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The Politics of Social Security Reform

The current political discourse is probably one of the greatest barriers to reforming the Social Security system.  As I have tried to explain in the past several posts, Social Security is on the verge of an epic crisis, which will not be easily resolved. 

At present, there are more than 50 million Americans receiving Social Security benefits, which is approximately one-sixth of the U.S. population.  The U.S. government will spend a whopping $1.15 trillion on Social Security and Medicare in 2010, which is 32.5% of all federal spending.  These factors alone illustrate the importance of Social Security in our society.

Since it impacts the lives of so many Americans, the same old tired political clichés need to be abandoned.  Someone who believes Social Security is bankrupt and in need of reform is not necessarily a cold, heartless person looking to steal money from the elderly and see them live out their final days impoverished and alone.  At the same time, a person who believes in maintaining Social Security as a safety net for other people is not automatically a socialist or reckless spender. 

I believe the first thing that needs to happen is for politicians (of all political parties and persuasions) to come clean about the current status and future of Social Security.  Politicians who continue to maintain that we have nothing to worry about for the next 30-40 years are disingenuous at best, and dishonest at worst.  I don’t know if they are more afraid of the panic that might erupt if people knew the truth, or if they are afraid they will lose their power and position.  We may not like the current situation and future prospects, but continuing to pretend like there isn’t a problem is only going to make it worse.  The longer we wait, the fewer options we have, and the more painful the process is going to be.

It may sound rather egalitarian, but it’s time to respect our differences and come together to work towards a solution.  We need to set aside the labels of liberal vs. conservative; Democrat vs. Independent vs. Republican; socialist vs. capitalist, etc.  Everyone has something to bring to the table of ideas. 

For the conservative, reform is not about entitlements, welfare or socialism.  Your advocacy of individual freedom, personal responsibility and fiscal restraint is commendable.  At the same time, there are real people, with real situations, who need help.  Retain your conservative principles, yet show compassion for those who are hurting, destitute or in need, even if it is a result of their poor decisions.

For the liberal, change is not about greed or simply saving money.  Your consideration for people is admirable, but at the same time there are limits to what can and should be done.  Just like your personal finances, there is only so much money to go around, and you can’t spend what you don’t have. Maintain your compassion for those in need but recognize the realities and fiscal limitation of what can be provided.

Reforming Social Security won’t be easy, but it will be near impossible unless the political discourse is transformed.  If nothing changes, then little will be done.  If I’m correct, a crisis will erupt within the next decade, and we will be forced to address the issue.  Unfortunately, opportunities and alternatives will be lost because politicians refused to modify their approach to reforming Social Security.  It doesn’t have to be this way, and hopefully our leaders will rise to the occasion, or we’ll elect those who will.

Social Security Reform: Increase Taxes

One of the easiest solutions to help resolve the financial crisis of Social Security  is to raise the tax rate.  The rate has been raised four times in the past 75 years.  It started at 2.0% in 1935 and is currently at 12.4%.  Although often lumped together, Medicare taxes are assessed separately from Social Security.  The Medicare tax rate is currently 2.9%.  Combined you pay 15.3% of your earnings in Social Security and Medicare taxes, before any income taxes.

If you’re self-employed, you know that you pay the entire 15.3% tax.  If you are an employee, you pay half of the tax, and technically your employer pays the other half.  Although you don’t see it, trust me when I say that you’re paying it.  How?  Because employers include payroll taxes and benefits into the cost of each employee, which determines how much you get paid.  Said another way, if your employer wasn’t paying half of your Social Security taxes, they could pay you more.

The separate assessment of Social Security and Medicare taxes started on January 1, 1994 when the wage cap on Medicare taxes was removed.  For 2010, you will pay Social Security taxes on the first $106,800 you earn, but you will pay Medicare taxes on all of your earnings, no matter the amount.

