Social Security Nonsense
Here's an idea: perhaps we can pass a bill mandating that the Washington press corps attend an educational seminar on the economics of Social Security. Otherwise, we're just going to get more and more stories like this one from Robin Toner of the New York Times. The headline reads: Fragile Hopes for Bipartisan Rescue of Social Security.
The headline implies, of course, that Social Security is in such a dire state that it needs to be rescued. Toner writes:
The "long-term fiscal problems" to which Toner refers are entirely speculative and may well prove to be illusory. If you don't want to take a liberal's word for it, here's Larry Kudlow writing over at The Corner last week:
Thus, the repeated use of the term "bankrupt" in the Social Security context is completely absurd. The program's solvency issues are minor and highly speculative.
But no matter how many times someone explains this, it never seems to soak into the brains of Washington journalists. They insist on portraying Social Security as some sort of doomed program desperately in need of a "bipartisan rescue" and "painful reforms."
Social Security's "fiscal problems" have been greatly over-hyped by people who are more interested in gutting the program than "saving" it. Their goal is to convince the public that the program is in such dire straights that only radical reform can "rescue" it (hence the "need" for private accounts and benefit cuts, etc.). And when journalists like Toner go on and on about these supposed solvency issues, they unwittingly play right into this game.
What's needed right now is not bipartisan reform, but a bipartisan consensus that Social Security is a successful program worth keeping. Only then can we have an honest debate about what minor reforms may or may not be necessary. Our federal government faces a number of very real and much less speculative solvency issues; we don't need to waste our time on fake ones.
The headline implies, of course, that Social Security is in such a dire state that it needs to be rescued. Toner writes:
Many Democrats and Republicans agree that this period of divided government should, theoretically, be an opportune moment to find a solution to the long-term fiscal problems in Social Security, the 72-year-old government pension system. It is almost universally acknowledged that any fix — which would be likely to involve a politically risky mix of benefit reductions, tax hikes or other painful changes — would require broad and deep bipartisan support.This is the newspaper equivalent of file footage, so standard that most Washington journalists could type it in their sleep. It's also totally inaccurate.
The "long-term fiscal problems" to which Toner refers are entirely speculative and may well prove to be illusory. If you don't want to take a liberal's word for it, here's Larry Kudlow writing over at The Corner last week:
As far as Social Security is concerned, a set of optimistic (yet eminently reasonable and realistic) economic assumptions exist which lead to no bankruptcy and no trust fund exhaustion.Moreover, even under the "doom and gloom" forecasts, the projected shortfall is vastly over-hyped. Those forecasts predict that full benefits will be paid up through 2040, and after that, there will still be enough to pay over 75% of promised benefits, which--because they rise faster than inflation--would actually be more in real dollars than benefits are today.
This scenario-one rarely discussed by most-includes slightly less than 3 percent real economic growth, and 2 percent productivity per year. Over the next seventy-five years, this solid growth forecast keeps the Social Security funds alive and well.
(Bear in mind, real GDP growth over the last fifty years has averaged 3.3 percent annually. Why would people assume the future will be the worse than the past?)
Bernanke's gloomy bankruptcy assumptions-where the trust fund is expected to exhaust in 2040-rely on a rather uninspiring economic outlook of around 2 percent growth. This is rubbish. With low tax rates, high productivity and low inflation, our technology based economy is poised for a long cycle of prosperity.
These doom and gloom Social Security scenarios aren't worth the paper they're printed on.
Thus, the repeated use of the term "bankrupt" in the Social Security context is completely absurd. The program's solvency issues are minor and highly speculative.
But no matter how many times someone explains this, it never seems to soak into the brains of Washington journalists. They insist on portraying Social Security as some sort of doomed program desperately in need of a "bipartisan rescue" and "painful reforms."
