Tuesday, February 1, 2011

Social Security-What Would FDR Say?

The news was not good for the federal budget or Social Security last week. The Congressional Budget Office latest projections indicate that we are heading for a $1.5 trillion federal deficit for the fiscal year.  This would be more red ink than we had in 2009 or 2010.  Social Security is also headed for a shortfall of tax revenues compared to benefits paid of $45 billion for the year.

The Social Security shortfall for the year does not include the cost of the $84 billion payroll tax holiday passed in the waning days of last year.  Adding that cost means that Social Security will pay out $130 billion more in benefits than it will take in from payroll taxes this year.  It is hard to understand how the payroll tax holiday made any sense considering that Social Security is facing a projected $600 billion deficit over the next 10 years.  It will get much worse as more baby boomers retire each year.

Why are these numbers important?  Despite the fact that you always hear about the Social Security Trust Fund there is nothing to trust.  It is a fiction.  Social Security can only pay benefits if it has revenues coming in.  It is a 'pay-as-you-go' system that some would argue is one step removed from being considered a Ponzi scheme. The one step is the fact that it is government sanctioned.  It needs a continual flow of payroll taxes from new workers to pay the promised benefits of the older workers.  It worked well in the early years when there were a lot of workers paying in and few beneficiaries.  This is no longer the case.

Consider this analysis done by the Urban Institute on taxes paid by workers compared to projected benefits over their lifetimes.  All of the examples assume an average wage ($43,100 in 2010 dollars) and assume that the taxes paid earned a 2% real rate of return (inflation + 2%) and the benefits earned a similar return.  I might add that the Urban Institute is a liberal-leaning think tank. Consider this as well as the fact that the average real return from a balanced investment portfolio (50% stocks, 50% bonds) has been about 4.5%.  Therefore, this analysis vastly understates the cost to the taxpayer.  Simply stated-the taxpayer would have been far better off with the money in an investment account.

For example, a single woman age 65 in 1960 paid only $17,600 in social security taxes during her lifetime but collected $145,000 in benefits.  A great deal! A woman turning 65 in 2030 (age 46 today) will pay $392,000 in taxes and collect $348,000.  A negative return for a lifetime of work!

A two-earner couple both earning the average wage that retired in 1980 paid $190,000 over their lifetimes and will have received $446,000 in benefits.  By contrast, a two- earner couple who retired in 2010 paid $581,000 into the system but will only receive $539,000 over their lifetimes.

Social Security was a great deal for my parents and grandparents. This was primarily due to the fact that the taxes they paid were very low.  For example, the tax rate was only 1% and the maximum wage base was only $3,000 for the first decade and a half of Social Security.  That is $30 per year.  When I graduated from college in the early 1970's the maximum tax was $414 per year.  The maximum tax today is $6,612 and the average earner will pay $2,672 (not counting the payroll tax holiday).  Of course, all these amounts are matched by the employer.  The tipping point has been reached.  It is not even a break even deal for people retiring today.  If you are under age 45, you are going to be taken to the cleaners.

Lost in history is this quote from Franklin Delano Roosevelt in his message to Congress on January 17, 1935 asking Congress to enact the Social Security program.  It is clear that Roosevelt understood that the program he was asking for was unsustainable and had to be replaced by a "self supporting system" in 30 years or so.  Unfortunately, that was 45 years ago.

In the important field of security for our old people, it seems necessary to adopt three principles: First, non-contributory old-age pensions for those who are now too old to build up their own insurance. It is, of course, clear that for perhaps thirty years to come funds will have to be provided by the States and the Federal Government to meet these pensions. Second, compulsory contributory annuities which in time will establish a self-supporting system for those now young and for future generations. Third, voluntary contributory annuities by which individual initiative can increase the annual amounts received in old age. It is proposed that the Federal Government assume one-half of the cost of the old-age pension plan, which ought ultimately to be supplanted by self-supporting annuity plans.

To be fair, the Urban Institute analysis does show that the Medicare program is a bargain the way it is structured today.  Lifetime benefits are significantly greater than lifetime tax costs.  However, this is why this program is in much worse financial shape than Social Security.  To use an analogy, fixing Social Security is a walk is the proverbial walk in the park.  Fixing Medicare is like climbing Mount Everest.

One of the biggest failures of the Clinton Administration was not fixing Social Security.  The economy was growing, the stock market was booming and you had Republicans in Congress that would have gotten it done if the President would have lead.  In addition, Social Security was running annual budget surpluses each year.  In 1998 it was $100 billion. This money could have been used to reform the system.  Nothing was done.

I give President Bush high marks for trying.  Unfortunately, the Democrats demagogued the issue to death.  Apparently, they forgot about FDR.  Let's hope President Obama does not.

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