sharply in the future, the resulting fund, even with
a level contribution rate, will be much smaller than under a plan
that has a sharply rising benefit cost. In fact, if a plan is developed
in which the benefit cost (related to payroll) would be the same
for every future year, then obviously the corresponding level contribution
rate would just meet the benefit disbursements each year, and no
fund would develop.
One disadvantage of having an increasing
contribution rate is that those who retire in the early years of
operation do not pay as high a rate for the benefits they receive
as do those who retire in subsequent years. Even with a level contribution
rate, those who retire in the early years usually receive far more
in benefits than their contributions would have purchased on an
actuarial basis, since through one method or another they receive
credit for service performed before the inception of the plan, and
accordingly only a small portion of their benefit is "purchased"
by their contributions. This procedure is customary under both private
pension plans and social insurance. Otherwise, if benefits paid
are related to contributions made, inadequate benefits would be
provided for the first few decades of the operation of the system,
and accordingly the program would not really be serving the purpose
for which it was established.
Another problem arising with an increasing
contribution rate is that ultimately rates may be higher than individual
equity would suggest--that is, the young entrant would be able to
purchase more protection with his own employee contributions from
a private insurance company than is furnished under the social insurance
system. If this situation were to arise, one possible solution would
be to lower the ultimate contribution rates arid make up the difference
by a Government subsidy to the system in the later years of operation.
On this basis, there could be a graded contribution rate starting
at a low level and not rising beyond the "individual equity"
level; at the same time a relatively small fund would be built up.
This solution would involve the concept of an ultimate Government
contribution or subsidy.
Concept of Actuarial Soundness
In discussions of any type of long-range
benefit program, the phrases "actuarial soundness" or
"actuarially sound" occur from time to time. Essentially,
these terms relate to the ability of the given plan to provide the
benefits established. Many different definitions may be given in
the absence of any strict legal requirements applicable (as, for
instance, in the case of reserve requirements for life insurance
and annuity reserves of private insurance companies). When non-insured
pension plans are being considered, there tends to be a somewhat
broader range of definitions. For Government social insurance plans
the range is even broader.
At perhaps one extreme might be a definition
that a plan is actuarially sound if the fund on hand is large enough
to pay all future benefits for those currently on the roll--in other
words, without any allowance for the accrued benefit rights of those
not yet retired. At the other extreme might be a plan under which
the existing fund was sufficient to pay for all benefit rights accrued
to date. This basis would be somewhat difficult to attain for a
newly organized plan that assumed considerable liabilities on account
of past service. Accordingly, some actuaries define an actuarially
sound plan as one "where the employer is well informed as to
the future cost potential and arranges for meeting those costs through
a trust or insured fund on a scientific, orderly
program of funding under which, should the plan terminate at any
time, the then pensioners would be secure in their pensions and
the then active employees would find an equity in the fund assets
reasonably commensurate with their accrued pensions for service
from the plan's inception up to the date of termination of plan."
{5} This definition permits a long period before all the past service
credits are fully funded.
5 Dorrance C. Bronson, "Pension Plans--The
Concept of Actuarial Soundness," Proceedings of Panel Meeting,
"What is Actuarial Soundness in a Pension Plan," sponsored
jointly by the American Statistical Association, American Economic
Association, American Association of University Teachers of Insurance,
and Industrial Relations Research Association, Chicago, Dec. 29,
1952.
Other actuaries have a somewhat less stringent
definition of an actuarially sound system: "one which sets
forth a plan of benefits and the contributions to provide these
benefits, so related that the amount of the present and contingent
liabilities of the plan as actuarially computed as of any date will
at least be balanced by the amount of the present and contingent
assets of the plan actuarially computed as of the same date."
{6}
{6} George B. Buck, "Actuarial Soundness
in Trusteed and Governmental Retirement Plans," ibid.
How do these concepts of actuarial soundness
apply to the old-age and survivors insurance system? According to
the first definition, this program is not actuarially sound; according
to the second definition, it is. Acceptance of the basis of the
first definition, however, does not mean that the converse is true--that
the old-age and survivors insurance system is actuarially unsound
and therefore by implication is bankrupt and should be liquidated.
Rather, the author of the first definition stated that he did not
"see any point in rigorously applying actuarial reserve techniques
to a broad national system. Such a system transcends 'actuarial
soundness' criteria of the usual kind. What purpose would be served
if reserve assets in the actuarial amount of $150 billion were now
on hand? They would not be used; the system is not going to terminate,
calling on a liquidation of the reserve for benefits."