Social Security's "fiscal problems" have been greatly over-hyped by people who are more interested in gutting the program than "saving" it. Their goal is to convince the public that the program is in such dire straights that only radical reform can "rescue" it (hence the "need" for private accounts and benefit cuts, etc.). And when journalists like Toner go on and on about these supposed solvency issues, they unwittingly play right into this game.
What's needed right now is not bipartisan reform, but a bipartisan consensus that Social Security is a successful program worth keeping. Only then can we have an honest debate about what minor reforms may or may not be necessary. Our federal government faces a number of very real and much less speculative solvency issues; we don't need to waste our time on fake ones.
posted by A.L. at 10:38 AM
12 Comments:
I don't know how anyone can look at the demographic trend of the United States and not conclude that Social Security is in enormous trouble. The ratio of workers to retirees is 3:1 and is approaching 2:1. At a worker:retiree ratio of 2:1, payroll taxes would have to be 50% to provide an average income to retirees; 25% to provide half of an average income.
The problem with Social Security isn't that it's unsustainable. The system can be sustained indefinitely by tax hikes and benefit cuts. The problem is that Social Security is a really bad deal. It wasn't always so, but with the shift in demographics has made Social Security a terrible investment. The real rate of return on Social Security is roughly 1.23% (it varies with income).
That rate of return is unacceptably low. Anything less than 4% is absurd. The S&P 500 averages 7.22%. Of course, with the higer return comes more risk. But even a money market fund provides a higher rate of return than Social Security. We can do better than Social Security without added risk.
How bad of a deal does Social Security have to become before we get rid of it? Every single American would be better off by privately investing their payroll taxes. Getting generation after generation addicted to Social Security is a great way to secure votes. But for many, it's also a one-way ticket to an impoverished retirement.
Amen Bill. Only someone with their head in the sand (or somewhere else) would think that our Social Security system is "successful."
It's an antiquated program that needs to go. Throw in all of the talk about extending benefits to illegals who have never paid a cent into it and you have a recipe for catastrophe.
When I stop and think about the returns I could have gotten had I been allowed to invest all of the money I've shelled into the S.S. system, it makes me shudder. I could retire 10 years earlier than I'll be able to. And all of that for crappy benefits.
Yeah, GREAT system...
I don't know how anyone can look at the demographic trend of the United States and not conclude that Social Security is in enormous trouble.
This demographic trend is a problem for medicare, but not so much for Social Security. Social Security currently runs a large surplus in anticipation of this trend. That surplus will be used to pay future benefits. By even the most pessimistic projections, only very minor tax increases/benefit cuts will be needed to keep the program going. And as Larry Kudlow points out, if our economic growth over the next 40 years is equal to our economic growth over the last 40, the program will remain perfectly solvent as is.
Ranting is not math. Find me any projections or sets of numbers that show the system to be in "enormous trouble". You won't find them.
Amen Bill. Only someone with their head in the sand (or somewhere else) would think that our Social Security system is "successful."
And only someone with no sense of historical awareness could think the program hasn't been successful. The Social Security program basically single-handedly ended the crisis of elderly poverty in America. America is a far better place today because this program was implemented.
I think both you and Bill misconceive what Social Security is supposed to be. It's not supposed to be a government-sponsored 401k plan. It's supposed to be a social safety net, a form of social insurance. It provides a minimum level of retirement support to all people and it provides disability protections to those who are injured and can no longer provide for themselves. In other words, it's much more analous to a life insurance policy than a 401k. Part of your "premium" goes toward providing you disability protection; the rest is given back to you with a modest return down the road.
Social Security currently runs a large surplus in anticipation of this trend. That surplus will be used to pay future benefits.
But the trend shows no sign of ending. The ratio of workers to retirees is approaching 2:1 and looks to stay there. Even if there were money in the Social Security Trust Fund, it won't last forever. The pay-as-you-go scheme cannot escape the reality of demographics. The ratio of workers to retirees is the absolute limiting factor.
By even the most pessimistic projections, only very minor tax increases/benefit cuts will be needed to keep the program going.
