Social Security Reform
Why We Have To Act NOW!!!
SOCIAL SECURITY FIX CAN'T WAIT
WE ARE:
- Mortgaging our children's future
- Crippling our economy with debt
- Promising our children benefits we can't deliver
OUR LEADERS:
- Fear debt reduction, especially in an election year
- Prefer underfunded entitlements to debt reduction
- Promise to tackle the debt at some vague future date
WE MUST:
- Understand that Social Security is not on their RADAR
- Recognize that it is unlikely to be addressed in this election cycle and probably not before 2013
- Demand urgent action to attack debt and give the system time to heal
Overview: Where Do We Start?
Origins of My Social Security Reform Proposals
Like most Americans over the last 25 years, I was vaguely aware that at some “distant” point, Social Security would be unable to meet its obligations. When President George W. Bush set out to reform Social Security, many of us studied the issue in more depth, attempting to indentify the flaws in the system and to understand the options for correction.
In the meantime, our financial systems, both private and governmental, have reached a tipping point. Economic growth and resulting revenues have taken a nose dive. This revenue reduction places new limits on our choices.
At the same time, two trends exacerbate the crisis. First, governmental fiscal and monetary policies have emphasized expansion rather than reduction of spending and deficits to cope with the “Great Recession.” Second, the government policy makers continue to woo voters with new entitlement programs, sequenced in a manner which increases debt and unfunded obligations while deferring entitlement reform.
The belief is that Social Security, a “third rail of politics,” presents huge risks to incumbency, thus discouraging action and reducing the debate to a quest for partisan advantage. How do we change the rules of the political game? For far too long, we have seen delay and the framing of the arguments in intellectually dishonest ways. A reduced rate of increase becomes a decrease in benefits. An effort to increase the amount of money earning a better rate of return becomes an effort to “destroy Social Security.”
We need to individually understand the problems and the reform choices and to convince our representatives that we are well informed and demand action. To accomplish this, public opinion must reach a critical mass which convinces our representatives that we will hold them accountable for solving this urgent problem now. Hopefully, we can accomplish this by shining the bright light of truth and logic on the problem, rather than merely creating partisan heat.
The purpose of this discussion is to stimulate public interest, understanding, and action. It is also a call for an American solution for an American problem, rather than partisan and self-serving response by our leaders.
Analysis and Framing The Debate
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Overview. The Social Security shortfall results from structural problems, not just current contribution rates and related benefit levels. If we only increase tax rates or reduce benefits without structural reform and focusing on both inflow and outflow, we merely defer the solution and fail to fix the problem just as was the outcome of the Greenspan Commission.
An honest appraisal of the original purpose of Social Security is that it was to be social insurance for retirement. Even the funding act was named “Federal Insurance Contributions Act.” In order to provide coverage quickly, the system incorporated a “pay-as-you-go” feature wherein current workers supported current retirees. This feature was an expedient solution to a prompt start-up, not necessarily a long-term requirement of the system.
Over the years, the system has trended away from the social insurance approach which provided beneficiaries with a sense of dignity (“I paid for my retirement.”), toward a welfare system. Some of the specific redistributive elements include the Earned Income Tax Credit, elevated caps on FICA taxation, AMT, and taxing the benefits of retirees with higher incomes. President Obama promises to further raise the tax cap and use this as a “refundable tax credit” to reduce net contributions of lower income earners, moving the system dramatically closer to welfare and reducing net contributions to the system.
This trend does not keep faith with the social insurance construct and further diminishes the veracity of Congress.
The structural problems result from demographic changes such as fluctuating birth and death rates, the percentage of people in the workforce, unemployment rates, people’s choice of retirement age, and the rate of immigration. The economic growth rate influences hours worked and total earnings. Productivity growth and inflation rates also impact the system. Finally, the system is based on a pyramid method of financing with no mechanism for adjusting to the actual ratio of workers to retirees – about 3:1 now, down from 50:1* at the start of the program. (*Based on the late Senator Moynihan’s comments during the final meeting of the “President’s Commission to Strengthen Social Security.” Others variously use 42:1, 40:1 and 16:1.)
