February 4, 2013

On Friday, the Bureau of Labor Statistics reported that total nonfarm payroll employment increased by 157,000 jobs in January, a middling result for a U.S. economy that shrank by 0.1% in October-December 2012. The unemployment rate ticked higher to 7.9%.

The underreported number, however, is the workforce participation rate, which has declined more rapidly despite the steady job growth over the last four years. The number of jobs created has not grown enough to offset population growth and to make up for the rapid increase in unemployment during the 2008-9 recession. The lower workforce participation rate has a subtle but direct impact on Social Security and federal and military pensions, since fewer tax payers per retiree strains both systems, as explained below.

According to the Congressional Budget Office, the labor participation rate – the percentage of the civilian population age 16 years or older who are working or actively seeking work – steadily increased in the 1970s and crossed over 64% in the early 1980s. It peaked in 2000 at about 67%. It slowly began to decline a percentage point to 66% by 2008, after which it dropped more precipitously to below 64%. For January, the BLS reported that the participation rate was 63.6%. (Participation rates can be found in the CBO Background Paper “Labor Force Projections Through 2021,” page 9.)

The impact is most quickly becoming evident in the social security program most directly affected by the recession: Disability Insurance (DI). The 2012 Social Security Trustees’ Report showed that the DI program was quickly running out of funds. The total income for DI in 2011 was just over $106 billion, while total expenditures were over $132 billion (see page 6 of the report). This left a deficit of $26 billion in 2011, drawing the DI assets down from $180 billion to $153 billion in just one year.

Independent media outlets have slowly begun to report on the near-term difficulties of the DI program. Business Week, for example, reported in late May that the DI program faces insolvency as soon as 2016 or 2017. If the DI program becomes insolvent, incoming taxes will have to cover payments to DI beneficiaries, which as of last year was around 79% of the current payouts. This payout rate would decrease further as the number of beneficiaries continues to increase more rapidly since the latest recession hit. Once on disability, fewer than 1% go back to work, Business Week reported citing government statistics. But as Business Week noted, neither Democrats nor Republicans wanted to tackle this issue directly because it was an election year.

This means that if nothing is done to improve the status of the DI program, after it runs dry in 2017 a beneficiary who currently receives $1,000 a month will only receive about $790 a month directly from taxpayers. This amount would most likely decline even further as more people claim DI in the coming years, given the trend in the increasing number of claimants.

As of December, 10.9 million beneficiaries collected DI, according to the Social Security Administration. This compares to an average of about 8.5 million beneficiaries in 2007, before the recession hit in 2008. After plateauing from 1977-1990 at around 3.4 million, the number of DI beneficiaries began a slow increase, with a sharper increase noticeable in the 2000s. (See the Social Security Administration’s Annual Statistical Report on the SSDI Program 2011, pages 20-21.)

As more people drop out of the workforce – whether due to retirement, changes in family status, permanent disability, or unfortunately due to long-term unemployment – relatively fewer workers pay taxes to support programs such as Social Security, Medicare, or pay federal taxes (from which federal retirees derive a large portion of their pension, in addition to payments made by current workers).

For example, in 1955 there were 8.6 workers paying into Social Security for each beneficiary. By 1965 that number was cut in half, to 4 workers paying into the program for each beneficiary. That number steadily decreased further, until 2010 when only 2.9 workers were paying into the system for every beneficiary. And according to Trustees’ figures, this number will continue to drop to around 2 workers paying into the system for every beneficiary after 2030, as baby boomers retire in staggering numbers (see page 12 of the Trustees’ annual report).

The same general trend impacts federal and military pensions as well, since a lower employment participation rate – and the lower ratio of workers to retirees – mean that fewer workers are supporting federal and military pension systems through federal taxes.

Given the trends, one or a combination of three things will have to happen in coming years: 1) taxes will have to rise even further; 2) benefits and/or retirement ages will have to be re-adjusted; 3) GDP growth will have to increase more rapidly so that real incomes (and hence, taxes paid under current rates) rise faster than payouts are due.

As the 2012 Trustees report notes: “Implementing changes soon would allow more generations to share in the needed revenue increases or reductions in scheduled benefits.” The corollary is that if changes are not implemented soon, only the younger generations will carry the burden of “needed revenue increases or reductions in…benefits.” Unfortunately, there is little sign of this happening in any bipartisan way in the next few years at least. Our only recourse is to keep saving and investing in the TSP, in Roth or regular IRAs, and on our own, because the current benefit structure is clearly unsustainable. The longer we as a nation wait to change it, the greater the pain will be especially for current workers – the only way to cushion it is through individual resources, of which the TSP can be a major component.