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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: Changing Perceptions

At present, there is a dichotomy in the perceptions and expectations of the Social Security system.  They are:

  • Social Security is a progressive/socialistic system of wealth redistribution – it takes money from one class of people (the workers) and gives it to another (the retirees).
  • Social Security is an individual pension plan – each person who pays into the system is entitled to a guaranteed benefit in return.

Wealth redistribution is contradictory to individual ownership.  The conflict between these perceptions will not be easily reconciled and will need to be confronted before serious reform will take place

A fundamental purpose of Social Security is to make sure that everyone has a basic level of survivor, disability or retirement benefits.  The need for these benefits is based on the presumption that the person does not have the wherewithal to provide for themselves, thus the government must step in to assist.  Whether or not you like the moniker, it is a socialistic concept.  In contrast, pure capitalism allows each person to fend for themself, irrespective of the consequences.

The Social Security Administration has also created an expectation that you will receive future benefits in return for the taxes currently paid in.  Each year you get an earnings history and a projection of your future benefits.  This is very analogous to a defined benefit pension plan, in which you are guaranteed a lifetime benefit based on your age and earnings history.  Armed with this information, is it any wonder people have a perception and expectation that they are entitled to a certain benefit and any potential reduction is seen as taking something that belongs to them?

I believe that politicians have been quite happy with this contradiction.  On the one hand, they argue that Social Security is a vital social program that must be funded.  On the other, the promise of a future benefit is justification for collecting taxes presently to fund their current spending (and overspending) habits.  Politicians have positioned Social Security to be a social program and an individual pension plan at the same time.

Lest you misread what I haven’t written, I believe Social Security does provide an important social purpose.  I may not agree with how benefits are calculated and administered, but taking care of the most vulnerable in our society is a good thing.

However, the promise and expectation of future benefits has allowed politicians throughout the decades to raise Social Security taxes and redirect the surpluses into other government programs.  A pension administrator would be guilty of breaching their fiduciary duty (maybe even fraud) if they managed your private pension assets the way the government has mismanaged Social Security.  Of course the politicians revert back to the argument that it’s a government social program, not an individual retirement account to justify their reallocation of Social Security taxes.

In the end, the politicians love the dichotomy, because they can triangulate between the two arguments to serve their immediate purpose.

True reform to Social Security should include a resolution of the conflicting principles and perceptions.  Either it’s a social program designed to provide basic retirement benefits for those who are most in need, and you have no entitlement to receive back any of the taxes you have paid.  Or, it’s a government sponsored pension plan whereby the administrators need to be held accountable for how the money is collected, disbursed and managed.

It can effectively be one or the other, but history has proven it can’t be both.  Let the debate begin and allow the American people decide what they want… after all… we are footing the bill.

Social Security Reform: Privatization

Of all the issues concerning the potential reforms of Social Security, nothing is as controversial as the topic of privatization.  The mere mention of it will likely spark a fierce debate from people of all walks of life and political persuasions. 

The history and issues of privatization are much more extensive than can be covered in this short post.  If you want an in-depth discussion of the issues, read this Wikipedia article.  For a quick synopsis, check out this side-by-side comparison on procon.org

President Bush made a push for privatization in his 2005 and 2006 State of the Union addresses, but Congress showed little interest in tackling this issue.  Given that President Obama is strongly opposed to this concept, there has been little discussion of the matter in the past 18 months.  The debate over the future of Social Security will continue, and as the pressure for reform mounts, expect privatization to be part of the discussion, even if it doesn’t become part of the solution.

It may be a good thing that a portion of everyone’s retirement benefits remain fixed and secure.  As most retirement and pension accounts have been battered over the past couple of years, the lure of placing more money in the stock market has lost some of its luster.  However, when you consider that the projected rate of return for people born after 1965 is less than 2%, you can understand why people want a greater level of control and rate of return.  Many Gen X’ers and Millennials doubt they will ever get back what they paid into the system, let alone receive a rate of return.

One of the greatest barriers to privatization is dealing with the short-term deficits that would occur in trying to pay current Social Security recipients.  When Social Security is referred to as a huge Ponzi scheme, advocates quickly point out that Social Security is a pay-as-you-go system.  Since current tax collections are paying present benefits, there would be a huge deficit if taxes were re-directed into private accounts and invested outside of Social Security.  Given the number of Baby Boomers set to retire in the next 10-20 years, I doubt the government could raise the revenue necessary to meet this obligation without retaining current Social Security taxes.

A primary purpose for enacting Social Security in the 1930’s was to help provide a basic retirement benefit for elderly people who were suffering through the Great Depression.  They either had no pension plan or were wiped out when the stock market crashed.  Allowing for complete privatization with self-directed accounts would be an abandonment of the original purpose of Social Security and risk having another group of retirees with no money.

You may feel like you are a savvy enough investor to take on such a risk, but the failures of the past 2-3 years should prove that anyone is at risk.  Many unsophisticated financial consumers got burned with subprime and option ARM mortgages.  At the same time, veteran Wall Street traders lost big too, which proves that everyone is susceptible to massive investment losses.