Finally, the question may be examined as
to whether a long-range social insurance system with "pay-as
you-go" financing (defined to mean that annual receipts and
annual disbursements are approximately in balance) could ever be
considered actuarially sound. It could not, of course, under the
first definition of actuarial soundness. Under the second definition,
however, it would be possible that such a program could be actuarially
sound if the contribution schedule, rising in the future, would
be determined so as to closely approximate the estimated future
benefit disbursements year by year.
Regardless of whether the concept of actuarial
soundness in its usual meaning can be applied to the old-age and
survivors insurance system, there must be thorough actuarial analysis
and cost estimates for the program--essential factors in considering
and determining the long-range benefit structure of the program.
Investment Procedures
Throughout the entire period of operation
of the old-age and survivors insurance program, the method of investing
the trust fund has changed relatively little. In general, it may
be said that the trust fund, which is under the direction of the
Secretary of the Treasury, receives the contribution income and
pays out the benefits and administrative expenses. The excess of
the income over the outgo is invested in Federal Government bonds,
and the interest therefrom further augments the income of the fund.
The investments can be either in special
issues or in any other securities of the Federal Government, bought
either on the open market or at issue. In the past some regular
issues have been bought, both on the open market and when they were
offered to the general public. Most of the investments, however,
have been in special issues. Before 1940, it was provided that these
special issues should bear an interest rate of 3 percent, but subsequently
they have carried an interest rate slightly below the average rate
on all interest-bearing obligations of the United States. At one
time in the past the rate on special issues was as low as 1-7/8
percent, but for issues after June 1951, it was 2-1/4 percent, and
for issues after February 1953, 2-3/8 percent.
Although there has been considerable opposition
to investing the excess income of the system in Government bonds,
no positive support has been offered for any other form of investment.
All other possibilities have seemed to be objectionable for overwhelming
reasons.
One possible investment practice would be
to purchase securities of private concerns, either bonds or equity
shares. There are several objections to this approach. First, with
the large amount of money available, the Government would control
a considerable portion of the private industrial economy, which
would, in effect, result in "socialism by the backdoor method."
Another practical disadvantage would be the need for a far-reaching
and deep-searching investment policy that would permit the fund
to obtain an adequate rate of interest with reasonable security.
Under such a policy the Government would in effect be setting itself
up as a rating organization, since the investment procedures would
naturally have to be open to full public view. If no preference
were shown for different types of securities, but rather investments
were made widely and indiscriminately, there would be a serious
danger of loss of capital and diminution of investment income.
Another possible procedure would be to invest
the funds in social and economic activities such as the construction
of housing, dams, hospitals, and the like. This method would be
open to some objection on the grounds mentioned previously--Government
entry into private fields of activity. Even more serious is the
argument that any use of public funds for such purposes should be
under the control of the elected representatives of the people (Congress)
rather than indirectly by having a social insurance organization
making decisions as to what is best for the country. Investment
of the funds in either public or private securities of foreign countries
would, of course, be impractical and undesirable.
Criticism of
the Trust Fund's Validity
The trust fund, which has developed from
the excess of income over outgo, has been subject to criticism on
two entirely different bases; first, as to the actuarial and economic
desirability and necessity of having such a fund, and second, as
to whether such a fund possesses any validity and significance.
Throughout the entire period of the program's operation, there has
been active discussion on these matters.
It has been argued that the resulting fund
is not valid because the money invested in Government bonds has
been spent for other than social security purposes. According to
this view, these bonds are mere "scraps of paper" and
are worthless, and there will be "double taxation for social
security--first, the old-age and survivors insurance contribution,
and second, the tax to redeem the bonds later (or to pay interest
on them). This argument has perhaps been the one most frequently
used against the trust fund (and its investments), since it appears
so simple. Those who disagree with the argument do not thereby necessarily
express themselves as being in favor of large reserves.
The bonds held by the trust fund are just
as valid as United States Government bonds held by insurance companies,
banks, and other private investors. There is no basis for the "double
taxation for social security" argument, since the taxes for
the redemption of the bonds in the trust fund (or for paying interest
on them) would have to be collected no matter who held the bonds.
Furthermore, it is quite likely that there will never be any necessity
for calling for redemption a large portion of the fund.
The validity of the trust fund would be open
to serious question in one situation--if there were no public debt
and the fund were given interest-bearing obligations while the moneys
were held idle in the general treasury. Under present circumstances
this situation is not likely to occur, at least in the near future.
