Ethics and Public Policy Center James C. Capretta October 24, 2006
In recent weeks, both President Bush and new Treasury Secretary Henry Paulsen have made it clear they are planning another effort to rein in future spending on the highly popular, but expensive, federal entitlement programs: Social Security, Medicare, and Medicaid.
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The unprecedented aging of the U.S. population will put tremendous pressure on the federal budget. According to the Congressional Budget Office (CBO), between 2010 and 2030, spending on the big three entitlements will go from 9.2 percent to 15.2 percent of GDP using intermediate assumptions — a 6 percentage point increase in just 20 years.
Bush’s attempt in 2005 to start the entitlement reform process with Social Security showed just how steep the hill is for would-be reformers. It is no accident that Social Security hasn’t changed in any significant way in more than two decades. With no imminent crisis, U.S. politicians have found it relatively easy to delay the tough decisions on entitlements even as the budget crunch draws near.
That’s not the case for most of Europe’s state pension programs. With plummeting birth rates, rapidly aging populations, and expensive benefit formulas, governments throughout Europe have been forced to act — some more decisively than others — to head off the financial train wrecks that were, and in some cases still are, already upon them.
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Yes, we should always study ways to make our Social Security system more financialy secure and sound. But as hard and fast rules, proposals to modify the existing system should neither compromise the economic security of the program’s beneficiaries, nor should it require that future taxpayers assume massive amounts of debt.
Republican proposals to “reform” (and I use the word loosely) social security that were offered in 2005 failed both tests. The GOP proposals would have required massive amounts of borrowing to initially fund private accounts. Once established, the private accounts themselves would have been exposed to the fluctuations and downturns in the market.
The fate of the social security system is always made to sound more dire than it actually is, by combining it with the Medicare program, which is in fact a a major cause for fiscal concern. By itself however, the social security program is not in trouble. Forecasts by actuaries continue to show that the program will meet its obligations through 2047 assuming strong or moderate economic growth. If there is weak economic growth, then it is safe to assume that private accounts tied to the stock market would not fare as well either.
After 2047 the Social Security Trust Fund will have at least 75% of the fubnds it needs to meet its obligations and the difference can easily be made up with minor changes such as raising the retirement age a few years or raising the income level subject to FICA taxes. We should remember that the dollar loss of revenue resulting from of the Bush/GOP tax cuts over 75 years is 3 times larger than the dollar amount that would be needed to make the socia security program completelty solvent for the next 75 years.
We could also strengthen our ability to meet our future socal security obligations by ending the reckless and fiscally irresponsbile deficit spending resulting from the economically unnecesary tax cuts for the etremely wealthy. Instead of piling up debt, we should be paying it down in preparation for the increase in entitlement spending coiciding with the aging of our population.
As our immigration crisis tells us, there is a severe disconnect between the immigration quotas set by our government and the actual labor needs of our economy. Expanding immigration for younger applicants would increase the number of younger workers paying into the system and also help by offsetting outlays to the baby-boomer retirees.
When you combine Social Security with Medicare, America does face a fiscally dangerous explosion in entitlements, but the Medicare program and not Social Security is the major source of the problem. Conservatives don’t want to acknowlege the Medicare problem, however because that would mean facing up to the fact that we need to revamp our entire system of Health Care.
Note 1, Dean, you are unclear on the concept of retirement security
Nothing in Note 1 is really objectionable as long as you don’t examine the elephant in the living room. The elephant is the fundamental defect in the entire approach to retirement security represented by the Social Security system.
Social security is not, repeat not, repeat again not, a retirement security scheme. It is a wealth redistribution scheme. It is a covenant between professional politicians to provide entitlements to a sector of the population in return for their votes. It does not, repeat not, repeat again not, provide retirement security to anyone.
Social security is a wealth redistribution scheme based on age. Wealth goes from the young and the working to the older and the retired. The amount of wealth transferred to an older person through Social Security is only weakly related to the amount that person paid in tothe system. No citizens has any guarantee that the Social Security system will continue for one more day, or that any amounts whatsoever will be paid out when that citizen chooses to retire. Although I have paid Social Security for decades Congress has the legal power to terminate the entire program. There is no guarantee of even a modest return on my compulsory and involuntary investment. The actual return on investment enjoyed by most retirees is a paltry 2%, far underperforming the simplest and most conservative long-term investment scheme. Contrary to the hysteria handed out by the Democrats, it would be easy for the government to set basic guidelines for acceptable retirement portfolios and then let citizens invest within these broad guidelines.
The fundamentals of true retirement security are so simple that they can be taught in a 3 week course in every high school in America. Those fundamentals are not taught because our society has abandoned the concept of adults thinking ahead and preparing for negative contingencies and instead embraced the concept of the nanny state caring for its dependent, childlike citizens. Even a person of modest income acquire the savings needed to retire comfortably. The tools required are compound interest, regular life-long saving and a reasonably diversified portfolio. Again, this could be taught to high-school students in three weeks.