Unlike the other three reform options (raising the retirement age, reducing benefits and raising taxes), I’m not going to proffer an opinion on privatization… at least not yet.  I want to discuss reforms to the perceptions and politics first.  After that, I’ll tell you what I think about privatization.

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.

Social Security Reform: Reducing Benefits

Let’s be honest.  Whether it’s Social Security or some other program, no one wants to see their government benefits reduced.  While most people agree the government needs to reduce spending, they just don’t want it to affect the benefits they receive.  It’s another form of NIMBY.

Increasing benefits is the history of Social Security.  The initial benefits paid in 1937 were primarily lump-sum death benefits for 53,236 beneficiaries.  In 1940, Social Security started sending monthly checks to recipients.  In 1956, disability benefits were added, and survivor benefits for dependent spouses and children were added in 1962.  For the first 25 years of Social Security, revenues exceeded expenditures, which made expanding benefits easy. 

The necessity and benefit s of passing Social Security was quite clear in the 1930’s.  Few people had pensions in the early 1900’s, and those who did were severely impacted by the Great Depression.  Providing for seniors had an additional benefit – it encouraged them to retire, which created more openings for unemployed workers.  Prior to the U.S. entering World War II, men held most of the jobs, which meant the financial stability and survival of a family was severely at risk if a man’s ability to work was hindered.  Thus, the inclusion of disability and survivor benefits were intended to help families survive if the primary breadwinner died or became incapacitated.

While far from perfect, we can be thankful a lot of things have changed in the past 75 years.  Many people have employer-provided or self-directed pension and retirement accounts.  Women comprise 46.8% of the current workforce making it less male-centric.  Today, it’s not uncommon for women to make more money than their husbands.  Even though society has changed in 75 years, Social Security basically remains the same.

Providing basic retirement, disability and survivorship benefits is a good idea, but it doesn’t mean that everyone who becomes disabled or experiences the loss of a loved one should receive the same benefits.  The financial security of your family may be totally independent of Social Security.  You may have personal assets or private disability insurance that is more than adequate to provide for you.  No amount of money can replace a child’s loss of a parent, but does a child living with a parent who earned all of the family’s money need a monthly stipend from Social Security?

Disability and survivor benefits are only a small piece of the pie.  Retirement benefits is the mother lode of Social Security.  This may not be popular with my wealthy friends, but I believe there is a point where the amount of money you’re receiving from Social Security has little effect on your finances or lifestyle.  It could be $100,000, $500,000 or $1,000,000, but at some level you really don’t need that Social Security check. 

Aside from whether or not you deserve it, consider a pure financial analysis.  Assume you’re receiving the maximum Social Security benefit (about $30,000), and 85% of your benefits are subject to income taxes.  At a 35% tax rate, you will have after-tax funds of approximately $21,000.  If tax rates increase by 5%, you’ll pay an extra $25,000 in taxes if you make $500,000.  In simple economics, you may continue to receive your Social Security benefits, but it may cost you more in additional taxes ($4,000 in my example) than you’re netting from Social Security.

Don’t think tax rates are going up? Read through some of my prior posts regarding the future budget deficits for Social Security, the nonexistent Social Security Trust fund and overall debt of the U.S. government and tell me you honestly believe tax rates are not on the rise.

Furthermore, what do you think is might happen to the economy and stock market as the U.S. debt continues to rack up more than $1 trillion a year?  Has your portfolio dropped more over the past 2 years than the Social Security checks you’ve received?  While it may not be a direct correlation, I believe the overall performance of the U.S. economy will eventually feel the strain of the uncontrolled spending and borrowing by the U.S. Treasury. 

My point is simple.  You’re going to pay one way or the other.  Whether it’s through increased taxes or lackluster performance of the economy, the looming Social Security deficits are going to cost you something.  You may find it’s less costly to give up the Social Security checks you don’t really need. Sure you worked hard, paid into the system and you deserve it, but just because you deserve it doesn’t mean you actually need it.

It’s a good thing to provide basic retirement, disability and survivorship benefits to people in need.  We can debate the level at which someone doesn’t need the benefits, but I believe that a needs-based requirement to receive benefits is appropriate. 

Therefore, I advocate that reducing or eliminating benefits to people who truly don’t need Social Security is part of the reform needed to secure the long-term viability of the Social Security system.

The Irony of the American Perspective on the Strikes in France

As Eric Olander wrote in an article yesterday, the French ended their annual ritual of a month-long summer vacation with another annual rite of passage – a strike.  Over 1 million unionized workers protested the planned proposal to extend the retirement age in France from 60 to 62. 

Many Americans are puzzled by the purpose of the demonstrations.  While we often stereotype the French as being snobs who look down their noses at us, we scoff at their strikes and demonstrations.  We don’t understand the fuss of changing the retirement age and chalk it up as being “French.”

Scan through some of the American news reports that have described the motives behind the government proposals that triggered the strike.