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Political Considerations. There is a considerable gap to be bridged between the Democrat and Republican approaches. Neither the respective Congressional leaderships nor the Obama approach bode well for meaningful reform. The net result is to squander more precious time during which real reform could incrementally improve the system’s sustainability.
Democrats reject enhancement of earnings by labeling them as efforts to destroy Social Security. They oppose attempts to slow the rate of growth in benefits, calling them “cuts.” This leaves tax increases as the only recourse. Further, they want substantially greater progressivity, which results in redistribution, moving toward welfare. Others suggest means-testing for benefits.
An alternate view is that benefits should be expanded. The funds would come from general revenues or increased debt. This is a debate for another, more prosperous day. Achieving solvency is the focus of this analysis and the priority of these troubled times.
Republicans want Personal Retirement Accounts (PRAs) to enhance earnings and benefits. Most subscribe to a system of “carve-outs” from current contributions. Critics label these as cost increases requiring interim deficit financing while increasing risks. Advocates argue that intermediate deficit financing is an investment in a more sustainable and perhaps generous system. Enhanced earnings entail possible higher risks as opposed to the certainty of inferior returns. Republicans also suggest raising the retirement age and recalculating the initial benefit level using CPI rather than wage increases. After retirement, they suggest using the more accurate and conservative chained CPI as the COLA. Others believe an “add-on” PRA is the appropriate approach.
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Solution Principles. Any solution should incorporate the following principles.
Truth in labeling. Keep faith with the original intent of providing a social insurance system. Avoid labeling a slower rate of growth as a “cut.”
Finish what you start. Solve the Social Security Retirement problem before starting any new entitlement programs. If the new plans are critical, expedite Social Security reform so we can move on to the next issue.
Reform the system. The current financial crisis magnifies the necessity of reforming our financial systems and reducing the growth in our structural debt. Social Security is one of the most important.
Solve the structural flaws. The rising deficits in the system flow directly from its structural flaws. Failure to fix these flaws merely delays the solution and increases the pain. The system must be secure and sustainable.
Maximize earnings. Any solution must include enhancing earnings, not just taxes.
Time is of the essence. The sooner the system is reformed, the longer it has to mend the system deficits and minimize the risks to the participants. Baby Boomers are beginning to retire, launching a spike in shortfalls and increasing the pain which must accompany both inaction and solving the problems.
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Problems and Solutions. The "List of Problems" page is reasonably comprehensive. Coupled with the above solution principles, they outline a framework for reform. My suggested solutions offer some reform ideas and are not intended to be the sole solutions to the problems.
