Posts Tagged ‘retirement’

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.

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.

Is Social Security Sustainable?

“This report is yet another reminder of what we have known for some time: Social Security’s long-term financing problems are very serious, and will not be fixed by wishful thinking alone.”

This quote probably sounds like it comes from some radical right-winger warning of the pending doom of Social Security.  However, this statement was issued by Jo Anne Barnhart, Commissioner of Social Security on March 17, 2003 when the 2003 Social Security Trustees Report was issued.  The press release for the report stated, “The Social Security Board of Trustees today declared that the Social Security program is not sustainable over the long term.”

For years, economists, politicians and citizens have expressed concern about the longevity and future of Social Security, but little has been done to address the problem.  Social Security has been the third rail of politics. Touching it is tantamount to political suicide.  The brave souls who have tried to address the looming crisis have met with such resistance that little has been done to change the system.

You don’t have to be a rocket scientist to recognize the unsustainable structure of Social Security, which is probably why I can understand it.  People will banter around sophisticated arguments about comparisons to GDP, the Social Security Trust Fund, the lockbox, actuarial infinite horizons, pay-as-you-go, etc.

Beyond intellectual arguments, when you consider a few simple facts about Social Security, the picture is not rosy, but fairly clear.

  • The Social Security Trust Fund has no real money; it’s just IOU’s from the government to itself
  • When Social Security was passed in 1935, the average life expectancy at birth was age 60; by 2000, it had grown to 77
  • Social Security initially had 42 workers paying into the system for every one receiving benefits; the number has dropped to approximately 3:1 and is expected to decline to 2:1 over the next four decades
  • Social Security and Medicare currently consume about 40% of all federal spending; expect the percentage to increase as the Baby Boomers move into retirement

What do you conclude after considering these four simple points?

Is Social Security sustainable?  The quick answer is yes.  Like most spending, if it’s a high enough priority, you will find a way to make it happen.  Social Security may continue to consume a larger amount of the government revenue, but it can be sustained if it’s a high enough priority.

Probably the better question is whether or not Social Security can be sustained in its current form? In my opinion… No.  As was stated by the Social Security Board of Trustees in 2003, the program is not sustainable over the long term.  It can be maintained, but only if changes are made. 

Social Security may be the third rail of politics and addressing it could end a political career.  However, the continued failure to address the systemic problems of Social Security could cause economic and social peril for millions of Americans if something isn’t done soon. 

Having addressed the problems with the Social Security system, it’s time to consider some solutions. Coming up next…