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PART I
Financing the Present
Program
In this part of the report the Council presents the results of
its study of the financial status of the existing social security
program and of the principles underlying the legislative provisions
for social security financing. The financial implications of the
Council's recommendations for program improvements as set forth
in parts II and III of the report are presented in conjunction with
those recommendations.
The financing provisions of present law are as follows: Employees
pay contributions on their annual earnings up to a maximum of $4,800.
Each employer pays at the same rate as the employee on the first
$4,800 paid to each of his employees in the year. The self-employed
pay at a rate approximately equal to 1.5 times the rate paid by
employees. Contribution rates are scheduled to increase from an
employer and employee rate of 3 5/8 percent each in 1965 to 4 1/8
percent each in 1966 and to an ultimate rate of 4 5/8 percent each
in 1968. The contribution rates now scheduled are intended to provide
enough income to meet all of the costs of the system, including
administration, into the indefinite future.
Funds not needed for immediate benefit payments are invested in
obligations of the United States Government and the interest earnings
on these obligations are available to help pay the cost of the system.
The scheduled contribution rates include an allocation to the separate
disability insurance trust fund of one-half of one percent from
the combined employer and employee contribution (three-eighths of
one percent for the self-employed).
1. The Status of the Program and Allocation of Contribution
Income
The social security program as a whole is soundly financed,
its funds are properly invested, and on the basis of actuarial estimates
that the Council has reviewed and found sound and appropriate, provision
has been made to meet all of the costs of the program both in the
short run and over the long-range future. The contribution income
should be reallocated between the two trust funds, however, so that
the disability insurance part of the program, like the old-age and
survivors insurance part of the program and the program as a whole,
will be in close actuarial balance.
As indicated in the latest Trustees' Report, the social security
program as a whole is in actuarial balance both over the short run
and for the long-range future. The review of the actuarial estimates
conducted by the Council supported this conclusion of the Trustees.
In the Council's opinion, based on actuarial estimates that the
Council has reviewed and found sound and appropriate, the contribution
rates in present law will supply income which, together with interest
earnings on the funds, will be sufficient to meet all benefit costs
and administrative expenses as they fall due.
While the old-age and survivors insurance part of the program and
the program as a whole are in close actuarial balance, the disability
insurance part of the program(which involves only a small proportion
of the total cost of the system) when looked at separately, is underfinanced.
It was recognized at the time of the last major disability amendments
in 1960 that the income to the disability fund was likely to be
about 0.06 percent of covered payroll short of what was needed for
the long- run. Experience since that timehas indicated that disability
benefit termination rates due to death and recovery of the beneficiary
are lower than had been assumed in the earlier estimates, so that
the expected deficit is now about 0.14 percent of covered payroll.
To correct this situation, the Council endorses the recommendation
of the Board of Trustees that there be a small reallocation of contribution
income--the Council would favor 0.15 percent of covered payroll
for present law--from the old-age and survivors insurance trust
fund to the disability insurance trust fund. {1}
This could be done without any increase in the over-all contribution
rates now scheduled for the program and would put the disability
insurance part of the program in close actuarial balance, while
also leaving the old-age and survivors insurance part and the program
as a whole in close balance.
In arriving at the conclusion that the system as a whole is in
actuarial balance, the Council examined not only the results of
the estimates but also the techniques used and the assumptions on
which the estimates are based. It found that the techniques used
in preparing the estimates of the cost of the program are in accordance
with sound actuarial practice and that the assumptions on which
these estimates are based are appropriate. The estimates take full
and proper account of the various economic and demographic factors
affecting the future cost of the program.{2} The Council favors the continuance of present practice
under which estimating techniques and the assumptions underlying
the estimates and the contribution schedule are re-examined and
adjusted in the light of developing experience.