One option for increasing Social Security tax revenues is to eliminate the wage cap.  The rate doesn’t change, but the amount of income subject to tax increases.  Some people consider the Social Security wage cap to be a regressive provision.  Thus, eliminating the cap would make Social Security taxes more progressive.

One challenge with this approach is that benefits are calculated based upon the taxes paid in.  If someone continues pays more into the system, they will be entitled to draw more out.  Congress can change the rules to be whatever they want.  However, eliminating the wage cap for paying taxes, but retaining the cap for receiving benefits is a fundamental change to the system and contrary to any other pension benefit calculation.

The other option is simply to raise the rate above 12.4%. This is the solution previous Congresses and presidents have used to solve prior solvency issues.  Each time they raise the rates, they promise the new rate will fix the Social Security problem for decades to come.  When President Carter signed legislation in 1977 that raised the Social Security and Medicare rate to 12.3%, he declared it would make Social Security sound until 2030.  It didn’t happen.  Additional reforms were needed in the 1980’s and 1990’s.  We’re still 20 years shy of 2030, and Social Security is facing a looming solvency issue.

Increasing taxes may need to part of the solution in reforming Social Security, but it should not be the first and only thing that is done.  Like other budgetary issues, there is an income and expense part of the equation.  It’s foolish to only look at one half when you’re trying to solve a problem.  For too long, we have tried keep Social Security sound by pumping more money into the system, but it hasn’t worked. 

Increasing Social Security taxes hasn’t fixed the problem in the past 40 years, and it won’t fix it now.  It’s time to take a new approach and reform the system of benefits, and then determine if additional revenue is needed.

Options for Reforming Social Security

Social Security was passed in 1935 as part of President Roosevelt’s New Deal, which was intended to help bring the country out of the Great Depression.  There were many legal challenges to the expansion of government authority and programs under the New Deal.  Social Security survived the legal challenges and has been operating for the past 75 years. 

In the first few decades, Congress continually expanded coverage and benefits.  The surplus tax revenues made it easy.  However, that all started to change in the1970’s.  As benefits grew and tax dollars shrunk during the recessions of the 1970’s, Congress faced a new challenge; how to pay for this burgeoning program.  However, the problems Congress faced in the 1970’s and early 1980’s pales in comparison to the current situation.   

Since Social Security has been dubbed the Third Rail of politics, most politicians are reluctant to propose any reform, until an absolute crisis occurs.  Political survival outweighs the concerns regarding the future of our country and the millions of people who depend upon Social Security to live.

If you have read some of my prior posts, you know that I believe the Social Security system will soon face a crisis, but you don’t have to take my word for it.  Read this CNN Money  article from May 11, 2010.  CNN is generally not considered to be a conservative or right-wing news organization, yet even they recognize the future financial problems facing Social Security.

Social Security reform generally involves a discussion of four broad options.

  1. Raising the retirement age
  2. Reducing future benefits
  3. Raising the payroll tax
  4. Creating private accounts

I’ll expand on each of these options in the coming days.  In any discussion of reforming Social Security, I think there are two primary points to remember:

  • It’s going to cost you something.  We all need to be willing to sacrifice something if we are going to avert a political, economic and social crisis that could arise from a collapse of Social Security.  Everyone has a vested interest in the outcome, and we all need to have a part in the solution.
  • There is no easy answer.  If it was easy, it would already be done.  Social Security involves promises to people; expectations for the future; and financial implications for individuals, businesses and the government.  It won’t be easy to craft a solution that satisfies these various and often conflicting demands.

I believe it’s possible to have an innovative solution to this problem. It may even be a Divine solution.  I’ll share my ideas, but maybe you have some of your own.  I invite you to share them. Maybe as we collaborate, we can develop something exceptional.

Social Security Solvency and the Crossover Date

Most of the discussion surrounding the solvency of Social Security is focused on the year in which the so-called Social Security Trust Fund is depleted.  In my opinion, the projected insolvency date is much less important than the crossover date.  The crossover date is the point in time when Social Security tax receipts are less than the Social Security benefits being paid.

