Friday, April 15, 2011

Thoughts on Social Security

I had to write about Social Security for a college class, so I started to dig into the issues since I never really paid close attention to it before. Below are my findings, a solution, and thoughts on privatization. Enjoy!

How Social Security works:

Workers pay social security taxes as part of FICA. The SSA pays out existing claims and puts the rest in a trust fund (3).
[Workers] --$$--> [SSA] --$$--> [Existing Claims] --$--> [Social Security Trust Fund]

This is the way the system was designed.

How the Social Security Trust Fund works:

Money put into the Social Security Trust Fund gets invested in special issue Treasuries (3):
[SSA] --$$--> [Social Security Trust Fund] --$$--> [Treasuries (government debt)]

Money removed from the Social Security Trust Fund involves the liquidation of these Treasuries (3):
[Treasuries in the Social Security Trust Fund] --$$--> [SSA]

Again, this is the way the system was designed.

In 2015, according to current projections, incoming Social Security taxes will not be enough to pay out benefits. At that point, the trust fund will have to be tapped, and this is where part of the controversy comes in: where will the US Government get the money to repay the Treasuries (4)?

On the face of it, this isn't strictly a Social Security problem. This is a government budget problem. If the Social Security Trust Fund is gone, it's because the government spent it without offsetting it by decreasing borrowing on the open market.

This is the question that defies a solid answer. Had there been no surplus Social Security taxes flowing into the Social Security Trust Fund, would government borrowing have remained the same? If so, then we as a nation have truly saved that money, and any tax increases necessary to pay it back would have occurred regardless of the existence of Social Security. If our government used that money to increase its overall borrowing power, then paying back Social Security will incur an additional burden we would not have had otherwise (2).

Suffice it to say, if we as a nation truly saved that money, and Congress did not use it to increase borrowing power, it's not a big deal.

But let's consider the more likely case where Congress took the bait and increased borrowing in response to Social Security surpluses. Let me state again: Social Security is not to blame, Congress is. Congress either 1) did not tax appropriately and/or 2) overspent. But in neither case were their actions forced by any burden imposed by Social Security (2).

Having to raise taxes to pay back the Social Security trust fund is not the fault of Social Security, it is the fault of Congress, and such tax increases are necessary only because Congress under-taxed and/or overspent. Social Security is a red herring to deflect responsibility. And it is sick and sad, because it places the burden of our wayward Congress on the backs of retirees.

General tax increases to preserve the solvency of the Social Security Trust Fund by providing funds to repay the Treasuries are a commentary on our federal government's long-term fiscal responsibility, not an indictment of Social Security.

However that's only part of the problem. In 2037, the Social Security Trust Fund itself will run out (4). It is at this point that Social Security truly becomes a problem in and of itself. Several scenarios present themselves:

1. Congress stops all transfers to the SSA as a matter of fully repaying the Social Security Trust Fund. Nothing else is done. Social Security FICA taxes are enough to pay 78% of benefits (4).

2. Same as #1, but Social Security FICA is increased. Social Security benefits remain the same.

3. Have Congress continue transfers to the SSA as a matter of supporting Social Security in the absence of Social Security Trust obligations. Nothing else is done. Social Security doesn't change.

4. Same as #3, but Congress continues transfers in a reduced amount. Nothing else is done. Social Security is able to pay out 90% of benefits.

5. Same as #4, but Social Security FICA taxes are increased. Social Security benefits remain the same.

Before making a selection, you should know that Social Security benefit obligations level off after 2035. This is important, because it occurs before the Social Security Trust Fund runs out. You really need to look at Figure II.D5 in SSA Trustees' 2010 report to understand the situation (4). What you will see there is:

1. Social Security surpluses running out circa 2009.
2. Social Security roughly breaking even until 2015.
3. Social Security benefits outstripping Social Security FICA income as it dips into its Trust Fund from 2015-2037.
4. Social Security reaching a maximum deficit of 1.5% GDP in 2035.
5. Social Security deficits reducing slightly until 2052, and then staying mostly even until 2067.
6. By 2085, the Social Security deficit is still slightly below the 2035 maximum.

Follow me here. In the first part of my post, I stake the position that Congress is responsible for repaying Social Security Trust Fund money. Because they are OUR Congress, we should accept whatever taxes are necessary to do so. By the time Congress is through paying off Social Security Trust Fund obligations, any reduction in transfers to the SSA after that point are a tax CUT. Because the Social Security deficit peaks before that point, merely maintaining those increased taxes and continuing transfers to the SSA is enough to solve the problem.