An able and clear discussion of the fallacies
in the argument that the trust fund is not valid was given by M.
A. Linton, Chairman of the Board of the Provident Mutual Life Insurance
Company and a member of the 1937 and 1947 Advisory
Councils on Social Security, in a paper given before the Thirteenth
International Congress of Actuaries, in June 1951, when he stated:
"Consider first the situation when the
Government is compelled to borrow as in time of war. It is then
clear that the borrowing of excess Social Security income is as
desirable as borrowing from any other source; and more desirable
than borrowing from the commercial banks which involves a corresponding
inflationary increase in bank deposits. The bonds in the hands of
the trustees of the Trust Fund are on a par with the Government
bonds bought, for example, by the life insurance companies. No one
has as yet seriously contended that their bonds are not valid because
the money has been spent by the Government.
In times when the Government does not have
to borrow, then the proper use of the borrowed Social Security funds
is to reduce publicly held Government debt. This in effect transfers
such publicly held debt to the Trust Fund. This occurred during
years following the war when the Federal budget was in balance.
The bonds in the Trust Fund thus acquired are as valid as any other
Government bonds and cannot be said to have come into being in a
way to damage the economy.
Perhaps the clearest way to show the error
in the [double taxation] charge is to consider a concrete example.
Suppose the Trust Fund consists of $10,000 million of Government
bonds bearing an average interest rate of 2%. The annual interest
charge is therefore $200 million. To provide this interest, $200
million of taxes must be levied on general taxpayers. Had the $10,000
million of bonds been in the hands of the public, the $200 million
would have been paid to public holders. But since the bonds are
in the trust fund the $200 million are paid to the Fund thereby
relieving the Social Security system of levying $200 million of
payroll or other taxes.
Therefore the dollars of taxes raised to
pay the interest on the bonds in the Trust Fund are 'double duty'
dollars, serving two purposes. First, they pay interest that would
have to be paid in any event, whoever held the bonds, and second,
they relieve Social Security or other taxpayers of an equal burden.
A similar statement can be made about taxes raised to meet principal
payments on the Trust Fund bonds. Thus it becomes clear that the
double taxation argument is not valid."
Need for Trust
Fund
Under any social insurance system, it would
seem that for practical administrative and legislative purposes
there should be at least a small contingency reserve. Although opinions
vary somewhat, it is rather generally believed that such a
contingency fund should be equal to the benefit payments for at
least 1 year. A fund of this type is obviously necessary for administrative
reasons--to have a working balance on hand and to meet any fluctuations
in contribution income due to cyclical changes in the economic situation.
There is, however, considerable difference
of opinion as to whether a large trust fund should be established
for a social security program. Any arguments in favor of a large
fund must necessarily be predicated on the assumption that economic
conditions will be relatively stable. Obviously, from the standpoint
of the social insurance system, there would be no point in building
up large reserves if they were subsequently to decline in value
as a result of inflation. Even under the premise of stable economic
conditions, however, there is still considerable difference of opinion.
Two major arguments have been advanced in
favor of a large fund. First, such a fund is said to be necessary
in order to have "honest accounting," so that both the
assets and the liabilities of the system will be fully recognized,
and therefore any changes proposed that would be too extravagant
can be avoided. Second, this financing method serves to distribute
the cost of the program more equitably between present and future
generations, since it involves the levying of a higher contribution
rate in the early years than is needed for the current benefit disbursements.
Interest on such a fund will help to meet the heavy load of benefit
payments in the future when the system becomes mature. Accordingly,
at that time, a lower contribution rate can be levied than would
otherwise be possible if no fund were built up.
There are several major arguments against
the accumulation of reserves. First, the existence of a large fund
might be widely misunderstood by the general public, who might feel
that the fund represents a "surplus" that can be used
to pay benefits on a scale that eventually would prove too costly.
In actuality, a large fund, whether in a social insurance system
or in a private insurance organization, does not necessarily mean
that there is a surplus, or excess of assets over actuarial and
other liabilities. Second, the existence of a large fund with considerable
excess of income over outgo might encourage unwise Government spending
because of the ready availability of the money. Third, the withdrawal
of money from the national economy through payroll taxation, and
its investment in government bonds, might have deflationary effects,
which at some stages of the business cycle might be desirable but
at other times could prove rather serious in bringing on, or prolonging,
a depression. Fourth, a large accumulation of funds means that the
current generation, in effect, contributes a substantial share of
the cost of benefits for those who retire in the early years. Such
contributions, made in the form of payroll taxes, might be more
regressive than general revenues.
