Saturday, November 17, 2007

Here Comes the Social Security Crisis

Paul Jacob at Townhall had a typical story about the looming social security crisis. So many political discussions of social security misrepresent how the program works, and make it difficult to form an informed opinion. Jacob's article makes for good fodder for a lesson on how the program really works, and what our options are for fixing it.

”When Social Security was set up, its supporters pooh-poohed critics who warned that by not investing the collected funds the government was setting up a major fiasco. The pooh-poohers were wrong, of course; the skeptics, right.”

This is one of the weaker statements of the article. Social security was set up, and continues to be, essentially a welfare program for old people. It’s a fairly equitable concept, since we almost all get old, and those of us that don’t aren’t complaining much. This is known as a pay-as-you-go program, and as such it is not flawed per se. Most government programs work this way:

”There was no investing going on. Money came in to the government. What did not go out to the early pool of recipients was sent to Congress to cover its deficits. Ostensibly, money that was supposed to pay future beneficiaries became IOUs that Congress owed those beneficiaries. They legally plundered the kitty. “

This is essentially correct. Since government programs cannot know exactly what their expenses are going to be, inexact estimates are made, and whatever difference results between actual income and expenses and the estimates, be it a deficit or a surplus, is accounted for. Surpluses become IOUs from the government. For social security, these are the dreaded “trust funds” so often spoken of. The main point to keep in mind about the Trust Funds is that, contrary to the way some manipulative politicians talk about them, they are not bank accounts with money in them. They are simply IOUs owed from the general treasury to the SS program. This is why talk of putting the funds in a “lock box” is nonsense. As to the plundering of the kitty, that requires a bit of history to explain, and unfortunately Jacob botches it:

”And the huge post-World War II Baby Boom helped keep the system afloat. You had this surge of young workers paying in, not taking much out.

But still, the system was so unstable that, throughout the sixties and seventies and eighties, FICA taxes to support it increased . . . increased so much that the FICA withholding, for many Americans, has grown to exceed other federal taxes.

And now the end is in sight. All those Baby Boomers whose FICA withholding kept the system afloat all these years now begin to retire. Soon, the money going to retirees will far exceed money coming in. And the crisis point will have been reached. “

That is a distorted version of the story. The baby boomers did not keep the program afloat, aside from slightly hiding the problem with increasing lifespans by contributing an increased level of taxes. But the program was far from being in a crisis. It simply needed to account for the increasing life expectancies by either increasing the eligibility age, or benchmarking it to new life tables over time to keep the payer/beneficiary ratio unchanged. Sadly, that is not what was done. Instead, in the early 80’s the actuaries started rumbling about the coming problem with social security due to the impending retirement of the baby boomers. This would greatly reduce the payer/beneficiary ratio of the program from the 15:1 or so ratio it had when it began.

However, rather than make changes to the eligibility age, congress in 1986, under the leadership of Ronald Reagan, decided instead to solve the problem by increasing the SS taxes while the baby boomers were payers, ostensibly to be put aside and drawn on years later when the baby boomers retired.

The problem is that, as I explained above, government money never gets set aside, and the SS over payments brought by the 1986 act were no exception. Those funds were used as general revenues to pay for other government operations, and the SS program accumulated many billions of dollars in government IOUs in the form of the trust funds. Now that the baby boomers are starting to retire, we need those additional funds to pay their benefits, and we get to the rub in the 1986 Act plan:

”It would be naive to say “Let Congress just pay it back — after all, those politicians merely borrowed the money; we just ‘owe it to ourselves.’”

It would be naive to say this, because the members of Congress don’t get their mad money from their own bank accounts. They take it from taxpayers.”

Exactly. The trust funds merely say that money collected for the general treasury should go to pay SS benefits. But that money doesn’t fall out of the sky. It comes the only way government money comes: via taxes, or the flip side of the equation, a reduction of government benefits. This is the tough decision we Americans are forced to make: do we increase taxes to keep SS benefits at their current levels, or do we reduce those benefits, either directly, or indirectly via increases in the eligibility age? There are arguments to be made. However, what we should not do is toss in a lot of emotionally and politically charged irrelevancies like this:

”Forcing more money from taxpayers to give to a subset of taxpayers is more (and boy, do I mean more) of what Congress has already been doing. Besides, there’s something indecent even about suggesting that we must now raise taxes to pay off people who had been taxed long ago for the fund in question.”

Um, Mr. Jacob, that’s how social security has always worked, just as every other government transfer program is done. Taxes are collected from one subset of the population and given to another subset. To criticize SS in this fashion is to criticize the way our entire government works. In the case of SS, it worked just fine until the population demographics tossed us the baby boom blip. The problem is not with transfer payments, or the taxes to pay for them. Jacob does not seem to understand this, as he goes off on a tangent talking about SS like it is a funded pension plan. It isn’t, and it never has been, and it is not useful to talk about it like it is. That is what led to the problem with the 1986 plan in the first place: the assumption that the increased revenues would be put into some sort of bank account to accumulate interest and be ready to pay benefits in the future, instead of the reality of being borrowed for general distribution.

”Putting the whole thing on an investment basis is essential, yes. But we still have to pay out generations expecting retirement help whose funds were not invested. Raise FICA taxes? Been there, endured that. Raise the retirement age to, say, 72? Yikes.

To postpone Social Security’s inherent insolvency by either a dramatic tax increase or a setting back of the retirement age — or both — would be to admit, quite plainly, the swindle at the heart of the system.”

Here Jacob is simply denying reality. It is not a swindle, but simple mathematics, that forces the decision between increasing taxes or decreasing benefits. There is no inherent insolvency in the program. As long as the proportion of beneficiaries to tax payers remains monitored and adjusted to take in the necessary income to pay current benefits, such a program can exist indefinitely.

Now it is certainly possible, once one gets past the messy transition period problem of finding additional funds to pay existing beneficiaries once the former tax payers are allowed to invest into a new actuarially sound government pension plan, thus removing that tax income from the program. However, such a decision would expose the program’s funding to the oscillations of financial markets, thus creating a real risk that the necessary funds will not be available in years of financial downturns. Imagine the effect on such a program of a stock market correction on the order of the 1929 correction. Do we really want our program protecting the elderly to be exposed to such risk? I think not. Given the distorted picture Jacob painted of the program, his closing statement was rich in irony:

”So its about time for Hillary, and Rudy, and Mitt, and the others to start talking about these issues up front, and honestly. “

Indeed, it is. But that will involve discussing the real choices we have to make between benefits and tax levels. Ranting that the program is a swindle and a fix, and talking about it like it is a funded pension plan, only further muddies the waters of reasoned discourse we need to be clear to solve this problem.

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