What Does the Fed Have to do With Social Security? Plenty

by

Most of the people who closely follow the Federal Reserve Board’s decisions on monetary policy are investors trying to get a jump on any moves that will affect financial markets. Very few of the people involved in the debate over the future of Social Security pay much attention to the Fed. That’s unfortunate because the connections are much more direct than is generally recognized.

The basic story of Social Security’s finances is that, while the program is entirely sound for the near future, the program is projected to face a shortfall in the decade of the thirties. Under current law, at that point it would be necessary to reduce benefits from their scheduled level, unless additional revenue can be raised.

Of course the answer from those on the right is to cut benefits, and the sooner the better. Progressives, along with most of the public, would like to see the current benefit level maintained and possibly increased. Most workers are approaching retirement with little other than Social Security to support them, which means that cuts from currently scheduled benefit levels will mean serious hardship for many.

The Fed figures in this picture both directly and indirectly. The Fed is not always able to provide as much of a boost to the economy as it might like. Following the Great Recession of 2008 the Fed wanted to promote growth and employment. It did so by lowering short-term interest rates to zero and initiating its quantitative-easing policy of buying long-term bonds.

These policies helped stimulate demand by making it easier for people to buy homes or refinance mortgages and for businesses to invest. But by themselves, they did not come close to restoring the economy to full employment.

Although the Fed cannot always boost the economy as much as it would like, there is little doubt that it can slow the economy. Higher interest rates would dampen the housing market and discourage other forms of consumption. They would also slow investment. By raising interest rates, the Fed can slow the rate of growth, thereby keeping people from getting jobs, and propping up the unemployment rate higher than it would otherwise be.

If fewer people are employed, fewer people are paying into the Social Security system. This trend, therefore, directly weakens its finances. (The system will pay out less in benefits, but this result will not be close to offsetting.) In addition, lower rates of unemployment strengthen workers’ bargaining position. At low rates of unemployment, workers at the middle and bottom of the wage distribution have the bargaining power to secure themselves a share of the gains from economic growth.

This affects Social Security directly, since one of the main reasons that the program is now projected to face a shortfall in the decades of the thirties is that so much wage income has been redistributed above the cap on the Social Security tax, which currently stands at $117,000. Back in 1983, the last time major changes to the system were instituted, only 10 percent of wage income was above the cap. Because of the massive upward redistribution of the last three decades, 18 percent of wage income is now above the cap.

If the Fed allowed the unemployment rate to fall back to the levels of the late 1990s (@4.0 percent to 5.0 percent) and stay there, the share of wage income going to workers earning above the cap would fall, increasing the revenue going to Social Security.

In addition to the direct Fed policy can affect Social Security’s finances, there is also an important indirect channel. Over the long-term it will likely be necessary to raise tax rates to maintain scheduled benefit levels.  Any substantial increase in taxes would impose a hardship on low and moderate income workers in the current context of stagnant wages. However if wages were rising in step with productivity, workers would be able to pay a somewhat higher tax rate and still have higher after-tax wages.

According to the most recent projections from the Social Security trustees, average hourly compensation in thirty years will be more than 60 percent higher (after adjusting for inflation) than it is today.  If the tax rate were increased by 1-2 percentage points in order to prevent cuts to scheduled benefits, workers would still pocket close to 60 percent more for each hour of work in 2044 than they do today, assuming the gains from growth are evenly shared.

Whether most workers share in the gains from economic growth, or we continue to see the massive upward redistribution of income of the last three decades, will depend largely on the policies of the Fed. If the Fed allows the unemployment rate to fall back to the levels we saw in the late 1990s, then workers could anticipate substantial wage gains in the decades ahead. Covering the cost of Social Security will pose little problem.

On the other hand, if those pushing for higher interest rates now get their way, then most workers will not see their wages rise by much. In that case, paying for Social Security through the current payroll tax can be a problem.

People who are concerned about the future of Social Security, then, should be paying a great deal of attention to what the Fed does. Raising interest rates will not only affect the economy today, but it will also affect Social Security tomorrow.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

This article originally appeared on Al Jazeera.