Did you know that this is going to happen this year (three years earlier than expected)?  Social Security payments in 2010 will exceed receipts by $41 billion.  The Social Security Administration attributes the acceleration to the economic recession.  High unemployment and falling wages have reduced tax receipts.  Additionally, more seniors have been forced to file for benefits as other sources of income have fallen.

Politicians have not expressed any concern and noted that the last crossover date was in 1983.  However, I don’t see any comfort in knowing that this happened for a short time in the early 1980’s.  The situation today is a lot different than it was 27 years ago.

The primary difference is demographics.  In the 1980’s, the Baby Boomers were heading into their peak earnings period.  Thus, there was a burgeoning group of wage earners who could help keep the system afloat.  Nearly 30 years later, those same people are moving towards retirement and will start drawing unprecedented dollars from the Social Security system.   

The significance of the crossover date stems from an understanding of the government’s fiscal management.  For years, the government has collected tens and hundreds of billions more in Social Security taxes than it paid in benefits.  This resulted in the creation of the Social Security Trust Fund, which was supposed to have saved trillions of dollars to pay future benefits.  See my post on why the Social Security Trust Fund does not exist for an explanation of why this means little in real economic terms.

 The excess Social Security taxes were not saved, they were spent.  Thus, the U.S. has been funding part of its programs and spending through the extra Social Security taxes collected.  Once the crossover becomes permanent in 2014, there is going to be an increasing burden on the budget, spending and deficit of the country.  Despite being able to balance the budget for decades, the federal government will need to simultaneously work towards balancing the budget and raise additional funds to pay Social Security benefits.

Think of it in these terms.  It’s like a person who has been consistently overspending for years and has been financing their lifestyle with credit cards that have minimal or no monthly payments.  Eventually, the credit lines will run out and they have to start repaying their debts.  Not only do they have to reduce their spending to balance their budget, they have to curtail it even further to service the debt.

This is exactly the situation the U.S. government is facing.  It has to raise taxes or reduce spending by hundreds of billions of dollars ($1.4 trillion for fiscal year 2010) to balance the budget.  They will have to cut spending or raise even more revenue to fund Social Security benefits ($41 billion this year).  The more Baby Boomers retire, the wider the gap between receipts and expenditures, which will make this task even more difficult.

Can this be done?  Absolutely… but it’s going to be painful.  For years, Washington politicians have shown little resolve to balance the budget.  Although the current recession has generated a lot of talk about deficit reduction and balanced budgets, the red ink flowing out of Washington is about as controlled as the oil that spewed out of control into the Gulf of Mexico.

For me, the solvency and potential crisis of Social Security is not determined by some hypothetical date 20+ years into the future.  It’s coming shortly after the crossover date becomes perpetual.  Finding a way to pay for current federal spending while simultaneously meeting the mounting obligations to seniors for Social Security and Medicare are monumental tasks.  It will likely result in a political crisis, and could lead to an economic crisis.

The Social Security Trust Fund Does Not Exist

The 2010 Annual Report of the Social Security Trustees was issued on August 5, 2010 with little attention and notice.   The report covers both Social Security and Medicare.  According to the Trustees, the additional Medicare taxes and reduced reimbursement rates for doctors treating Medicare patients contained in the health care reform legislation extended the solvency of Medicare by 12 years to 2029, and Social Security is expected to last until 2037.

It all sounds good, but the dirty little secret in Washington is the Social Security Trust Fund does not exist. 

Think of this situation.  Imagine that I made $1 million dollars a year, but I spend $2 million each year.  Fortunately for me, my grandfather left $10 million in a trust fund for my benefit.  To cover my excess spending, I borrow $1 million each year from the trust.  At the end of 10 years, the only assets owned by the trust are the $10 million of promissory notes due from me.