Identifying the Problems...And Possible Solutions
| Problem | Solution |
|---|---|
| 1. People are living longer, resulting in an increase in the total cost of retirement. | Index benefits to reflect life expectancy. Cost shift to younger workers will be eliminated or reduced. Perhaps a choice of higher contributions or a combination of the two approaches would be practical. Some have suggested raising the retirement age. The downside of this approach is that physical and mental deterioration due to advancing age do not necessarily delay their appearance, just because life expectancy increases. Retirement age should recognize this fact and be as humane as practical. |
| 2. Social security is a pyramid system, requiring existing workers to support a smaller number of retired citizens. The number of retirees keeps rising while the workers supporting them decline as a percentage of retirees. This increases the unfunded liability, ultimately shifting the shortfall to workers, present and future, as drastically elevated taxes or reduced benefits. It further increases the “real” national deficit and influences the strength of the dollar and other economic factors. | Move the system toward an insurance or annuity system where each employee’s benefits become increasingly funded by contributions based on his own earnings over time. A Personal Retirement Account (PRA) similar to the Federal Thrift Savings Plan should be established. As part of this plan, we should shift at least part of the 401(k)-IRA programs to the Thrift Plan under the Social Security System. If established as an opt-out program, broader enrollment should result. Management fees should be less and management should be generally better and more consistent. As the health of the Social Security System improves, a small but increasing share of this improvement would be diverted to the PRA, thus making a larger pool of investable funds and enhancing benefits at retirement. It would also be an added incentive for the enrollee to invest more in his PRA, if allocated on a partial matching basis. The system would initially be an add-on, but could gradually be transitioned to a “carve-out” system. |
| 3. Pay-as-you-go exacerbates the pyramid nature of Social Security. It is complicated by demographic changes and reduces the pool of investable funds and thus reduces ultimate benefits. | Phase out the pay-as-you-go feature over time, moving the system toward a “premium for benefit” plan. The personal account could be a vehicle to do so. Over time, this will increase the pool of investable funds, enhancing earnings growth and retirement benefits. |
| 4. Indexing to wages rather than to CPI raises the retiree’s benefit well above the cost-of-living increase during his working years. This disconnect is expected to double a retiree’s benefit by 2077. | Convert to a CPI indexing. A system similar to that proposed by Robert C. Pozen might be a suitable model. |
| 5. The cap on income subject to FICA tax is a point of contention. To use it as a means of increasing funding and transferring wealth fails to deal with the structural problems and moves away from an insurance and toward a welfare system. | Maintain the existing cap system. Continue the current method of indexing the cap to wage inflation. Avoid increasing the real rate of taxation. |
| 6. Penalizing “retired” workers who work while drawing Social Security reduces their income enhancement options. It also reduces contributions from those who are discouraged from working due to the penalty. | Eliminate or minimize this penalty. As life expectancy increases, more retirees may choose this option, reducing the strain on the system while improving income. |
| 7. Increasing payroll taxes to enhance revenue fails to solve structural problems and kicks the can down the road. Furthermore, there is a temptation to increase the progressivity of the tax, thus moving the system closer to a welfare plan. | Avoid merely raising tax rates. However, increasing rates by indexing to life expectancy is an acceptable solution, because it enhances the insurance aspect of the system and moves toward a solution of a structural problem. |
| 8. There is a limited amount of investable funds in the system earning inadequate rates of return (1-2% on contributions) to play a significant role in the program’s sustainability. | Better returns are required and the inflow of more funds into the investment pool are necessary. Contribution rates and PRA’s mentioned above are ways to improve this area. |
| 9. Stabilizing investment market values is a necessity. | PRA values must be protected by insurance, hedging or other risk-reduction techniques to prevent catastrophic losses. |
Dispelling Myths About Social Security
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Just raise the contribution rate and the problem is solved. Since its inception, the Social Security contribution rate has been raised more than 20 times, yet debt problems persist. When you combine FICA taxes with the taxes required to pay off the Medicare and Medicaid shortfalls, it will require draconian rate increases which will not only retard enonomic recovery, but stifle future growth.
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Congress should be covered by Social Security. They are. The law was changed in 1984 (25 years ago). All subsequent incoming members are covered under Social Security. The existing members had a choice of remaining in the Civil Service Retirement System or converting to the new system.
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Borrowing from Social Security Trust Fund is the underlying problem. I disagree as apparently do more than a dozen authors of proposals on reform, because they do not include changes in the Fund as one of their suggestions. Furthermore, once the accumulated annual surpluses are depleted, the Fund will equal zero and the unfunded obligations remain and must be paid.
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The suggestions are not actuarially sound. Untrue. The short answer is (1) The Progressive Indexing plan of Robert C. Pozen has been reviewed by the Chief Actuary of Social Security and found to result in a solvent and financially self-sustaining system by the end of 75 years and (2) regarding Senator Bennett’s “Social Security Solvency Act of 2009”, S.426, the Chief Actuary in his 2/12/09 Memorandum says “The Bill would be expected to restore solvency for the OASDI program through the next 75 years and beyond ---.” This bill reflects substantially my suggested solutions.