 

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. This article originally appeared in Al Jazeera America.  

Like What You’ve Read? Support CounterPunch
Weekend Edition
July 31-33, 2015
Charles Larson
Tango Bends Its Gender” Carolina De Robertis’s “The Gods of Tango”
July 30, 2015
Bill Blunden
The NSA’s 9/11 Cover-Up: General Hayden Told a Lie, and It’s a Whopper
Richard Ward
Sandra Bland, Rebel
Jeffrey St. Clair
How One Safari Nut, the CIA and Neoliberal Environmentalists Plotted to Destroy Mozambique
Martha Rosenberg
Tracking the Lion Killers Back to the Old Oval Office
Binoy Kampmark
Dead Again: the Latest Demise of Mullah Omar
Kathy Kelly – Buddy Bell
No Warlords Need Apply: a Call for Credible Peacemaking in Afghanistan
Ramzy Baroud
Darker Horizons Ahead: Rethinking the War on ‘IS’
Stephen Lendman
The Show Trial of Saif Qaddafi: a Manufactured Death Sentence
John Grant
The United States of Absurdity, Circa 2015
Karl Grossman
The Case of John Peter Zenger and the Fight for a Free Press
Cesar Chelala
Cultural Treasures Are Also Victims of War
Jeff Taylor
Iowa Conference on Presidential Politics
July 29, 2015
Mike Whitney
The Politics of Betrayal: Obama Backstabs Kurds to Appease Turkey
Joshua Frank
The Wheels Fell Off the Bernie Sanders Bandwagon
Conn Hallinan
Ukraine: Close to the Edge
Stephen Lendman
What Happened to Ralkina Jones? Another Jail Cell Death
Rob Wallace
Neoliberal Ebola: the Agroeconomic Origins of the Ebola Outbreak
Dmitry Rodionov
The ‘Ichkerization’ Crime Wave in Ukraine
Joyce Nelson
Scott Walker & Stephen Harper: a New Bromance
Bill Blunden
The Red Herring of Digital Backdoors and Key Escrow Encryption
Thomas Mountain
The Sheepdog Politics of Barack Obama
Farzana Versey
A President and a Yogi: Abdul Kalam’s Symbolism
Norman Pollack
America’s Decline: Internal Structural-Cultural Subversion
Foday Darboe
How Obama Failed Africa
Cesar Chelala
Russia’s Insidious Epidemic
Tom H. Hastings
Defending Democracy
David Macaray
Why Union Contracts are Good for the Country
Virginia Arthur
The High and Dry Sierras
Jon Langford
Mekons Tour Diary, the Season Finale, Mekonception in Redhook
July 28, 2015
Mark Schuller
Humanitarian Occupation of Haiti: 100 Years and Counting
Lawrence Ware
Why the “Black Church” Doesn’t Exist–and Never Has
Peter Makhlouf
Israel and Gaza: the BDS Movement One Year After “Protective Edge”
Carl Finamore
Landlords Behaving Badly: San Francisco Too Valuable for Poor People*
Michael P. Bradley
Educating About Islam: Problems of Selectivity and Imbalance
Binoy Kampmark
Ransacking Malaysia: the Najib Corruption Dossier
Michael Avender - Medea Benjamin
El Salvador’s Draconian Abortion Laws: a Miscarriage of Justice
Jesse Jackson
Sandra Bland’s Only Crime Was Driving While Black
Cesar Chelala
Effect of Greece’s Economic Crisis on Public Health
Mel Gurtov
Netanyahu: An Enemy of Peace
Joseph G. Ramsey
The Limits of Optimism: E.L. Doctorow and the American Left
George Wuerthner
Bark Beetles and Forest Fires: Another Myth Goes Up in Smoke
Paul Craig Roberts - Dave Kranzler
Supply and Demand in the Gold and Silver Futures Markets
Eric Draitser
China’s NGO Law: Countering Western Soft Power and Subversion
Harvey Wasserman
Will Ohio Gov. Kasich’s Anti-Green Resume Kill His Presidential Hopes?