Newsweek: But the truth is that the economic downturn has accelerated France’s pension crisis exponentially, and the French way of life is more unsustainable than ever.

CNN: One of Sarkozy’s top aides said over the weekend that while there is some flexibility on the details, the fundamentals of pension reform must be enacted, since increasing life expectancy increases the financial burden on the pension system.

The Boston Globe: The government says the change to the money-losing pension system is an obligation, given France’s burgeoning deficit and its aging population.

As Americans, we ridicule the protests without seeing the irony of our own situation. Before you laugh at the French… consider these facts.

  • Retirement age in France is 60.  It’s currently 66 in the U.S. (for Social Security purposes).
  • The 2010 annual deficit of the French government is 8% of GDP, which is well in excess of the European Union limit of 3%. The U.S. annual deficit will be approximately 10% of GDP this year.
  • France currently has about 3 workers per retiree.  Social Security has about the same.
  • Without reform, the French pension system will have a deficit of nearly $25 billion in 2010 and $57 billion by 2020.  Social Security will have a deficit of $41 billion in 2010 and will have a deficit in excess of $100 billion by 2025.

Clearly there are differences in the economies, cultures, governments and pension systems of France and the U.S.  However, there is one thing in common.  Both face substantial future deficits trying to support a retirement system for an aging population.  It’s no laughing matter on either side of the pond.

You may disagree with their reform proposals, but give the French government credit for trying to proactively deal with a burgeoning pension problem and institute some austerity measures to their budget.   France is attempting to tackle their problem by raising the retirement age.  The U.S. has done little in decades to face its pending Social Security crisis.  We may take a different approach than France, but we still need to act.  As I wrote in a post last week, raising the Social Security retirement age seems to be common sense.

France has been our ally since the Revolutionary War, but it’s been an awkward relationship.  We both tend to have a way of deriding each other.  When it comes to pension and government reform, we may find that we laugh and commiserate with, and at, each other.

Social Security Reform: Raising the Retirement Age

One option for extending the life and solvency of Social Security is to extend the retirement age.  This has a two-fold benefit.  By working longer, more taxes are paid into the system, and less money is paid between retirement and death.

Since Social Security was passed in 1935 the retirement age has changed only once – in 1983.  The change was not implemented immediately, but phased in for people who were less the 40 years old at the time of enactment.  For the first 74 years of Social Security, you could retire with full benefits at age 65.  Starting in 2009, retirees had to wait until they were 66, and for those people who turned 50 this year, they will have to work an extra year… all the way to 67 to get their full benefits.

By the time the retirement date of 67 is fully implemented, Social Security will have been in operation for 92 years.  The average life expectancy of Americans has increased well in excess of 2 years during that period.  That’s not a bad thing, but Social Security was not originally designed to pay benefits to people for multiple decades.

The average life expectancy in 1930 was 58 for men and 62 for women; both below the retirement age of 65.  According to Social Security data, these statistics were skewed by a high infant mortality rate, and the life expectancy for those who reached 65 in 1935 is only 5 years less than those who reached 65 in 1990.  Aside from statistical arguments, common sense tells us that medical advances are allowing people to live longer today than they did 75 years ago.

Ida May Fuller received the first monthly Social Security check in 1940.  She had paid $24.75 in Social Security taxes.  Her first check was for $22.54.  She lived to be 100 and collected checks totaling $22,888.92.  Ida May Fuller received a 92,480% rate of return on her money. 

Most of us hope we have the genes like Ida May and enjoy a long life.  That’s all good, but Social Security was not intended to be a long-term pension system for large numbers of people.  It could be, but it would take a lot more tax dollars to support the system.  While Ida May is an extreme example, many current retirees have received money far in excess of their contributions, plus a reasonable rate of return.  In contrast, many Generation X’ers don’t believe they’ll see any of their money back.

With the future of Social Security on a perilous path, I believe that periodically increasing the retirement age to receive Social Security benefits is necessary.  Social Security was not supposed to be a mechanism to help you retire early and live as many years in retirement as you worked.  “Early retirement” was not common in 1935.  It’s great if you can afford to retire early, but don’t rely upon Social Security to do it.  It’s your choice to stop working early, but it’s also not up to the rest of us to help subsidize your life of leisure.

You may think it’s great if you get a rate of return similar to Ida May Fuller, but remember, the money isn’t just created.  Someone else’s tax dollars is the source of providing you an exceptional rate of return.  A few people can reap huge rewards, but eventually the system will collapse like an illegal Ponzi scheme if everyone wants to take out of the system far more than they paid in.

The retirement age shouldn’t change annually. It makes more sense to change it every decade after the census is completed.  Like the change in 1983, don’t change the deal for current beneficiaries or those very near to retirement.  Change it for those who are 50 or younger, which still gives you 15+ years to plan and prepare for the age you can receive your Social Security retirement benefits.

As the life expectancy goes up or down, it makes sense for the age to receive full Social Security benefits to change accordingly.