The Council believes that it is proper for a national system of
compulsory social insurance to use what is known as an "open-group"
technique in preparing actuarial cost estimates--that is, to take
into account not only present assets, future benefits for present
beneficiaries, and future contributions and benefits with respect
to workers now covered, but also the contributions and benefits
to be paid with respect to workers to be covered in the future as
well. The Council is in agreement with the previous groups that
have studied the financing of the program that it is unnecessary
and would be unwise to keep on hand a huge accumulation of funds
sufficient without regard to income from new entrants, to pay all
future benefits to past and present contributors. A compulsory social
insurance program is correctly considered soundly financed if, on
the basis of actuarial estimates, current assets plus future income
are expected to be sufficient to cover all the obligations of the
program; the present system meets this test. The claim sometimes
made that the system is financially unsound, with an unfunded liability
of some $300 billion, grows out of a false analogy with private
insurance, which because of its voluntary character cannot count
on income from new entrants to meet a part of the future obligations
for the present covered group.
It is important to note that the long-range cost estimates prepared
for the program are based on the assumption that earnings will remain
at a given level (at the 1963 level under the estimates shown in
this report). If average earnings continue to rise in the future,
as there is reason to expect they will, then, assuming no change
in other cost factors, the income of the program relative to outgo
will be considerably higher than the estimates show. {3}
The Council believes that making the estimates on a level-wage assumption
allows for a desirable margin of safety and recommends that the
practice be continued in making the long-range estimates. If the
assumptions which underlie the intermediate or low-cost estimates
are borne out by experience, then the use of level wages allows
for benefit increases if wages rise without any increase in the
contribution rates. If experience comes close to the high-cost assumptions,
then the use of the level-wage assumption will result, if wages
rise, in an offset to the cost consequences of the unfavorable experience
and still allow for some upward adjustment in benefits without any
increase in the contribution rates.
The Council suggests only one significant change in the assump-tions
underlying the long-range estimates. In the past an attempt has
been made to present cost estimates into perpetuity. Specifically,
it has been assumed for purposes of the estimates that trends for
the factors affecting the cost of the program will level off at
some point in the distant future (about 85 to 90 years) and continue
at that level indefinitely. The Council believes that it serves
no useful purpose to present estimates as if they had validity in
perpetuity. A period of 75 years would span the lifetime of virtually
all covered persons living on the valuation date and is as long
a period as can be expected to have a realistic basis for estimating
purposes. When costs are reassessed at frequent intervals, as has
always been the practice, 75-year projections allow sufficient time
to adjust to new and changing experience as it emerges. The long-range
cost estimates shown in this report, therefore, are developed for
a period of 75 years and it is our recommendation that long-range
estimates in the future also be made on this assumption. The effect
of this changed procedure is to make the estimated level-cost of
the present program about 3 percent lower (about 0.25 percent of
payroll) than when using the earlier procedure. At the same time
the Council believes that the financing should be such that the
actuarial status of the program will be reasonably close to an exact
balance according to the intermediate-cost estimates.{4}
The Council has also examined the practices followed with respect
to investment of the funds of the program. From the inception of
the program in 1937, the investment of trust fund assets has been
restricted by law to interest-bearing obligations of the United
States or obligations guaranteed as to principal and interest by
the United States. The investments can be either in special obligations
issued exclusively for purchase by the trust funds or in publicly
available obligations of the Federal Government. Under the present
provisions of the Social Security Act relating to the investments
of the trust funds, the special obligations issued exclusively to
the trust funds bear interest rates equal to the average market
yield at the end of the preceding month on all interest-bearing
marketable obligations of the United States not due or callable
for 4 or more years after that date. This market-yield formula,
based on the recommendations of the Advisory Council on Social Security
Financing appointed in 1957, has served as a model for determining
interest rates on special obligations issued to certain other Federal
trust funds. This Councilbelieves that the present procedures for
investing the trust funds and for setting the interest rates on
the special obligations are satisfactory.
2. Adjustment in the Contribution Rate Schedule in the
Short Range
The contribution rates now scheduled in the law should
be adjusted to avoid the rapid increase in trust fund assets that
will otherwise begin with the rate increases
scheduled for 1966 and 1968.
The 1956 legislation establishing the social security advisorycouncils
scheduled them so that each would make its report 1 year before
the date when an increase in the social security contribution rates
was due to go into effect, and one of the primary duties of the
councils, as specified in the law, is to make recommendations with
respect to the social security contribution schedule. Thus the Council
recognizes a special obligation, without regard to other change
it is recommending, to report its findings and make recommendations
regarding the social security contribution rates designed to support
the existing program.