In any event, whether a large fund or only
a contingency fund is favored, the financing basis to be adopted
is secondary; primary consideration must be given to the benefit
and coverage structure. Certainly, the financing method should not
serve as a "straitjacket" on the benefit and coverage
provisions. Much of the fund "problem" can be mitigated
if benefit and coverage provisions are adopted that bring the program
as near maturity as possible--if, in other words, from its inception
(or later modification) the system pays benefits to as large a group
as would have been on the rolls if the system had been in effect
for many years.
Actuarial Basis
of the 1935 Act
In 1935 the Committee on Economic Security,
appointed by the President in 1934, had recommended what was, in
effect, a contingency fund (amounting ultimately to about $15 billion).
This fund would be developed under a graded tax schedule, providing
for a rise from a combined rate of 1 percent of payroll for the
first 5 years to an ultimate rate of 5 percent after 20 years (the
contribution to be shared equally by employers and employees). Eventually
a Federal subsidy would be introduced when the outgo from the fund
would otherwise have exceeded income. It was estimated that the
Federal contribution would ultimately be about two-thirds as large
as the total tax collections from employers and employees.
The legislation enacted, however, did not
provide for any Federal contribution. The cost estimates indicated
that the system would be self-supporting from the contributions
of employers and employees--partly because the benefit structure
differed from that in the original recommendations and partly because
of the use of a more steeply graded tax schedule. Under the schedule
adopted, the combined rate of 2 percent in effect for the first
3 years of operation was to rise to an ultimate rate of 6 percent
within 12 years. The system would be self-supporting, according
to the estimates, since for the first 30 years the contribution
income would exceed benefit outgo and a substantial fund would be
built up (amounting eventually to $47 billion); in the later years,
when benefit payments would exceed contribution income, the difference
would be made up from interest on the fund.
Actuarial Basis
of the 1939 Act
In 1937 an advisory council was established
by Congress and the Social Security Board to study the old-age benefit
system. To finance the program the council recommended the development
of only a small contingency fund with eventual Government contributions.
It also recommended that more in benefits be paid out in the early
years than under the existing program and less later; if the contribution
rates were unaltered, the result would be smaller fund accumulations
and requirements.
The legislation enacted in 1939 changed the
basis of financing to what was believed by some to be a pay-as-you-go
basis or, more properly, a "contingency-fund" basis. The
shift to this approach was not specifically stated in the law, however,
and it is not clear that actual experience has followed this pattern.
The law provided that there should be a report whenever the trust
fund was estimated to exceed three times the highest annual expenditures
expected during the next 5 years, or conversely whenever the fund
was unduly small. This "three times" rule gave support
to the view that the system was on a contingency-fund basis.
The "three times" ratio was exceeded
almost from the very beginning. Perhaps for this reason, among others,
legislation was enacted at various times during the 1940's, "freezing"
the contributions at a combined rate of 2 percent until 1950, when
they were allowed to rise to 3 percent.
The 1939 amendments made no specific provision
for any Federal contribution to the trust fund, despite the fact
that a contingency-fund approach had apparently been adopted. The
1943 legislation "freezing" the 2-percent tax rate did
include, however, a provision authorizing appropriations to the
trust fund from general revenues in the amounts necessary to finance
the benefit payments. No appropriations have been made or requested
under this provision, probably because the trust fund grew rapidly
and none seemed to be required.
The original actuarial cost estimates for
the 1939 act indicated that the system would not be self -supporting
and that eventually a Federal contribution would be necessary. With
the rapid increase in wages during World War II,
the cost of the system in relation to payroll decreased.{7} As a
result, cost estimates made after the war indicated that, according
to the tax schedule in the law, the system was then probably on
a self-supporting basis. Presumably the tax schedule might be modified
in the future by Congress if the trust fund should become so large
that it would be in conflict with what was apparently the financing
philosophy of the 1939 legislation.
{7} Because of the "weighted" benefit
formula, beneficiaries with higher wages receive relatively lower
benefits in relation to their wage. Accordingly, as wages rise,
the average benefit as a proportion of the average wage becomes
lower, and therefore the cost of the program relative to payroll
decreases.
