The topic of Social Security sustainability has been widely discussed in recent years and is receiving increasing attention from policy makers as well as economists, actuaries and other experts. Sustainability is a particularly complex topic that is influenced by several factors including demographic, economic and financial considerations. Sustainability is often assessed in terms of projected financial stability and affordability. Two of the major secular demographic trends that impact sustainability are increasing life expectancy and declining fertility rates. These trends are typically communicated by means of a dependency ratio that relates the number of elderly persons to the number of persons of working age. The true underlying cost of a social security system is represented by the projection of future expenditures for benefit payments and administration; this economic cost is generally quoted as a percentage of Gross Domestic Product (GDP) on an annual basis. This series of projected economic costs will indicate the effects of demographic changes over time, including the aging of the population. This current economic cost for the US Social Security system is projected to rise from 5.0% in 2012 to 6.2% by 2035 and then decline gradually, stabilizing at about 6% thereafter. Because of this inherent upward trend in economic costs, policymakers have attempted to introduce some degree of stability into the manner in which these economic costs are financed in practice. The US Social Security system is mainly financed by a payroll tax that is set at a fixed rate of 6.2% of covered earnings for both employer and employee. This method of financing was adopted in an attempt to stabilize the incidence of the financing costs over a period of 75 years so as to produce equilibrium between the actuarial value of economic and financing costs. In effect the financing method generates excess funds in the early years of the projection period that are offset by projected deficits in the later years. Regrettably, this approach to achieving stability does not work in the long run. The economic costs as a percentage of covered payroll in the years beyond the initial 75-year projection period are greater than the established 6.2% stable payroll tax rate. These “out-years” should require a modestly escalating financing cost from year-to-year in order to maintain solvency and sustainability over the long run beyond 75 years. As a result of freezing the payroll tax rate at 6.2%, a moderate step-up in the financing costs will be necessary at some point before the accumulated surplus is dissipated. An increased payroll tax rate of 7.6% is required at present in order to maintain solvency over the next 75 years.
It is clear that without additional revenue inputs, there will be a point in time at which the equilibrium test of 100% solvency will not be met and that the solvency percentage will fall below 100% beyond that point. This measure of solvency is essentially a measure of the adequacy of the 6.2% payroll tax rate to meet the projected scheduled benefits. The 100% solvency test is satisfactorily met over the next 20 years from 2013. The solvency ratio is projected at 96% over 25 years, 88% over 50 years, and 84% over 75 years. Subject to approval by the US Congress, an increase of just 1.4% in the payroll tax rate would be sufficient to restore the 75-year solvency ratio to 100% according to the results published in the 2013 annual trustees’ report. This aspect of social security financing raises issues regarding the affordability of any payroll tax increase and still leaves unresolved the challenge of providing the requisite financing to meet the projected economic costs in the range of 6.0% to 6.2% of GDP over not only the next 75 years, but also over the long run.
In this connection, a recent World Bank paper stated “Sustainability may be compromised in the basic design of the program if the parameters lead to actuarial imbalance. The capacity to calculate and report both the short and long term financial status of the program is an important component and necessary to inform policy. This capacity, and even the basic information system to produce the required information, is often missing or underdeveloped.” In order to monitor more closely the secular trend of the solvency ratios under the fixed payroll tax regime, it is helpful to produce a matrix of solvency ratios that is both dynamic (over various projection periods) and stochastic (indicating a range of plausible outcomes). This matrix of solvency ratios, when constructed on a secular basis over a period of several years, gives a much clearer indication of the extent of the solvency and sustainability issues that need to be addressed in order to maintain the integrity of the commitment to provide scheduled benefits over the long run.