Perhaps only minor payroll tax increases. There is no money in the Social Security trust fund; there are only bonds. When the government goes to cash those bonds to fund Social Security, they're going to have to raise the money, somehow. Do you really think Congress will cut that much discretionary spending? If it's not an increase in payroll taxes, it'll be an increase in income taxes.
Ranting is not math. Find me any projections or sets of numbers that show the system to be in "enormous trouble".
The funding of Social Security is governed by a very simple equation: p = t*w/r where p is the percentage of an average salary to be provided to retirees, t is the payroll tax rate and w/r is the ratio of workers to retirees. As w/r decreases, you only have 2 options: increase t or lower p. The Trust Fund (if it weren't an accounting fiction) could be used to smooth out small blips in the demographics, but it cannot alter the reality of the situation.
Here's more math. Consider the case of a minimum wage worker. He works 2080 hours per year at $5.15 per hour. His total payroll taxes are $1,638.94. Instead of paying payroll taxes, what would happen if he were allowed to purchase private disability insurance and invest the rest in an S&P 500 index fund?
Disability insurance costs about 2.74% of salary, leaving $1345.63 for investment. An S&P 500 index fund has an average real return of 7.22% (at least; some will argue it's over 8%). Full retirement age is 67, making for 67-18=49 working years. How much money would our minimum wage worker have upon retirement?
F = D * (exp(r * t) - 1) / r
= $1345.63 * (exp(7.22% * 49) - 1) / 7.22%
= $622329.76
That's over half a million dollars, which will generate an expected $46,594.01 per year in earnings. In comparison, Social Security will replace at most 85% of his pre-retirement earnings. That's a paltry $9105.20 or one FIFTH of the projected earnings. Even if his investments only produce HALF the expected earnings, that's still 250% of what Social Security will provide.
So again I ask: How bad does Social Security have to get before we get rid of it? It's already a really bad deal and it's just going to get worse. Do the expected earnings have to be ten times Social Security "guarantee"? Twenty times? And in the mean time, what do we say to the people who could have had a comfortable retirement, but will instead spend their golden years bordering on poverty because of Social Security?
The Social Security program basically single-handedly ended the crisis of elderly poverty in America. America is a far better place today because this program was implemented.
Your statement assumes that the opportunity cost for Social Security is zero. It is not. What if Social Security had been implemented like a 401k plan instead of a pay-as-you-go program? Not only would the program be on more solid financial footing, but everyone would be getting higher benefits. If that's not a win-win situation, I don't know what is.
But the trend shows no sign of ending. The ratio of workers to retirees is approaching 2:1 and looks to stay there.
Of course the trend will end. Unless people stop procreating altogether (ala "Children of Men") the trend will level off. The demographics calculations are factored into even the most pessimistic models.
When the government goes to cash those bonds to fund Social Security, they're going to have to raise the money, somehow.
I agree, but this isn't a flaw in the Social Security program; it's a flaw with the overall budget. Social Security pays for itself.
I'm all for looking through the budget, including Social Security for ways to cut back, but it's dishonest for politicians to put the blame on the Social Security program.
Instead of paying payroll taxes, what would happen if he were allowed to purchase private disability insurance and invest the rest in an S&P 500 index fund?
That depends on whether you made this mandatory or not. If it was voluntary, then most low to medium wage workers would elect to forgo disability insurance and keep their money rather than invest it in any 401k type fund. That's human nature. The result would be a lot of very desparate disabled and elderly people that the government would end up bailing out anyway and would create all sorts of strains on society. This would end up costing more and would defeat the entire point of Social Security.
If you made the purchase of disability insurance and investment in the index fund mandatory, you've basically just recreated our current system, except you've made it much more complicated and added lots of unnecessary transition costs.
What if Social Security had been implemented like a 401k plan instead of a pay-as-you-go program? Not only would the program be on more solid financial footing, but everyone would be getting higher benefits. If that's not a win-win situation, I don't know what is.