Actuarial Basis
of the 1950 Act
Another Advisory Council on Social Security
was established by Congress in 1947 to consider necessary
changes in the program. Although primary consideration was given
to benefit and coverage changes, the financing problem was also
given serious study. It was recommended that the combined tax rate
should be increased immediately to 3 percent and that a further
increase to 4 percent should be made only when the fund began to
show an excess of outgo over income. Eventually, when outgo again
would exceed income, a Federal contribution, sufficient in amount
to maintain the fund at its size at that time, would be introduced.
The Federal contribution was never, however, to be more than half
as large as the total contributions from employers, employees, and
the self-employed or, in other words, never more than roughly one-third
of the disbursements. Accordingly, when this situation would otherwise
occur, the contribution rate for employers, employees, and the self-employed
should be raised.
In the legislation enacted in 1950, this
recommendation of the Advisory Council was not followed; instead
Congress expressed its intention that the system should be completely
self-supporting, without Federal subsidy. In accordance with this
view, the provision for a potential Government contribution, which
had been incorporated in the 1943 law, was eliminated.
A new graded tax schedule was adopted; from a combined employer-employee
rate of 3 percent in 1950-53, the rate was to
rise to 6-1/2 percent by 1970. {8}
{8} Self-employed persons pay three-fourths
of these rates on their covered earnings. For years before 1951
the tax rates applied to the first $3,000 of annual covered earnings,
while for years following 1950, this amount was raised to $3,600.
This tax schedule would, as closely as could
be estimated at the time, place the system on a self-supporting
basis, with the ultimate size of the trust fund about $100 billion,
according to the intermediate-cost estimate.{9} When benefit outgo
exceeds contribution income, the difference is to be made up by
interest on the fund. Accordingly, it may be seen that the financing
basis of the program had essentially completed a full circle and
was back at the same point as when the 1935 act was passed.
On the basis of past experience, however, it should be realized
that Congress may at any time change the financing basis.
{9} See "Actuarial Cost Estimates for
the Old-Age and Survivors Insurance System as Modified by the Social
Security Act Amendments of 1950," prepared for the use of the
Committee on Ways and Means by Robert J. Myers, Actuary to the Committee,
July 27,1950.
Actuarial Basis of the 1952 Act
The tax schedule in the 1950 act was left
unchanged by the 1952 amendments, despite the liberalizations
in benefits. No change was necessary because, according to the cost
estimates, the estimated cost {10} in relation to payroll was not
materially changed.
{10} See "Actuarial Cost Estimates for
the Old-Age and Survivors Insurance System as Modified by the Social
Security Act Amendments of 1952," prepared for the use of the
Committee on Ways and Means by Robert J. Myers, Actuary to the Committee,
July 21, 1952.
The cost estimates for the 1952 act
prepared at the time of its consideration by Congress used the same
methodology and assumptions employed in making those for the 1950
act with two exceptions. An interest rate of 2-1/4 percent
instead of 2 percent was used (since interest rates had risen significantly),
and the assumptions as to average earnings were about 20 percent
higher (corresponding to the 1951 experience, while the
previous estimates had been based on 1947 experience).
Both of these changes, but especially the latter, result in relatively
lower costs (as a proportion of covered payroll). The weighted nature
of the benefit formula is such that, as earnings rise, the benefits
represent a relatively lower proportion of credited earnings. The
reductions in cost were thus utilized to meet the increased cost
of the benefit liberalizations.
Accordingly, the financing basis currently
in effect is the same as it was under the 1950 act--that
is, the system is intended to be completely self-supporting from
worker and employer contributions. The ultimate result will be a
large interest-earning fund, amounting to slightly more than $100
billion according to the intermediate-cost estimate. (The trust
fund was $17.4 billion as of the end of 1952.) For
1953, estimated income will be about $4.3 billion ($3.9
billion in contributions and $0.4 billion in interest), and outgo
will amount to $3.1 billion ($3.0 billion in benefits and $0.1 billion
in administrative expenses), leaving a net income of $1.2 billion.
For 1954, contribution income will be considerably increased
(to about $5.1 billion) because the conibined employer-employee
rate is scheduled to rise from the present 3 percent to 4 percent;
benefit disbursements will rise somewhat (to about $3.4 billion).
As a result, the net income to the fund in 1954 will be roughly
$2.1 billion.{10a}
{10a} On May 20, 1953, President Eisenhower
recommended to Congress that the increase in the contribution rate
from 1.5 percent to 2 percent, scheduled to go into effect in 1954,
should be postponed for 1 year. If this deferment were made, the
net income to the fund for 1954 would be about $900 million.