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Social Security is unconstitutional. This is an opinion, not a fact. Thus far, it has not been the opinion of the Supreme Court nor has it emerged as a contemporary national issue. Furthermore, the law and its precedent have been in place for nearly 75 years, so it is reasonable to consider it settled law. In the meantime, its problems remain and must be fixed.
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"Currently, the Social Security system is generating surplus tax revenues and is not facing an immediate financial crisis.” (This is a direct quote from the 9/28/09 letter to me from Congressman Jim Matheson.) According to an article dated 10/02/09 in the Deseret News, “The program paid out $6 billion more in August than it took in. It’s projected to run in the red for the next two years before returning to a surplus in 2012.” Additionally, the Social Security Administration projects deficits to resume by 2016 and continue unabated thereafter through the 75-year time frame. Meanwhile, the national debt is exploding and the unfunded entitlement obligations are outstripping our most pessimistic forecasts. Coupled with the “Great Recession” and its increasing and continuing unemployment causing plunging tax revenues, I believe we have an immediate crisis.
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Changing to progressive indexing employing CPI rather than wage indexing would reduce benefits. Untrue. While the rate of increase will be reduced, benefits will remain basically unchanged in real dollars because they are tied to CPI.
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Indexing to longevity will reduce benefits. Untrue. It will leave total retirement dollars constant, but will alter the monthly distribution. Raising the retirement age reduces total retirement dollars and may result in additional contributions during the excluded retirement years.
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Changing COLAs to chained CPI will reduce benefits. Untrue. While excessive increases due to miscalculating inflation will be eliminated, the resulting benefit will be more accurate and remain inflation protected. It will be constant in real dollars.
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Current program benefits are guaranteed, so you are really reducing these guaranteed benefits. Untrue. Promised, but unfunded “benefits” are not true guaranteed benefits because they can be modified by passing a law, may be defaulted, funded by increased taxes, or “paid for” by borrowing and debasing our currency. In all cases, net real benefits would be reduced.
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Personal savings accounts will require massive borrowing, “destroy” Social Security, and cause unacceptable risk. This assumes the funding is by utilizing part of current FICA revenue, thus reducing traditional Social Security Funds. If it is a contributory add-on feature, no borrowing will be necessary. A choice of investments ranging from government bonds to stock and bond funds would be available. The base of traditional Social Security would maintain current safety, while the add-on offers the high probability of increased ultimate benefits at moderately increased risk. Freedom to opt out, determine contribution level, and select the degree of risk remain with the participant. The 401(k) and IRA systems already mimic this approach. If it is a carve-out, it will likely increase benefits and would require less interim borrowing than maintaining the current system through borrowing.
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Personal savings accounts are a radical idea and will “privatize” the system leading to its destruction. Untrue. Privatization is a politically charged word implying totally scrapping the existing insurance approach. By employing add-on Personal Savings Accounts under Social Security, you combine the best of the current system with the promise of improved earnings, ownership, and dealing with the difficulties posed by pay-as-you-go and the declining ratio of workers to retirees.
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These "fixes" will fall too heavily on the shoulders of the lower-paid workers when they retire. Unlikely. The "Progressive Indexing" concept does not change the benefit level for the bottom 30% of wage earners, so there is no change in their initial benefit level. Longevity indexing could have significant impact on initial benefits if longevity changes rapidly. However, it does not change the total amount of retirement benefits. By indexing contributions instead, this burden can be spread out over a working life.
Is Borrowing From The Fund The Problem?
Is Governmental Borrowing From The Fund The Cause of The Impending Bankruptcy of Social Security?
Many people believe that Social Security has a fund that is designed to accumulate all or most of the money planned for their individual retirement and that somehow government-borrowing diminishes this fund and is responsible for the Social Security shortfall.
