Federal Reserve Bank of Cleveland
Press Release

For Release: July 2, 1997
Contact: June Gates, 216/579-2048

Social Security Reform: A Call to Action?

While reform of the Social Security System is imperative to thwart looming insolvency, any effective remedies must incorporate structural changes that boost saving and investment and improve work incentives.

In a recent Economic Commentary, Federal Reserve Bank of Cleveland Economic Advisor Jagadeesh Gokhale says that Social Security reform is one of the most pressing tasks facing the United States. While Social Security’s own accounting conventions suggest that the program will remain solvent until 2029, Gokhale cautions that insolvency could come much sooner--somewhere between 2000 and 2012.

According to Gokhale, reform efforts must focus on reducing or eliminating the present system’s pay-as-you-go structure, whereby current workers’ contributions are directly and immediately used for retirement and other benefits. Demographically, he notes, the members of the baby boom generation are in their prime working years and contributing substantial amounts of money to the system. However, over the next three decades, the increase in retirees will far surpass the number of young persons. Today, there are 3.3 workers per beneficiary. By 2025, that figure will fall to 2.2.

Because of the growing number of older Americans, Social Security outlays are expected to rise rapidly over the coming years, while reported income will fail to keep pace. Consequently, the Social Security trust fund will be drawn down to finance the shortfall. Gokhale further explains that the elderly, on average, consume a larger fraction of their resources than do younger individuals. Thus, Social Security’s redistribution of resources from young to old implies greater aggregate consumption and smaller aggregate saving, which hinders capital formation and thus reduces labor productivity.

Gokhale also notes that Social Security’s wide variety of benefits (insurance against old age, dependency, disability, and death) has caused an inefficient allocation of resources. Under current rules, some individuals receive benefits whether or not they worked and contributed to the system. Such redistribution breaks the connection between employment and its rewards and, ultimately, causes a disincentive to work. The resulting lower supply of labor services directly reduces our country’s output.

Gokhale concludes that obvious policy changes -- increasing taxes or cutting benefits -- are in themselves not enough to secure the retirement of the baby boomers and following generations. Effective reform packages must restore individuals’ incentives to work, and alter the intergenerational redistribution that leads to low national saving. Given that the oldest baby boomers will begin retiring in 10 years, Gokhale says lawmakers must act now to remedy Social Security’s shortcomings.

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