Relationship With Railroad Retirement
System
An important element affecting the financing
of the old-age and survivors insurance system arose through amendments
made to the Railroad Retirement Act in 1951.{11} The law provides
for a coordination of railroad compensation and covered earnings
under old-age and survivors insurance in determining not only survivor
benefits but also retirement benefits for persons with less than
10 years of railroad service. All future survivor and retirement
benefits involving less than 10 years of railroad service are to
be paid by the old-age and survivors insurance system.
{11} See Robert J. Myers and Wilbur J. Cohen,
"Railroad Retirement Act Amendments of 1951: Benefit Provisions
and Legislative History," Social Security Bulletin,
February 1952; and Robert J. Myers, "Railroad Retirement Act
Amendments Of 1951: Financial and Actuarial Aspects," Social
Security Bulletin, March 1952.
The financial interchange provisions are
designed to place the old-age and survivors insurance trust fund
in the same financial position it would have held if there never
had been a separate railroad retirement program. It is estimated
by the Social security Administration that the net effect of these
provisions will be a relatively small net gain to the old-age and
survivors insurance system, since the reimbursements from the railroad
retirement system will be somewhat larger than the net additional
benefits paid on the basis of railroad earnings.
The long-range cost estimates currently developed
(tables 1 and 2) are for the operation of the trust fund on the
basis, as provided in current law, that all railroad employment
will be (and always has been) covered employment. The basis of the
figures showing the balance in the fund thus corresponds exactly
to the procedure that will actually be followed in the future. The
contribution income and benefit disbursements shown in the tables
are slightly (less than 5 percent) higher than the amounts that
will actually be paid directly into the trust fund by contributors
and the payments that will actually be made from the trust fund
to the individual beneficiaries. This difference occurs because
the figures here include both the additional contributions that
would have been collected if railroad employment had always been
covered and the additional benefits that would have been paid under
such circumstances. The balance for these two items is to be accounted
for in actual practice by the operation of the financial interchange
provisions.
Future Operation of Trust Fund
Cost estimates on an intermediate basis were
prepared as a base for the financing provisions of the 1950 and
1952 acts, because a single set of figures is necessary in developing
a tax schedule to make the program self-supporting, according to
a reasonable estimate. These intermediate-cost estimates, however,
were not intended to represent the "most probable" estimates,
since it was believed impossible to develop any such figures. They
were, rather, a simple average of the low-cost and high-cost estimates,
both based on high-employment assumptions representing close to
full employment.
Table 1.-Estimated
progress of the old-age and survivors insurance trust fund
in selected years, 1960-2000, under high-employment assumptions
{1}
[In
millions]
|
Calendar year
|
Contributions
{2}
|
Benefit payments
|
Administrative
expenses
|
Interest {3}
|
Balance at end
of year
|
|
Actual Data {4}
|
1950
1951
1952 |
$2,671
3,367
3,819
|
$961
1,885
2,194
|
$61
81
88
|
$257
{5} 417
365
|
$13,721
15,540
17,442
|
|
Low-cost estimate
|
1960
1970
1980
1990
2000 |
$6,646
9,985
11,176
12,224
13,591
|
$5,267
7,723
10,321
12,584
13,455
|
$101
125
151
175
191
|
$657
1,186
1,868
2,345
2,830
|
$30,482
54,982
85,263
106,282
128,585
|
|
High-cost estimate
|
1960
1970
1980
1990
2000 |
$6,578
9,878
10,874
11,435
12,191
|
$6,166
8,913
11,9?9
14,725
16,169
|
$134
170
208
246
268
|
$540
741
915
557
{6}
|
$24,673
34,084
40,941
23,547
{6}
|
|
Intermediate-cost estimate
{7}
|
1960
1970
1980
1990
2000 |
$6,612
9,932
11,025
11,830
12,891
|
$5,716
8,318
11,116
13,656
14,812
|
$118
148
180
210
230
|
$598
964
1,392
1,451
1,265
|
$27,578
44,533
63,102
64,914
56,412
|
{1} The provisions for financial interchange
with the railroad retirement system affect the data; for an
explanation see discussion.
{2} Employer, employee, and self-employed.
The combined employer-employee rate is 3 percent for 1950-53,
4 percent for 195-59, 5 percent for 1960-64, 6 percent for
1965-69, and 6 percent for 1970 and after. The self-employed
pay three-fourths of these rates.
{3} Figured at 2.25 percent on average
balance in fund during year.