This is not the case. Social Security is designed as a pay-as-you-go system, which means that current workers’ contributions fund current retirees’ benefits. Combined with a declining ratio of workers to retirees, you have a Ponzi scheme. For example, if you have a system which requires that ten (10) workers each pay $5,000 annually or $50,000 total to support one (1) retiree, but the number of workers supporting that one retiree shrinks to five (5), their combined annual contribution will drop to $25,000. Thus, a $25,000 annual shortfall results. This growing shortfall is exacerbated because benefits are already growing faster than revenues.
In the short term, there are temporary periods when the system collects more than it pays out. The difference results in a small surplus which can be invested to earn income for the system. By 2016 these temporary surpluses will cease and investable surpluses will be drawn down to zero within 28 years from now. At that point, there will be no fund and future shortfalls will be reflected as unfunded obligations, regardless of previous borrowings from the Fund.
Others have the impression that there is an inherent problem with government-borrowing from an agency or institution within the government. They also believe this is a major contributor to the shortfall. I disagree, although I concede it makes borrowing easier and therefore may marginally influence total government spending and deficits.
Institutions with a surplus of cash typically do not hide it under the mattress. Instead, they lend the cash or otherwise invest it to yield revenue. The Social Security Fund is no exception. Its possible choices are to lend it to the government or to some other creditor. In either case, the Fund is converting idle cash to a receivable or other type of asset which can be converted back to cash when required. Few would suggest that the institution, even the Social Security Administration, is “broke” by virtue of such a transaction. Furthermore, corporations frequently “borrow” from one division or subsidiary to meet cash requirements of other divisions.
The Federal Government has run annual deficits, with few exceptions, during the post-WWII era. To finance these shortfalls, they have had to borrow. Whether they borrow from the Social Security Fund or elsewhere, they generate the needed cash and obligate the taxpayer. This has the same effect, regardless of the source of funds. When the government repays the fund, the taxpayer’s obligation remains the same, because repayment must be financed by borrowing due to the continuing deficits.
If a commitment is made to pay 100% of a promised benefit, but only 80% of that amount is funded, the shortfall is 20%. If part of that 80% is loaned out and is subsequently repaid by the borrower, the shortfall is still 20%, ignoring interest earned and administrative costs. The basic problem remains unchanged.
Therefore, the shortfall in the Social Security Fund is underfunding due to mismatching revenues and payments over the long run. This mismatch is due to increased longevity, benefits rising faster than revenues, fewer workers supporting more retirees (originally 40:1 now 3:1 moving toward 2:1) and “pay-as-you-go” funding. So this mismatch must be addressed to solve Social Security’s problems.
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Your essay touched on this, but didn't specifically identify what I believe is the overall "big picture" issue. Social Security suffers from the same flaw as the automakers retirement plans which contributed to their recent bankruptcies.
All are examples of Defined Benefit Plans. Benefit levels are set ahead of time, based on projected future contributions. The problem comes when, as you mentioned, demographics change, or the economy struggles. Contributions to the plan vary. Soon the unfunded obligations can spiral out of control.
I think the problems you mention are all caused by this.
The alternative is a plan, of which an IRA is an example, called a Defined Contribution Plan. These are necessarily individualized plans in which the amount contributed = the amount paid out. Such plans work because the contributions are invested, and grow over time, multiplying the benefits.
I think that's what you had in mind when you talked about getting away from the pay-as-you-go funding.
I think Pres. Bush's proposal to invest some FICA taxes in individual accounts was a step in the right direction. I think the system will need to be privatized eventually, over time. Ultimately, the best solution will be to invest all out FICA taxes, and the employer component into individualized accounts invested in the private sector (inaccessible to the beneficiary, as are FICA taxes), with perhaps a small fund to equalize benefits for those who's earning power is greatly below average,or who are close to retirement age.
This would not only shore up SS, but the added investment, long-term investment, would help the overall economy. And, finally, this, if done properly, would reduce government influence in the private lives of citizens - always a good thing.