Fixing Social Security
Social Security is the financial backbone of most Americans’ retirements. For 20 percent of retirees, it’s their sole means of support. For 50 percent, it’s their major source of income. And for 70 percent, it’s either their sole, major or second-most important income source. It’s no wonder that the system has so much political support. The elderly are a major voting block and are rightfully concerned that no one touch their Social Security.
Unfortunately, the system is in grave financial trouble that can no longer be ignored. It also puts large numbers of workers in their early 60s into a 50 percent perceived higher tax bracket, giving them every incentive to stop working when the exact opposite is what they really need to do. As if these two concerns weren’t bad enough, the system is unfathomably complex, thanks to 2,728 basic rules in its handbook and hundreds of thousands of rules about these rules in its program operating manual system.
This complexity makes it impossible to figure out which of the system’s nine benefits we can and should collect and when to do so. Only a highly sophisticated computer program can provide the right directions. But since most people aren’t using software, most are taking the wrong benefits at the wrong time, losing benefits because they weren’t aware they were available or both. You can have an IQ of 200, the best education money can buy and still lose tens to hundreds of thousands of dollars in lifetime Social Security benefits because you didn’t know some critical Social Security gotcha that its maniacal architects concocted.
As I mentioned, my small company makes personal financial planning software, including a program to help people figure out their best Social Security collection strategy. In order to help our engineers program our software, I had to become very well versed in the system’s provisions. This took years of questioning current and former Social Security technical experts.
It was a daunting task as Social Security has its own internal language (e.g., the word “entitled” has an entirely different meaning from the word “eligible”) and its rules have endless exceptions to the exceptions. To help keep things straight in my brain I decided, one day, to write down the mathematic formula determining benefits for a spouse at a given age.
Social Security’s Benefit Maze
It took most of a week to get it entirely straight. When I finally got the formula right, and stared at it for a while, I realized that it was one of the most complex mathematical expressions I’d ever encountered. The formula, if you will forgive a few lines of geek talk, encompasses 10 mathematical functions, some of which are continuous (smooth), some discontinuous, some discrete (taking on only two values) and some maximum functions (select the larger of two or more numbers) and other minimum functions (select the smaller of two or more numbers). Indeed, one function is a maximum function defined over a minimum function.
In contemplating this monster formula, I also realized that I was looking at the solution to a horribly cruel puzzle that bureaucrats had designed as some kind of intellectual sporting event with complete disregard as to how it would affect ordinary people trying to collect what they’d paid year in and year out in FICA taxes. I also realized that the puzzle provided a tremendous and durable ego boast to its creators. They had produced a special Rubik’s Cube that only they and a few others could fully solve. Consequently, the vast number of Social Security’s 40,000 staff would have to rely on them for “technical assistance” — to the extent they were available to help. Otherwise, the staff would do its best on its own, and if the public lost a boatload of benefits as a result, so be it.
I’ve had many a lesson about how Social Security’s staff treats the public. To be brief, it’s a horror show. While the vast majority of its employees are well meaning, they aren’t sufficiently well trained to provide correct answers more than half the time. However, because they are understaffed and constantly harassed, they adopt an attitude of complete certainty in providing answers even when they know enough to know their answer could be completely wrong.
The result of all the complexity and, frankly, bureaucratic incompetence is that Social Security benefits are largely a lottery. Countless numbers of people have lost huge sums of money because either a) they didn’t know they were eligible for certain benefits, b) they took their benefits early when they should have waited to collect far higher benefits, c) they didn’t understand that their Social Security decisions could affect their spouse’s benefits and vice versa, d) they got divorced too early, e) they got married when they shouldn’t have and, yes, the list goes on.
Social Security Is Broke Today, Not Down the Road!
Even were the system in decent financial shape, the case for fixing it from the ground up would be overwhelming. But the system is in horrific financial shape. Its fiscal gap – the present value of its projected future benefit commitments net of both its projected future taxes and the value of its trust fund — is $26 trillion. This is clearly not the main source of the government’s overall $199 trillion fiscal gap, but it’s an important component.