{4} Based on Daily Statement of the
Treasury. For 1950, benefit payments were made under 1939
act for first 9 months and under 1950 act for last
3 months; for 1952, payments were made under 1950 law for
first 9 months and under 1952 law for last 3 months. Contribution
income for 1950 collected on coverage and maximum wage base
in 1947 law; for later years, on provisions in 1950 law.
{5} Figure inflated because it includes
a large part of the interest that accrued in the second half
of 1950 and almost all the 1951 interest.
{6} Fund exhausted in 1997.
{7} Based on average dollar costs under
the low-cost and high-cost estimates.
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Since the present contribution schedule was
established to make old-age and survivors insurance approximately
self-supporting, on an intermediate-cost estimate, it could be anticipated
that the low-cost estimate should show that the system would be
more than self-supporting and that a high-cost estimate would show
an eventual deficit. The low-cost estimate made at the time the
1952 legislation was enacted showed a trust fund building up rapidly
and becoming very large--almost $225 billion in the year 2000, when
it would be growing at a rate of $5.5 billion a year. Under the
high-cost estimate, the trust fund would grow more slowly, reaching
a maximum of roughly $60 billion in about 30 years and then decreasing
until it is exhausted in another 20 years. In actual practice, if
the financing basis established in 1950 were followed--that the
program should be self-supporting from contributions of employers
and workers--the tax schedule or the benefit provisions undoubtedly
would be appropriately adjusted at some future date so that neither
development would ever eventuate.
Naturally, long-range cost estimates cannot
be expected to be precise and unchangeable. As experience develops,
these estimates require modification from time to time. Since the
congressional action on the 1952 amendments, new cost estimates
have been developed to take into account further actuarial and statistical
data available from program operations and from the 1950 Census.{12}
Estimates have been made on the assumption of low-employment and
high-employment conditions as well as on the basis of low-cost and
high-cost factors (tables 1 and 2).
Table 2. -Estimated
progress of the old-age and survivors insurance trust fund
in selected years, 1960-2000, under low-employment assumptions
{1}
[In
millions]
|
Calendar year
|
Contributions
{2}
|
Benefit payments
|
Administrative
expenses
|
Interest {3}
|
Balance at end
of year
|
|
Actual Data {4}
|
1950
1951
1952 |
$2,671
3,367
3,819
|
$961
1,885
2,194
|
$61
81
88
|
$257
{5} 417
365 |
$13,721
15,540
17,442
|
|
Low-cost estimate
|
1960
1970
1980
1990
2000 |
$5,627
8,397
9,361
10,164
11,238
|
$5,241
7,452
9,686
11,517
12,369
|
$98
116
139
160
172
|
$517
727
979
968
839
|
$23,651
33,432
44,260
43,228
37,468
|
|
High-cost estimate
|
1960
1970
1980
1990
2000 |
$5,563
8,324
9,138
9,519
10,082
|
$5,835
8,310
10,903
13,373
14,811
|
$125
158
193
227
246
|
$431
416
298
{6}
{6}
|
$10,397
18,847
12,557
{6}
{6}
|
|
Intermediate-cost estimate
{7}
|
1960
1970
1980
1990
2000 |
$5 595
8,361
9,250
9,842
10,660
|
$5,537
7,881
10,294
12,443
13,583
|
$112
137
166
194
209
|
$474
572
638
298
{8}
|
$21,524
26,140
28,408
12,124
{8}
|
{1} The provisions for financial interchange
with the railroad retirement system affect the data; for an
explanation see discussion.
{2} Employer, employee, and self-employed.
The combined employer-employee rate is 3 percent for 1950-53,
4 percent for 195-59, 5 percent for 1960-64, 6 percent for
1965-69, and 6 percent for 1970 and after. The self-employed
pay three-fourths of these rates.
{3} Figured at 2.25 percent on average
balance in fund during year.
{4} Based on Daily Statement of the
Treasury. For 1950, benefit payments were made under 1939
act for first 9 months and under 1950 act for last
3 months; for 1952, payments were made under 1950 law for
first 9 months and under 1952 law for last 3 months. Contribution
income for 1950 collected on coverage and maximum wage base
in 1947 law; for later years, on provisions in 1950 law.
{5} Figure inflated because it includes
a large part of the interest that accrued in the second half
of 1950 and almost all the 1951 interest.
{6} Fund exhausted in 1986.
{7} Based on average dollar costs under
the low-cost and high-cost estimates.