Note 2, What Americans can “afford” with a savings rate of 1%
While in the private practice of law I was consulted by many individuals who ran into legal difficulty. Maybe is was a injury from an accident at work, or on the road. Maybe it was the need to care for an incompetent older relative or set up a trust for a disabled younger relative. As part of the basic interview I frequently obtained a financial statement. About 80% of the time, when fees for needed legal services were quoted, a stricken look would pass over the faces of my clients and they would say “I can’t afford that.”
America’s savings rate is 1%. The average American has a credit card debt of more than $5,000. Our saving rate is lower than most of the developed world although we are richer than virtually every country in the world. The clients that visited my office consistently could claim ownership of a house, at least two cars, at least two TV sets, a DVD player, and more. Typically, they would also own RV’s, golf clubs, hunting guns, a trailer and more. Yet, each and every household was stretched to the limit on credit cards and was utterly devoid of any savings. If one of the two wage earners were to lose a job or be ill for an extended period of time, the house of cards would collapse.
Given this when you see programs about how American’s cannot “afford” health insurance or health care or retirement, think about our life-time savings rate of 1%.
As a Christian don’t I care about the poor? Yes, and and as Christian I see the first cure of poverty to be education, followed by a job, followed in the most extreme cases direct aid to those unable to learn and work. However, we are not talking about the less than 5% of the population that probably needs direct aid to get by, we are talking about middle America. The same middle America with the 1% savings rate, the fashionable clothes, the flashy cars, the multiple TVS who cannot afford to set aside money for any negative contingency whether it be health insurance, legal trouble, retirement, or the other ordinary and predictable negative events of life. We are overindulged and now we are signing up for government to take us into its tender clutches and take care of us like good little drones.
NOte 3, Social Security is a Ponzi Scheme
Social Security is a Ponzi Scheme and shoveling more taxpayer money into that scheme to hold it over a few more years will not change the reality. We have reached with mathematicians call the exponential corner, that is, where the curve straights to point nearly straight up and head for infinity. As Dean says it is very unhealthy to ignore reality.
Note 4, Solution is simple. Really.
Kenneth Arrow received a Nobel Prize in Economics for proving that you maximize returns and minimum risk by diverting your portfolio into at least ten independent sectors. In other words, you invest in ten different parts of the economy, this means that if one or two sectors are depressed you still have the remaining sectors to provide an income. This approach also reduces the risk of portfolio loss to a very, very low level.
The government could draft a set of investment guidelines fore retirement savings. I could write one up that would be no longer than 10 pages. Individual taxpayers could set up an automatic savings/investment plan of even relatively small amounts when they leave college. The contribution could be tax sheltered and allowed to grow tax free. The funds would be truly segregated and privately owned which means that Congress could not use the funds as a political favor to reward voters who vote for them. The individual investor would be assured by law that the funds he invested and their earnings would be there for him when he retired. About 90% of all working Americans could afford to participate in this plan. Even low income American could earn retirement security IF they started saving in their 20’s and continued steadily until retirement. Government could help by directly funds to safe investments and providing tax breaks to allow a faster accumulation of wealth.
It really is easy, very easy. We don’t do it because politicians want to have the power over the massive Social Security tax bonanza. As for me I would be wealthy today if I had the 15% of my wages that have gone to Social Security and even a modest 3% rate of return on them. Wealthy today, able to retire and never work again. Government blocked me from using those funds which I earned, they have my money and I have no guarantee that I will get it back.
Missourian: I agree with and support your ideas for encouraging individual savings by future social security program beneficiaries. There is much that could be done to encourage greater savings, for example, changing existing 401-K programs so that employees are automatically enrolled, and then have to opt-out, rather than opt-in as they do now. The law could require mandatory diversification of portfolios, so we don’t have people wiped out by a single company’s failure which is what happened to many Enron employees.
The government could even provide a one-time loan to lower income tax-payers to be used to begin a retirement fund, to be paid back through taxes over time with no interest.
However all of these should be add-ons to, rather than carve-outs from, the existing system, which we will still need to maintain as a saftey net. You don’t seem to appreciate the fact that adding millions of destitute seniors to the welfare rolls would cost far more than maintaining the current social security system.
Without Universal Heath Care inurance families can still see their savings wiped out by uncovered medical expenses associated with catastrophic illness. As a lawyer perhaps you know whether 401-K funds are off the table during Bankruptcy proceedings, or must be used to liquidate debts, but I’m assuming the later.
We can also assume that there will always be business cycles with economic upturns and downturns, so workers planning to retire during the downturn will be forced to decide to work another 5 years or accept a drastically lower income.
We can also not assume that every individul has the same ability to put money away for retirement. Defined-contributions by employers are made as a percentage of salary – so not all workers have the capacity to put away the same amount. Unemployed workers don’t have the same ability to put away money as those employed. Workers beginning their retirement savings in the forties don’t have the same capacity to put away as much money as workers beginning in their twenties. Your plan assumes ideal conditions and would threaten low income workers, those who become unemployed, and those who started saving late, with poverty during their sunset years.
Social Security is not a Ponzi scheme. I’ve been paying into the system for several decades and the money I have paid into the system is mine to be paid back to me. This was the assumption made under the social security reform legislation signed by President Reagan in 1986 which raised FICA deductions with the specific goal of creating a surplus to pay for the baby-boomer retirees.