The benefit outgo of the program will increase for many years,
mainly because of the increasing number of people eligible for benefits
at age 62 or over. This increased cost is to be met under the present
law by raising the rates to 4 1/8 percent each for employees and
employers and to 6.2 percent for the self-employed in 1966, and
finally to 4 5/8 percent each for employees and employers and 6.9
percent for the self-employed in 1968. The question to which the
Council is here addressing itself is whether changes should be made
in these scheduled rate increases.
On the basis of the actuarial cost estimates the Council has examined,
it is clear that some increase in income to the program over what
the 3 5/8 percent tax rate now in effect would produce will be needed
in 1966. The Council finds, however, that the increase to 4 1/8percent
each for employers and employees now scheduled for 1966 and 1967
is higher than it believes is desirable forseveral years.
The Council is recommending an increase in the contribution and
benefit base in order to maintain the wage-related character of
the benefits, to restore a broader financial base for the program,
and to apportion the cost of the program appropriately between high-paid
and low-paid workers. If the increase in the base is adopted in
accordance with the Council's recommendation, the increase needed
in 1966 in the income of the program will be provided thereby. If
the base is not increased, and if all other provisions remain unchanged,
the Council would propose the contribution rate be increased in
1966 to 3.9 percent. This rate would produce a slight excess of
income over outgo for about 2 years. In the Council's opinion it
is highly desirable that the income to the funds exceed
outgo year by year. As has been evidenced in several recent years,
if this is not the situation, there is danger of public misunderstanding
of the financial condition of the program. On the other hand,
as nearly as can now be determined, it would seem to be desirable
from the standpoint of the general economy to avoid the deflationary
effect of large trust fund accumulations. In the absence of any
other changes in the law the Council would also propose revisions
in the rates scheduled for 1968 and later years. The imposition
of the 4 5/8 percent rate as scheduled in 1968 would build very
large trust fund accumulations--as much as $4 billion a year--and
would also involve the possibility of imposing rates higher than
will ever be needed to pay for the benefits provided under present
law. The rate of 4 5/8 percent in 1968 is designed to meet long-range
costs falling about halfway between the high- and the low-cost estimates.
If the actual experience is close to the low-cost estimates, for
example, a contribution rate of 4 1/8 percent in 1968, rather than
4 5/8 percent, would cover the cost of the present program for 75
years.
This Council agrees with the last Advisory Council in the view
that once the social security contribution rates actually in effect
are high enough to cover the long-range cost of the program as shownby
a reasonable minimum estimate, then decisions on whether scheduled
rate increases are allowed to go into effect should be guided largely
by conditions expected in the 15- or 20-year period immediately
ahead. The Council recommends that if the present program continues
unchanged in other respects the proposed 3.9 percent rate for 1966
be continued through 1968 and the rate scheduled for 1969-1971 be
4.1 percent of payroll. This figure is close to the 75-year level
cost of the program under the low-cost estimates. The recommendations
for rates to be included in the law for years after 1971--but to
be allowed to go into effect only if developing conditionsindicate
that they will be necessary--are given on page 21.
The Council believes that reducing the scheduled rates as suggested
for the 6 years after 1965 would not threaten the financial soundness
of the program. Since continuing income from social -security contributions
is assured, the only fund balances required are those needed to
meet temporary excesses of outgo over income due to relatively high
benefit costs or low social security tax revenue in a particular
period. In the opinion of the Council, fund balances high enough
to maintain the solvency of the program in the face of recession
conditions as severe as, say, those referred to in the annual report
of the Board of Trustees--that is, conditions that would prevail
if there were a drop of 5 million in the number of people with covered
earnings in a year--would be adequate to provide protection against
any contingency that might reasonably be expected, and the trust
fund balances resulting from the Council's recommended rate schedule
would be sufficient to do this. {5}
Holding the trust funds to reasonable continency levels, instead
of allowing them to increase as they would under the present tax
schedule, will of course mean a loss of interest income to the program.