{8} Fund exhausted in 1995.
|
The level-premium costs {13} (as a percentage of covered payroll)
based on 2.25 percent interest for the new estimates are as follows:
Estimate |
Level-premium cost based
on assumption of-- |
Low employment |
High employment |
Low-cost
Intermediate-cost
High-cost |
6.34
7.28
8.37
|
5.69
6.58
7.63
|
{12} For the estimates and a general description
of their underlying assumptions see the Thirteenth Annual Report
of the Board of Trustees of the Federal Old-Age and Survivors Insurance
Trust Fund; they will be given in more detail in a forthcoming
study by the Division of the Actuary.
{13} For benefit payments after 1952; takes
into account the trust fund at the beginning of the period and future
administrative expenses.
The graded contribution schedule in the law
is roughly equivalent to 6 percent of payroll. Accordingly, all
estimates except that based on the low-cost, high-employment assumptions
indicate that the system is not self-supporting. This situation,
however, would be considerably altered if a higher interest rate
had been used. Currently the interest rate is rising rapidly. If,
for example, a rate of 2.75 percent were assumed, the level
premium cost based on intermediate-cost, high-employment assumptions
would be 6.22 percent and the system would be nearly self-supporting.
On the whole, the new estimates indicate
a somewhat higher cost than the previous ones. Except in the low-cost,
high-employment estimate, the trust fund reaches a maximum and then
decreases significantly, rather than leveling off as it would if
it were on an exactly self-supporting basis.
The variability of the cost estimates made
at different times poses an important question as to the possibility
of determining a precise contribution schedule to make the system
exactly self-supporting. In general, however, the estimates clearly
indicate that there will be rising costs for many years and at the
same time show the general magnitude of the trend at alternate levels.
Effect of Maturity
on Financing
It is clear that the financing problems of
any system providing old-age benefits are simplified when the program
becomes mature. There are really two stages of maturity. The first
occurs when all persons over age 65 have had an opportunity to be
in covered employment during their entire working lifetime (or else,
through some means, are given prior service credit). The second
stage occurs necessarily much later--when the aged population of
the country ceases to represent an increasing proportion of the
total population.
The first stage of maturity can, by various
means, be attained or approached currently. Under old-age and survivors
insurance, for example, all the uninsured aged could be "blanketed
in" so that they would receive at least the minimum benefit.
Under such a proposal, this type of maturity would be partly attained
immediately but would not be fully attained until some years hence,
when all individuals had had an opportunity to obtain more than
the minimum benefit. The second type of maturity, of course, cannot
be reached for many decades. Even with a blanketing-in of the current
aged, benefit outgo relative to payroll will rise in the future,
but the rate of increase would be much lower under a blanketing-in
proposal than under the present program.
If coverage were extended to all or substantially
all gainful employment, the reduction in the cost of the program
in relation to payroll would meet part, or perhaps even all, of
the long-range, over-all cost (on a level-premium basis) of the
blanketing-in provisions.{14} Under a combination proposal for both
extension of coverage and blanketing in, the cost relative to taxable
payroll would be raised in the early years and lowered in the later
years. The rate of increase of benefit cost would therefore be smaller,
and, as indicated previously, the financing problems of fund accumulations
would be lessened.
{14} If coverage is broadened, the cost of the program relative
to payroll decreases for two reasons. First, all earnings, subsequent
to coverage extension, of all individuals are covered so that some
persons do not receive high benefits relative to covered earnings
through being in covered employment only part of their working lifetime.
Under the benefit computation provisions, the average wage is determined
over the entire potential working lifetime, and the benefit is determined
by a weighted benefit formula. Accordingly, a reduction in the average
wage because of non-covered periods produces less than a proportional
reduction in benefits. Second, the broader application of the work
clause, or retirement test, prevents the payment of "retirement"
benefits to persons who are actively engaged in gainful employment.
Conclusion
This article has traced the development of
the actuarial financing basis of the old-age and survivors insurance
system in the United States. A substantial trust fund has been built
up which under present provisions will continue to grow-at least
in the near future. No definite, final policy has been adopted as
to the financing basis of the program. Congress, when it last considered
the question, in 1949 and 1950 {15} seemed to favor a self-supporting
system with a relatively large trust fund developing over the years.
It is impossible to predict what course of action will be taken
in the future as to the financing of the program, since this is
a matter inherently linked not only with possible changes in the
nature and scope of the program but also with the state of the national
economy.
{15} The 1952 amendments were enacted without full consideration
of all aspects of the program because extensive hearings on the
subject and executive committee sessions had been held just 2 years
earlier.
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