I can claim that I have a trust fund worth $10 million, and technically this is correct.  However, if the only assets of the trust are the notes that I owe it, what’s it really worth?  The only way I can draw more money out of the trust is if I pay the cash into it.  I have a trust fund worth $10 million on paper, but I really have nothing of value.  I spent it all.

This is exactly the situation of the Social Security Trust Fund.  According to the 2010 Annual Report, the Social Security Trust Fund has over $2.2 trillion dollars in it.  There’s only one hitch, the entire $2.2 trillion consists of notes issued by the U.S. Treasury.  Like my illustration with the $10 million trust fund, the U.S. Government owes itself. 

What do you think of when you hear the term “Social Security Trust Fund?”  It’s easy to conjure up an image of a huge vault at Fort Knox piled high with cash or gold.  If only it was true.  In reality, the Social Security Trust Fund is nothing more than an accounting entry on the books of the U.S. Treasury.

If you want a better understanding of how the Social Security Trust Fund was actually operates, read the article Misleading the Public: How the Social Security Trust Fund Really Works by the Heritage Foundation.  I acknowledge that the Heritage Foundation is a conservative think-tank.  While you may not agree with their political perspective or opinions, I think they accurately describe the functioning of the Social Security Trust Fund.

Lest you read what I’m not saying, I am not suggesting that Social Security payments will cease in the near future.  I’ll discuss the sustainability of Social Security in an upcoming article.  Just realize that benefits may continue to be paid, but they won’t come from dollars that are stashed away somewhere just waiting to be tapped. 

My objective today is to pull back the curtain on the fallacy that there is $2.2 trillion of actual money in a trust fund, or as politicians like to refer to it… a lockbox.  To me, the Social Security Trust Fund has been treated much more like a Congressional cookie jar than a lockbox. 

In my opinion, one of the greatest travesties of the modern age is the lack of information and misinformation regarding this matter.  Politicians of all political affiliations and persuasions have mostly been silent on this issue.  Newscasters are also complicit, as they report the solvency and repeat the political claims without taking time to truly understand or evaluate the situation.

I believe if most Americans understood the situation, they would be outraged.  For years Congress has been able to use the excess Social Security taxes for other spending.  They have pushed the problem into the future, but I believe the day of reckoning is coming soon.  I’ll delve into that topic in the next post.

It can be unnerving to know that the Social Security Trust Fund is nothing more than paper IOU’s by the government to itself, but the next time you hear or read something about the Social Security Trust Fund, take note of what is being said and what is not.  You have the information.  It’s up to you what you do with it.

Are Strikes, Demonstrations and Riots Coming to the US?

]In May it was Greece.  June it was France.  Will it soon be the US?

Massive strikes and demonstrations occurred in Greece during early May, which eventually led to a riot in Athens resulting in three Greek citizens being killed.  The reason for the civil unrest… people were protesting the proposed austerity measures necessary to keep the government from economic collapse.  Some of the “draconian cuts” included eliminating a 14-month pay system (12 months of pay plus 2 month’s salary as a bonus) and extending the retirement age from 65 to 67.

In late June, French labor unions led strikes across the country shutting down modes of transportation and causing a widespread reduction of government services.  People are protesting President Nicholas Sarkozy’s proposal to increase the retirement age from 60 to 62, to reduce the losses to the national pension system.  The strikes occurred in June, even though the French Parliament won’t be debating the measure until September, and the increase won’t take effect until 2018.

Greece, France and many Western European nations provide very generous social services to their populations.  As the global economic recession drags on, these countries are realizing that their programs are unsustainable for an aging population.  For Greece, it took coming to the brink of bankruptcy to make changes.  France is trying to be more proactive, but it remains to be seen if President Sarkozy will prevail.

A big question for those of us in the US… is this the precursor of what’s to come in the good old US of A?  We can argue the differences between economies, politics, and culture all day long, but are we really all that different?  