First of all, Social Security was implemented the way it was because elderly people were destitute and needed support right away. There was no way to go back in time and deduct money from their checks, so it was implemented as a pay-as-you-go system where one generation helps fund the next.
Second, while stocks have performed better over time than bonds, they have done so unevenly, meaning your benefits would vary quite a bit depending on the happenstance of when became eligible to collect them (and that's assuming the equity premium going forward is the same as it has been historically).
I think it would make more sense to allow the government to invest the whole pool of money in something other than bonds. This would reduce transaction costs and give everyone the equal benefit of the equity premium regardless of what stage of the market cycle they happen to retire.
If you did that, though, there would be high transition costs as you switched from a paygo system to a stored assets system. That money would have to come from somewhere else.
Of course the trend will end. Unless people stop procreating altogether (ala "Children of Men") the trend will level off.
Poor choice of words on my part. But the point stands. The ratio of workers to retirees is decreasing and doesn't look like it's going back up any time soon. People are living longer and having fewer children. It's the way it is.
I agree, but this isn't a flaw in the Social Security program; it's a flaw with the overall budget. Social Security pays for itself.
That's simply not true. If Social Security is going to pay for itself, payroll taxes are going to have to increase to more like 25%. As long as the system is pay-as-you-go, there's no way it will be able to pay for itself without tax hikes or benefit cuts. And either one of those will make the program an even worse deal than it is today.
That depends on whether you made this mandatory or not. If it was voluntary, then most low to medium wage workers would elect to forgo disability insurance and keep their money rather than invest it in any 401k type fund.
Comparing Social Security to a non-mandatory 401k-type plan is the ultimate in comparing apples to oranges. Yet people make that comparison all the time. Of course it would be mandatory, just like Social Security is mandatory, now.
If you made the purchase of disability insurance and investment in the index fund mandatory, you've basically just recreated our current system, except you've made it much more complicated and added lots of unnecessary transition costs.
That's nothing like the current system. The current system is pay-as-you-go, has no concept of ownership, is extremely sensitive to demographic changes and is on seriously questionable financial footing. What I've described is none of these things. Nor is it complicated. You take your money and purchase securities which you own to finance your retirement. How is that complicated? Millions of Americans do it every day.
Second, while stocks have performed better over time than bonds, they have done so unevenly
That's true, but it evens out over time. I'm not talking about short-term investing, here. Investing for retirement is a very long-term prospect. If you look back over the returns of the S&P 500, the difference in returns between the best 40 years and the worst 40 years is a mere 1/2%.
I think it would make more sense to allow the government to invest the whole pool of money in something other than bonds.
Well that would certainly be better than the current situation. I know a lot of people who cringe at the thought, though. Allowing the government to buy vast amounts of corporate stock is a sketchy prospect. Even if the government waived its corporate voting rights, it would still have undue influence in publicly traded companies. Personally, I think this could be worked around. Others are not so sure.
If you did that, though, there would be high transition costs as you switched from a paygo system to a stored assets system. That money would have to come from somewhere else.
I admit the transition costs are high. But the cost of waiting (or worse, doing nothing) is much, much higher. I have what I consider to be a pretty novel idea for covering the transition costs. There are trillions of tax-deferred dollars sitting in IRAs and 401ks. Just tax them. These shelters are mostly abused by the wealthy, anyway. And it's not like the taxes aren't owed; they're just deferred. Even if that money were only taxed at the 15% rate, it would raise enough money to completely bail out Social Security.
Bill, I appreciate the dialogue. You've clearly given this a lot of thought.
I've got to disagree strongly with this, though:
If Social Security is going to pay for itself, payroll taxes are going to have to increase to more like 25%. As long as the system is pay-as-you-go, there's no way it will be able to pay for itself without tax hikes or benefit cuts.