However, despite the very substantial funds that would be built
up under the present schedule, the interest earned on these funds
is expected to supply only about 10 to 15 percent of the income
of the program over the long-range future. Thus the role of thetrust
funds as interest-earning reserves is not very great even underthe
present schedule; the funds are even now to be thought of largely
as a reserve to meet unexpected contingencies rather than as fundsfor
the purpose of earning interest. Moreover, if the system is improved
as earnings levels rise in the future, as seems likely to be the
case, interest earnings on a fund of any given size will meeta decreasing
proportion of benefit costs. It may therefore prove to be unwise
to count on interest earnings meeting even as large a partof benefit
costs in the distant future as is now contemplated.
The Council does not consider the use of interest in the financing
of the program to be a major issue. A reasonable contingencyfund
will result in interest earnings which will supply 4 to 5 percentof
benefit costs. Even under the present contribution schedule interest
earnings may not exceed 10 percent of costs. The Councilbelieves
that, on balance, any advantage of imposing rates that willbuild
up large interest-earning trust funds is outweighed by thedisadvantages.
3. The Contribution Rates in the Long- Range
There should continue to be included in the law a schedule
of contribution rates which, according to the intermediate -cost
estimates, will be sufficient to support the Program over the long-range
future. However, decisions about putting future rate increases into
effect, once the rates actually being charged are high enough to
cover the long-range cost of the program as shown by a reasonable
minimum estimate, should be guided largely by estimates of program
costs over a 15- or 20- year period.
Like the last Advisory Council, the present Council endorses the
practice of including in the law a contribution schedule that, according
to the intermediate-cost estimates, places the system in actuarial
balance over the long-range future. As that Council pointed out,
this procedure is needed to make people conscious of the long-range
costs of the program and the costs of proposals to change the program.
Accordingly, this Council is recommending that for the present
program, if the contribution rates it recommends for 1966 and
1969 are put into effect (bringing the rates about to the level
needed for the next 75 years under the low-cost estimates), further
contribution rate increases nevertheless should be scheduled in
the law for 1972 and 1975. The 1972 rate should reflect the estimated
cost for the next 3 years on the basis of the long-range intermediate-cost
estimate, while the 1975 rate should represent the level cost for
the succeeding 65 years. The employee (and employer) rate for 1972-74
should be 4.3 percent. A rate of 4.7 percent effective in 1975 would
be sufficient to finance the present program under the intermediate-cost
estimate throughout the period covered by the estimate.
While the Council believes that the rates for 1972 and 1975 should
be scheduled in the law in order to assure public appreciation of
the approximate long-range cost of the program, decisions on whether
theserates should be put into effect as scheduled, since they are
higher than would be needed if the low-cost estimates are borne
out by experience, should be made in the light of circumstances
prevailing just before the proposed effective dates. These decisions
should be made largely in the light of conditions that are expected
to exist over the 15 or 20 years following the proposed effective
dates.
If there are no other changes in the program, and if the contribution
and benefit base is not increased, the Council would recommend that
the 4.125 percent rate scheduled for employees and employers in
1966 be reduced to 3.9 percent, that the rate be held at this level
through 1968, and that the rate for 1969 be set at 4.1 per cent.
Rates of 4.3 percent in 1972 and 4.7 percent in 1975 should be scheduled
in the law, subject to future review. If the Council's recommendations
for improvements in the program are adopted, the rates would of
course need to be higher than those shown here, the cost of the
changes and the recommended rates for the cash-benefit program as
it would be improved are shown on pages 84 and 85. The financing
of hospital insurance is discussed on pages 45-52.
4. The Contribution and Benefit Base
The maximum amount of annual earnings that is taxable and creditable
toward benefits needs to be substantially increased in order to
maintain the wage-related character of the benefits, to restore
a broader financial base for the program and to apportion the cost
of the system among low-paid and higher-paid workers in the most
desirable way.
The Council recommends that the maximum amount of annual earnings
that is taxable and creditable toward benefits--the contribution
and benefit base--be increased to at least $6,000 effective in 1966
and $7,200 effective in 1968. These increases are needed in order
to maintain the wage-related character of the benefits, to restore
a broader financial base for the program, thus keeping the contribution
rates lower than they would otherwise have to be, and to apportion
the cost of the system appropriately.