At present, the US government is racking up debt to the tune of $3.8 billion dollars of day.  This isn’t monopoly money being printing.  It’s being funded by selling US Treasury securities to foreign nations like China, big banks and individual investors.  What would happen if suddenly people stopped buying our debt?  The changes in government spending would be harsh and dramatic.  Do you think people would riot if funds for education, transportation or Medicaid stopped coming to the State governments or if Social Security checks stopped coming to seniors? 

Seem farfetched?  Maybe… but maybe not.  I’m not an alarmist or a pessimist.  I’m actually an optimist.  However, I can also be a realist, and I understand one basic financial principle.  You can’t continue to spend more than you make forever.  You can borrow for a while, but eventually you have to pay it back.

Greece’s public debt is currently about $400 billion.  That’s huge for their population and economy, but that pales in comparison to the way our government spends money.  We’ll add another $400 billion to our national debt by the end of October.  This is serious money, and it’s a serious problem.

Strikes, demonstrations and riots can be avoided, but things must change soon.  The longer we wait the harder it’s going to be to rectify the situation.  The present mood and culture in Washington is procrastination and stagnation. 

I recognize there are no quick or easy solutions, but I also know that the bigger the debt, the fewer the options and the harder it is to fix.  If we want to avoid the challenges Western Europe is currently facing, our leaders need to act soon.  We probably won’t like every solution they develop, but we’ll like the consequences of doing nothing even less.

The “Doc Fix” – Kicking the Can Down the Road

Last week, President Obama signed legislation known as the “doc fix.”  It reinstated the reimbursement rates for doctors who are treating Medicare patients.  However, the “fix” was extended only until November 30, 2010, a short six months away. Instead of doctors being subject to a 21% reduction payments for Medicare treatments, they will receive a 2.2% increase.

The bill was viewed as a “fix” to a problem, because doctors were threatening to stop treating Medicare patients or not accept new patients.  There is already a shortage of doctors, and with the millions of baby boomers ready to enroll in Medicare, this could be a disastrous situation.  If you want more background on the “doc fix” issue, Austin Frakt wrote a good summary piece you can read.

Issues regarding Medicare, cost shifting and the new health care bill will be reserved for another day.  What I want to tackle is the lack of leadership for fiscal matters that exists in our current political leaders… on both sides of the aisle.

Who do you think created the problem with the Medicare reimbursement rates to begin with?  It was the US Congress.  This accounting gimmick has been used many times in the past to disguise the real cost of Medicare.  Congress writes legislation mandating cuts in Medicare payments, only to reduce or reinstate them before they take effect.  This time they were late by about three weeks, but true to form, they retroactively reinstated the payments… and increased them by 2.2%.

Unfortunately, much of the media glossed over this subject in the fierce debate over the health care reform bill that eventually passed Congress in March.  In order for the proponents to meet their cost estimates, they assumed the reduction in Medicare rates would occur.  If they had included the “doc fix,” they would have needed to include another $245 billion of costs for the next decade.  Opponents argued the costs should be included since the reduction would not happen.  Last week they were proven correct.

Before you get all worked up, I’m not arguing in favor of these cuts.  What I’m addressing is the political game that is being played with our money.  It is not a coincidence that the “doc fix” expires on November 30, which happens to be a few weeks after the next election.  What do you think the chances are that they will pass yet another temporary fix?

To me, this issue is a glaring example of our political leaders’ approach to the fiscal matters of the country.  Instead of dealing with difficult issues and making politically unpopular decisions, they kick the can down the road. 

Good leaders don’t pass the buck to someone else, nor do they defer difficult and potentially unpopular decisions until after their next re-election.  Great statesmen (and women) make the necessary sacrifices to do what is best for the country, even if they lose the next election.  How many current politicians do you think are willing to make that choice?

Kicking the can down the road doesn’t work for you, and it won’t work for the government.  The “doc fix” may have “fixed” the problem for the moment, but it will come back again in November.  It won’t be any easier to address in November than it was last week.  Tough decisions need to be made, and the sooner we make them, the less painful it’s likely to be.