Richard G. Anderson

English

Research Papers in Economics

April 2005 NationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
T
he largest retirement plan in the United States is
the Old Age, Survivors, and Disability Insurance
(OASDI) program of the Social Security Adminis-
tration. During 2004, 48 million persons received $493 billion
in benefits, and 157 million persons with earnings subject to
the program’s payroll tax furnished the bulk of the program’s
$658 billion income. The $165 billion in excess revenue was
added to the program’s trust fund, which at the end of 2004
totaled $1.7 trillion.
During the next 25 years, it is projected that the OASDI
program’s ratio of beneficiaries to taxpayers will decrease
from its current 3.3 to 1 to about 2.2 to 1. As a result, it is
projected that outlays will persistently exceed revenues after
2018 or so. Under current tax and benefit rules, and by draw-
ing down the trust fund, it is projected that all scheduled
benefit payments can be made for at least the next 25 years,
at which time the trust fund will be exhausted. Thereafter, if
no changes are made to benefits or taxes, it is projected that
incoming tax revenue will be sufficient to fund about 70
percent of scheduled benefit payments through 2080. Many
analysts (and politicians) have argued that this shortfall is
unacceptable and that the OASDI program must change.
Proposals include increasing the payroll tax, reducing benefit
levels, increasing earnings on the trust fund’s investments,
and delaying the age at which new retirees are eligible for
full benefits. Economic analysis suggests it is important to
analyze these proposals carefully because each is likely to
have different effects on various groups in the economy.
Consider, for example, the Social Security trust fund. Prior
to 1983, the OASDI program operated largely as a pay-as-you-
go system. Established by Congress in 1940, the program’s
trust fund grew little prior to 1983 as a result of Congressional
deferrals of proposed tax increases.1 In 11 of the years
between 1940 and 1983, the level of the fund decreased as
benefit outlays exceeded revenues. In 1983, the Greenspan
commission on OASDI recommended that the program be
changed from one in which benefits were paid solely from
current revenues to a partially funded retirement plan. Payroll
tax rates were increased, and the trust fund began to grow.
Recently, some analysts have proposed that the trust fund
ought to seek to earn a higher rate of return so as to mitigate
the future OASDI shortfall. This proposal is problematic
because the fund consists solely of Treasury securities. Not
until benefit payments begin to exceed payroll tax revenues,
say in 2018, will the Treasury be required to redeem these
securities and transfer funds to OASDI. How the Treasury
chooses to raise those funds will have tax-incidence implica-
tions. Increases in income taxes, to fill the Treasury’s general
fund for payment to OASDI, will fall more heavily on upper-
income households; decreases in OASDI benefits or increases
in payroll taxes will fall more heavily on lower-income
households.2 Hence, higher rates of return credited to the
trust fund by the Treasury during the next several decades
would have the effect of transferring more of the burden of
resolving the OASDI shortfall to higher-income households.
Current law sharply limits the trust fund’s investment
options: The fund is permitted to invest solely in securities
backed by the full faith and credit of the federal government.
In practice, each year the fund purchases nonmarketable
Treasury securities with maturities varying from 1 to 15 years,
at a yield equal to the average market yield on Treasuries with
4 years or more to maturity. In 2003, the fund purchased
$210 billion at a 3.5 percent yield; in 2004, the fund purchased
$215 billion at a 4.6 percent yield. Some analysts have sug-
gested that the trust fund’s investments should more closely
resemble those of private retirement systems by including
long-maturity inflation-indexed securities. A few of these
proposals suggest that the Treasury be required to issue, to
the trust fund, long-maturity Treasury inflation-protected
securities (TIPS) with above-market yields. Although con-
troversial, such a change would shift the tax incidence of
resolving a substantial portion of the OASDI shortfall from
lower-income to higher-income households. Simple calcula-
tions, using current benefit and tax projections, suggest that
the trust fund’s exhaustion date likely might be delayed to
as late as 2080 if the entire current fund were invested in such
special-issue TIPS at a real coupon rate of approximately 5.5
to 6 percent.
—Richard G. Anderson
1Technically, the OASI trust fund was established in 1940. The DI fund came
later.
2This discussion assumes that the Treasury will not be able to fund its entire
obligation by marketing new securities to the public and, hence, at some point
will require higher income taxes. 
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TIPS for Social Security?

TIPS for social security?

http://research.stlouisfed.org/publications/net/20050401/cover.pdf

TIPS for social security?

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Research Papers in Economics