As is discussed in Part III, failure to keep the contribution and
benefit base up to date has serious effects on the benefit protection
provided as more and more workers have earnings above the base and
their benefits are related to a smaller and smaller part of their
earnings. In addition, unless the contribution and benefit base
is increased as earnings rise, the foundation of the financing of
the: program--the proportion of the Nation's payrolls which is subject
to social security contributions--is weakened.
Moreover, if benefits were raised without increasing the contribution
and benefit base, the increases in the contribution rates would
have to be higher than they would have to be if the base were raised.
and lower-paid workers as well as those earning at or above the
maximum would have to pay these higher rates. It is much more desirable
to meet the cost of increased protection for workers at average
or higher earnings levels by increasing the amount of earnings on
which those workers contribute than by increasing the contribution
rates that all workers pay.{6}
The contribution and benefit base is now substantially out of date
because of large advances in the general wage level. When the program
was enacted in 1935, the $3,000 base providedwould have covered
95 percent of total earnings in covered workin that year, and would
have covered the full earnings of 98 percent of all workers and
of 97 percent of regularly employed men.{7} When
the base was raised to $3,600 in 1950, the $3,600 base would have
covered 86 percent of earnings in covered work andall of the earnings
of 81 percent of all workers and of 62 percentof regularly employed
men. In 1965, with the $4,800 base, only about 72 percent of earnings
in covered employment will be taxedto support the program and only
66 percent of all workers and 36percent of regularly employed men
will have all their earnings covered.
The concept embodied in the original $3,000 base was thatpractically
all of the Nation's covered payrolls should be subject to contributions
for the support of the program and that all but
the mosthighly paid workers should have all their earnings counted
toward benefits. The Council does not think it would be practicable
to attempt at this time to restore all of the ground that has been
lost over the years. A base of $14,500 would be needed now to cover
95 percent of total earnings in covered work, as was contemplated
in 1935. Nor does the Council believe it necessary that the original
situation with respect to the proportion of total earnings covered
under the program be fully restored in order to carry out the general
principles of the original Act.
The Council believes that a return to the relationship that existed
in 19550, the first year the Congress increased the contribution
and benefit base, is a practical goal. The Council recognizes, however,
that it may not be practical to move to this level in one step,
and is recommending, therefore, that the base be increased at least
to $6,000 for 1966 and 1967 and to $7,200 in 1968. A contribution
and benefit base of $7,200, if effective in 1968, would, it is estimated,
tax about 80 percent 6f total earnings in covered work and would
result in 82 percent of all workers, and 63 percent of regularly
employed men, having all their earnings counted toward benefits.
{8} The result would be comparable to the 1950
situation in respect to the last two measures and somewhat short
in respect to the first measure.
The members of the Council are agreed on the changes here recommended
as the minimum desirable. Some members, however, think that the
proposed amounts for the contribution and benefit base are not high
enough and would recommend that they be substantially greater, rising
in the second step to nine or ten thousanddollars. This group believes
that it is important to go beyond restoring the 1950 situation and
move toward the situation contemplated under the original Social
Security Act.
5. The Contribution Rate for the Self-Employed
Increases in the social security contribution rate for the
self- employed beyond the present rate should be put into effect
gradually, and only to the extent that the ultimate rate will be
no more than 1 percent of earnings greater than the rate paid by
employees.
Since 1951, when self-employed people were first brought into the
social security program, they have paid social security contributions
at a rate 1.5 times the rate paid by employees. The policy of imposing
the contribution at this 1.5 times rate balances two opposite considerations.
On the one hand, to the extent that the self-employed person does
not contribute at rates as high as the combined employee-employer
rate, there is a financial disadvantage to the program in covering
him, as compared to covering an employee. On the other hand, looked
at from the standpoint of an individual contributing toward his
own protection, some self-employed people willbe "overcharged"
when paying over a lifetime at the ultimate rate now scheduled.