You are far too certain. These projections are all highly speculative because they involve forecasting how the economy will grow over the next 40+ years. As a number of economists have pointed out, there are a very reasonable set of assumptions under which growth more than compensates for liabilities and there is no Social Security shortfall. Even under the gloomy Trustees forecast, the shortfall is not that big. It could be paid for entirely by rescinding just a fraction of Bush's tax cuts, without any benefit cuts.
You also overstate the demographic trends. While the trends are real, they will level out and the continued immigration of young workers can and will compensate somewhat for the aging of the population. Like I said, the various projections all take this into account.
As for this:
I have what I consider to be a pretty novel idea for covering the transition costs. There are trillions of tax-deferred dollars sitting in IRAs and 401ks. Just tax them. These shelters are mostly abused by the wealthy, anyway. And it's not like the taxes aren't owed; they're just deferred. Even if that money were only taxed at the 15% rate, it would raise enough money to completely bail out Social Security.
That's actually a very interesting idea. It would essentially be a loan, but an interest free one for the government. Creative. I wonder if there are any Due Process or Takings Clause problems with such a plan. Do you know if it's ever been proposed?
"Part of your "premium" goes toward providing you disability protection; the rest is given back to you with a modest return down the road."
Unless you inconveniently die too early, whereby the government takes every cent you've paid in and keeps it (oh, I forgot about the $255 death benefit to the family.)
It was intended as a social safety net at a time when our economy was in ROUGH shape. It's not needed anymore. It needs to be pitched. If the government wants to "force" people to save for retirement, fine. But give them better options than what we're offered now. I can get a MUCH better rate of return on my money than what the government offers.
Dynamite post. I keep telling people the same thing, and have yet to meet a person (with exception of a few economists) that understand this as the true situation we are in.
These projections are all highly speculative because they involve forecasting how the economy will grow over the next 40+ years.
Our exchange reminds me very much of a scene from "Monty Python and the Holy Grail". "It's not a question of where he grips it! It's a simple question of weight ratios! A five ounce bird could not carry a one pound coconut." And really, that's exactly what we're talking about, here. Two workers are simply not enough to support one retiree. Given any reasonable amount of real wage growth, it's just not going to happen.
Imagine you're a new retiree with an average pre-retirement salary. There are two workers out there, also with average salaries, who are going to give you their Social Security taxes. Only you don't get all of their Social Security taxes because only 78% of Social Security taxes go to retirees. So you end up getting 9.6% of each worker's wages. Since there are two workers, you end up getting 19% income replacement.
That's not nearly enough to cover Social Security's liabilities. Social Security currently promises to replace between 45% and 85% of pre-retirement wages, with an average of 63%. In order for that to happen, real wages would have to go up by a factor of three from one generation to a next. That would require real wage growth over 6% annually. Even the GDP only grows at 3% or so. Real wages have no chance of growing at 6%.
But all that is missing the point. As I said in my first comment, Social Security can be sustained indefinitely by tax hikes and benefit cuts. But even under the current tax rate and benefit schedule, Social Security is a bad deal for everyone. There's just no reason to "stay the course" with Social Security. It's a bad deal that's just going to get worse.
That's actually a very interesting idea. It would essentially be a loan, but an interest free one for the government. Creative. I wonder if there are any Due Process or Takings Clause problems with such a plan. Do you know if it's ever been proposed?
I have no idea. I don't think of taxing 401ks and IRAs as a loan to the government. Quite the opposite, I think of it as the government calling in a loan. That's essentially what the tax-deferred retirement plans are. The government agrees to defer taxes on your savings (i.e. float you a loan) in exchange for two things. First, you don't touch the money until age 59.5. Second, when you do touch the money, you pay ordinary income taxes on it.
Obviously, I can't speak for everyone. But if someone offered to let me stop paying FICA in exchange for giving up my tax shelters, I'd do it in a heartbeat. I'd even give up all the money I've paid in to FICA. Heck, I'd give up my tax shelters to get HALF of my FICA dollars back. That's how bad of a deal Social Security is.
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