Checking in on the retirement crisis

Obviously, we have been preoccupied with two major crises and their fallout over the last 13 years, so we may be forgiven if we lost track of another crisis that is looming in the background: the global retirement crisis. In 1995, the World Bank published a major analysis of the state of retirement systems around the world, which warned that around 2030, the social security systems in the United States and other industrialised countries would be running out of money.

More prominently, a 2002 report by Richard Jackson, which was sponsored and then heavily promoted created an entire wave of investment reports on the topic. These reports focused on how the demographic changes and the retiring baby boomer generation are going to deplete social security and public pension systems and how we all have to save more in our private savings vehicles to overcome the shortfall in public pension benefits.

20 years after this important report it might be a good idea to check in on the retirement crisis and its current state.

First, the bad news. The projections for the funding status of public pension benefits around the world have hardly changed over the last 20 years. I have gone through the long-term projections of the Social Security Trust Funds every year since 1980 and in each and every one of these projections the trusts are projected to run out of money sometime between 2030 and 2035. The same seems true for state pension benefit schemes in other countries like Switzerland. The year when they will run out of money has been remarkably constant and for most countries in Western Europe is sometime in the first half of the 2030s (though there are some exceptions).

Then there is the mixed news. Going back to the 2002 report sponsored by Citi, we can compare the current state of government spending on pension benefits with the spending that was projected for 2020 twenty years ago. The chart below shows that for the United States and the UK the projections made two decades ago were pretty good and if anything too optimistic. Pension benefit spending over the last twenty years in these countries has increased more than anticipated.

Government spending on pension benefits projected twenty years ago and reality

Source: Jackson (2002), OECD

But note that the three countries shown in the chart with the most severe demographic challenges and some of the most generous pension systems in the world (Germany, France, and Japan), have pension benefit spending that is much lower than anticipated. For these countries, the retirement crisis is less of a crisis today than it was twenty years ago.

And this brings me to the good news (sort of). Countries with less sustainable pension systems have engaged in significant pension reform over the last twenty years, while countries like the UK and the United States that had less generous and thus more sustainable pension systems, to begin with, have not. This shows once more that demographics are not destiny because demographic projections that point to a major crisis in the distant future typically do not include the reaction of people to these crises. In the case of the retirement crisis, governments have kept costs under control by cutting benefits, increasing the retirement age, and increasing contributions.

But before you start complaining about the massive tax increases and benefit cuts that are coming our way in the late 2020s, let’s look at a real-life example from the United States. Did you know that in the early 1980s the Social Security Trusts were projected to run out of money sometime between 1981 and 1983? The government of Jimmy Carter had less than five years to prevent US Social Security from failing.

So, in 1977 Congress enacted a law that would increase payroll taxes for social security and disability starting in the 1980s and increase the maximum taxable income for social security. Between 1978 and 1983, the social security payroll tax increased from 10.1% to 10.8% and the maximum taxable income for social security purposes doubled from $17,700 to $35,700. But since that wasn’t enough to stabilise the trusts, President Reagan created a National Commission for Social Security Reform headed by Alan Greenspan. In 1983 Reagan signed the recommendations of this commission into law. The changes made were a continued increase in payroll taxes to 12.4% in 1990 and an increase in the retirement age to 67 by the year 2027. In total, an increase in payroll taxes by 2.3% over a decade and an increase in the retirement age over several decades managed to get the Social Security Trusts into a healthy surplus that lasted several decades.

Today, the payroll taxes for social security still stand at 12.4% and the maximum taxable income has essentially increased with inflation since the Reagan reforms.

Obviously, the demographic challenges waiting for us in the early 2030s are more extreme than the ones in the early 1980s, but this example shows one thing that is often overlooked by fearmongers. When it comes to retirement systems, small changes can have a large impact. All it takes to delay the retirement crisis by a couple of decades are a small increase in payroll taxes of 2% to 4% and an increase in retirement age by a couple of years. And my gut feeling is that if politicians can kick the can down the road with such small measures, they will do just that. So here is my prediction for the retirement crisis: Absolutely nothing will happen until at least 2028 and then governments in the United States and the UK as well as other countries will raise the retirement age to 70 years and increase payroll taxes by a couple of percentage points (just a little bit so as not to cost them too many votes). And we’re done. Then our children and grandchildren can take care of the rest in 2060 or 2070 when most of us are dead or long retired anyway.