However, I fully understand the desire to avoid extra post-2037 expenses. The 2010 Social Security Trustees' report indicates that immediately raising the Social Security FICA tax to 14.24 percent from its 2010 level of 12.4 percent will, in addition to Congress paying back the Social Security Trust Fund money, ensure the solvency of Social Security until 2085 (4). At a US median household income of $52,029 (2008), that's an additional $957.33 a year per family over 2010 rates (5).
That's the "increase taxes only" route. The trustees' report tells us that an immediate cut equivalent to 12 percent of benefits would also achieve the same goal (4).

But what is the problem with this? These measures (benefit cuts and Social Security FICA increases) will come as costs to the citizen ON TOP OF general tax increases needed for Congress to repay the Trust Fund. We can't afford that now, but neither should we let Congress and ourselves out of the obligation to repay the Trust Fund. The Republican strategy seems to be one of avoiding fully repaying the Trust Fund through draconian cuts to Social Security. That's not the fair and moral thing to do.
The better thing to do is leave Social Security alone FOR NOW, and focus on repaying the Social Security Trust Fund in full. Do that, and you've solved the problem until 2037, at which time we can either continue our transfers to the SSA (problem solved) or reduce them with an equal offset from a combination of Social Security FICA hikes and benefit cuts (problem solved). Yes, we are looking at increased cost, but that is a consequence of changing demographics.

Repaying the Trust Fund and making Social Security less of a value (higher cost for less) isn't something we can absorb all at once. Let's focus on the Trust Fund now. If we can come up with the fiscal discipline to do that, we can afford to wait a bit longer to solve the longer-term Social Security problem. If we can't come up with the fiscal discipline to just repay the Trust Fund, adding an additional FICA burden or benefit cut isn't going to make it easier to do so.

Also, keep in mind that a percentage of the new taxes needed to repay the Social Security Trust Fund would have been needed anyway, in proportion to the amount of government borrowing that was not done on the open market due to Social Security Trust Fund Treasuries.

Now that we understand that every FICA dollar is needed to pay benefits, plus more, what would we be left with to privatize? I can't find an answer to this from anyone promoting privatization. This is probably because privatization, as a mainstream idea, went down in flames under G.W. Bush. If it had taken hold then, the surpluses from 2004-2009 could have been used to bootstrap such a scheme. Now, frankly, it's too late.

A powerful indictment of privatized Social Security is the finding of Stanley Logue in San Diego, CA. In 2004 he decided to go back and compare what his 45 years worth of Social Security FICA contributions would have earned under Social Security versus what they would have earned on the Dow Jones Industrial Average. The surprising finding was that the stock market investment lost out by about five thousand dollars (1).

It is also important remember that, fundamentally, Social Security is a form of insurance, NOT an investment scheme (1). The goal isn't to generate the highest payout for citizens, it is to preserve capital so that there is something to pay retirees. It is for this reason that Social Security is not a "Ponzi scheme."

Failure of privatized Social Security would only require new and costly government outlays to make up for that failure. Failures of this sort have been seen in Britain (1).

The idea that we could restrict such retirement accounts to safe investments fails too. One of the most aggressive "safe" investments, "Money Market" funds, barely even keeps up with inflation (6). Buying government debt, another "safe" option, is exactly what our current system is doing!

Of course, the recent economic misery is just a nail in the coffin for this bad idea.

(1) Francis, David R. "One Man's Retirement Math: Social Security Wins." December 27, 2004. Accessed April 14, 2011.

(2) Greenspan, Alan. "Economic Outlook and Current Fiscal Issues." Board of Governors of the Federal Reserve System. March 2, 2005. Accessed April 13, 2011.

(3) HowStuffWorks. "How Does the Social Security System Work?" HowStuffWorks. Accessed April 14, 2011.

(4) The Trustees of the US Social Security Administration. "2010 OASDI Trustees Report--financial Outlook for Social Security." Social Security Online. August 9, 2010. Accessed April 14, 2011.

(5) US Census Bureau. "USA QuickFacts." US Census Bureau. November 4, 2010. Accessed April 14, 2011.

(6) Waggoner, John. "5 Things You Can Do Now to Prepare for Rising Inflation." April 23, 2009. Accessed April 14, 2011.

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