In business school we learned that “the full faith and credit of the United States Government” is the gold standard of safety by which the risk of all other investments are measured. So long as we have a fiscally responsible President and Congress who refrain from running up gigantic amounts of debt, with runnaway spending and ill-considered tax cuts, the government should be able to meet its social security obligations. Vote Democratic tommorow!
Note 6, Dean, social security paragraph by paragraph
As a practical matter, it would require some care to transition from one system to another, however, it should still be done. The change in the system that I proposed would not be a net loss for participants. Instead of paying 15% of their income in every year, the same or greater amount would be invested in a true individual investment account reserved only for them and not subject to political power plays. Given our current rate of economic growth a conservative investor could double their savings every 6 to 10 years. Persons who had already contribute large amounts to Social Security could be given a refund of those funds to be used to start their new individual funds. Would it be easy, no, but my plan does not involve the pauperization of seniors. Remember Dean, Social Security is not a welfare plan, it does not transfer money from the well-to-do to the poor, it transfers money from the young to
old without regard for wealth.
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In this paragraph you demonstrate that you are simply unfamiliar with the mathematics of long-term conservative investment strategies. In times of economic downturns a diversified portfolio will protect against losses exceeding 5 to 10%. Therefore savers with 30 years in the market will not have to postpone retirement. I’m sorry but you really don’t understand the math here. Given the regulation of the financial markets and the banking system there is virtually no change of a market meltdown comparable to the stock market crash which started the Great Depression.
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Dean, all employees are currently subject to a 7.5%-7/5% Social Security Tax rate in addition to federal withholding. By this I mean that the employer sends in 15% of the gross wage to the government for each employee. Obviously, since this is a percentage tax, higher paid employees pay more into Social Security. This is what we currently have NOW with Social Security.
True, however, few people are unemployed for more than a small percentage of their working years and given a 20 to 40 year time frame, this shouldn’t have a significant effect. Lastly, we will not achieve perfection in any system. This is a problem for Social Security also because unemployed workers don’t contribute to the Social Security system.
Correct AND people who exercise are in better health than those who do not exercise. People who drive safely are have fewer accidents than those who drive recklessly. Sometimes I just have to throw up my hands, Dean. Government cannot prevent some people from being profligate and unwise. Government should not penalize the frugal, the thoughtful and the productive by subsidizing the wasteful, the thoughtless and the unproductive. Under today’s scheme, every single worker regardless of wage or income level pays a regressive 15% tax on his or her income, even the minimum wagers do. How is my proposal worse?
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Let’s take each of your classes of victims. First, low income workers. Under the current Social Security system, low income workers pay the same regressive tax that all other workers do. In addition, their pay-out benefits are lower. Social Security is not a welfare system. It does not pay out on the basis of need, it pays out on the basis on contributions to the system. My system is not worse for low income workers, it is better because it gives them a better rate of return. Second, the unemployed. Most people are not unemployed for more than a small fraction of their working years. People who are unemployed for a significant period of time cannot and do not contribute to Social Security and their ultimate payout is lessened somewhat as a result.
My plan is not worse the the current scheme. Those who started late.
Well, what can I say, Dean? Some people do not think ahead, some people are not wise. People who start to participate in Social Security early in life are better off than people join the workforce later in life. There are certain things that no legislation can change, such as human nature.
O.K., Dean, this is the most disturbing comment ever. You do not understand what the “full faith and credit” clause means. I will explain. The “full faith and credit” pledge of the U.S. Government applies to government debt instruments: Treasury Bills and Bonds, not Social Security. Congress is legally free to slash benefits at any time.
Social Security IS a Ponzi scheme. In my plan, money deducted from my earnings are placed in an individual, segregated account. The funds are invested in real businesses according to sound investment principles. No one else can touch the funds, they are “vested.” Under Social Security the money deducted from our paychecks is not segregated for individual contributors, it is not even truly segregated from other tax monies as the Highway Trust Fund is.
The definition of a Ponzi scheme is that early investors are not paid dividends as a result of real earnings off investments but rather as a result of the investment of later participants. Today’s Social Security does not pay the current recipients based on a investment return on the current recipients money, it pays the current recipients of our current workers current tax. Ergo, it is a Ponzi scheme.
As to voting Democratic, I would crawl over broken glass to vote Republican, as lackluster and flawed as they are.
What the Social Security Administration just mailed to me.
I recently received a new statement of my contributions to Social Security and my estimated benefits (should the current levels of benefits remain the same until I retire). Here is a direct quote from the flyer they sent me.
Although reference is made to a “Social Security Fund,” there is no true segregation of funds from general tax revenues. There is no protection for the contribution of any individual to the “Social Security Fund” which is just a fiction floating in an accountant’s mind. There is no guarantee that the level of benefits which exist today will be available to me when I want to retire. They can be reduced and eliminated in every session of Congress.
It is not incorrect to refer to Social Security as a Ponzi scheme because early “investors” are paid with the “investments” of later investors.