Although the policy of setting the self-employed rate at 1.5 times
the employee rate seemed a reasonable compromise at the time it
was adopted, the Council believes that, as the rates have gone up,
the substantial difference between the employee rate and the self-employed
rate has become difficult to justify. The contributions paid by
self-employed people above the rates paid by employees are, like
employers' contributions to the program, used in large partto help
provide protection for low-paid workers, workers with large families
and workers who were already on in years when their jobs were first
covered.{9} The Council believes that it is reasonable
to use the contributions of an employer for general purposes, rather
than for the benefit of the particular employees on whose earningsthe
contributions are based, as long as the employee can in general
be said to get his own money's worth. On the other hand, the Council
does not believe that self-employed workers should as a rule be
charged rates for their own coverage beyond the rates needed to
pay for the protection they are provided by the program in order
to helpmeet the cost of the protection provided to others.
The Council recommends, therefore, that, except for the financing
of new types of benefits such as hospital insurance, increases in
the social security tax rate for the self-employed beyond the rate
now being charged be put into effect only to the extent that the
self-employed will pay no more than 1 percent of covered earnings
above the rate paid by employees at the time the ultimate rate goes
into effect.{10} With self-employed contributors
paying, ultimately, 1 percent of earnings more than employees, their
contribution ratewould reflect the fact that to a degree they are
in the same position asan employer, that is, that they are their
own employers. At the same time, they would not be overcharged when
paying for a full workinglifetime at the ultimate contribution rate.
{11}
6. Maintaining the Integrity of the Trust Funds
To maintain the integrity of the trustfunds, the reirnbursement
of the trust funds for the cost of paying social security benefits
basedon military service for which no contributions were paid should
begin without further delay and the Board of Trustees should begiven
specific responsibility for reviewing those administrative charges
against the trust f unds which are based on estimates ratherthan
on actual costs.
The last Advisory Council called the management of the social security
trust funds "the greatest financial trusteeship in history."
This Council agrees, and it has reviewed the management of the funds
to be sure that their integrity is maintained. As a result of its
study, the Council has concluded that, in general, the trust funds
are managed with due regard for their nature as funds held in trust
for the contributors and beneficiaries of the program. The Council
does, however, want to call attention to two respects in which improvement
should be made.
Military service after 1956 is covered in the same way as is all
other work in covered employment, and social security employee and
employer contributions with respect to military service are paid
into the trust fund by the Federal Government just as are the contributions
of private employers and employees. For service prior to 1957 (and
after September 16, 1940), however, non-contributory wage credits
were provided, and, in addition, benefits were provided for the
Survivors of certain World War II veterans who died within 3 years
after discharge. Social security contributions were not paid with
respect to those special wage credits and benefits.
The social security system has been reimbursed from the general
fund of the Treasury for the cost resulting from the special benefits
paid through August 1950. The authorization for such reimbursement
was repealed by the 1950 amendments. In 1956 the law authorized
reimbursement of the system for the cost resulting fromthe payment
of the special benefits from September 1950 on and for the cost
resulting from the non-contributory wage credits for military service.
Although the 1956 legislation authorized such reimbursement beginning
in fiscal year 1960, no reimbursement has yet been made.
The Council views the reimbursement owed the trust funds by the
United States Government for benefits arising from non-contributory
military service credits in the same light as social security contributions
payable by employers generally, and therefore urges that the Government
as the employer of the servicemen discharge its obligations to the
trust funds just as it requires employers generally to meet their
obligations. The Council also believes that this reimbursement should
begin without delay.
The Council notes also that, although the Board of Trustees is
directed to review the general policies followed in managing the
trust funds, there is no specific requirement in the law that it
review the way in which administrative costs incurred outside of
the Social Security Administration--for example, by the Internal
Revenue Service in the collection of social security taxes and by
the Treasury Disbursing Office in issuing benefit checks--are arrived
at and charged to the funds, nor has any other agency of Government
beenassigned this responsibility. Many of these costs, unlike those
of the Social Security Administration, are charged to the trust
funds on the basis of estimates rather than of actual cost. The
Council believes that there should be a review of such charges and
that the Board of Trustees should do it.
The Council does not believe that the Board of Trustees should
be required by law to meet every 6 months, as it now is. The Council
has been informed that important financial policy issues suitable
for consideration by the Trustees do not come up every 6 months.
The Council recommends that the law be changed so that the Trustees
would not be required to meet more than once every year. |