Unfortunately, since the rest of the government’s fiscal affairs are in worse shape, Social Security can’t look for help from other parts of the overall federal budget. The entire fiscal system is 53 percent underfunded. The $26 trillion of Social Security red ink is 31 percent of the present value of the system’s projected taxes. Hence, Social Security is 31 percent underfunded.
Saying that Social Security is 31 percent underfinanced is another why of saying that Social Security’s 12.4 percent FICA payroll tax rate needs to rise, immediately and permanently, by almost one third to permit the system to pay all its promised benefits over time. That translates into 3.8 cents more in FICA taxes on every dollar earned up to Social Security’s taxable earnings ceiling, now $118,500.
Social Security’s Zero-Sum Generational Game
Telling the vast majority of American workers they need to fork over another 4 percent of their pay for the rest of their working lives and receive absolutely nothing in return is not something our politicians have been eager to do.
The only candidate to make much of an issue of Social Security’s finances this campaign season was Governor Christie. Unfortunately, even he never conveyed that Social Security is 31 percent underfinanced. Had he done so, the public might have drawn a comparison with Detroit’s pension system, which was roughly 20 percent underfunded when it helped force the city to declare bankruptcy.
Senator Sanders has been the most vocal of all the candidates when it comes to Social Security. His campaign website describes it as “the most successful government program in our nation’s history.” The Senator correctly points out that many of those living solely on Social Security are living in dire poverty because their benefits are so low. He proposes expanding benefits by $65 per month. On an annual basis, this is, $780. That, by the way, is less than the $2,000 annual payment per person I’m proposing.
What the Senator isn’t worried about is the system’s existing finances. Perhaps he hasn’t examined Table VIF1 in the 2015 Social Security Trustees Report. This table reports the system’s $26 trillion unfunded liability. But the table is relegated to the far end of the report’s appendix – so that no one will see it. No surprise there. The decision to hide this table was made by the system’s “trustees,” all of whom are political appointees.
Like our overall fiscal gap, resolving Social Security’s fiscal gap is a zero-sum game, generationally speaking. If we don’t raise Social Security’s employer plus employee payroll tax by 31 percent starting today, we’ll need to raise it by an even larger percentage when someone finally takes the problem seriously. This, of course, means our children and grandchildren will face an even higher payroll tax rate than 16.2 percent (12.4 percent plus 3.8 percent). It also means that many of us will retire before the payroll tax rate is raised and, thereby, avoid the problem entirely.
On his website, Senator Sanders says that anyone, particularly Republicans, who claim Social Security is broke are “dead wrong.” The Senator supports his view that the system is solvent by pointing to its $2.8 trillion trust fund and noting that the system can pay benefits in full for the next 19 years, and three quarters of scheduled benefits thereafter.
With all due respect to Senator Sanders, he’s miles off base about Social Security’s finances. The system’s $26 trillion shortfall, calculated by the system’s own actuaries, properly assumes that the $2.8 trillion trust fund is an asset of the system. In other words, even taking into account the $2.8 trillion worth of assets held by Social Security and also taking into account all the future taxes it will collect, the system is still $26 trillion in the red. That’s because the projected future benefits, valued as of today, exceed the present value of projected future taxes (plus the trust fund) by $26 trillion.
Furthermore, telling us that the system is OK for the next 19 years and then would be short one quarter of what’s need to meet its obligations is hardly reassuring to today’s and tomorrow’s Social Security beneficiaries. They are all counting on receiving 100 percent of their benefits for the rest of their lives, not 100 percent for 19 years and 75 percent thereafter.
Were Senator Sanders writing in this space, he’d no doubt say that the $26 trillion shortfall takes into account all future benefits (and taxes) and not just the system’s finances over Social Security’s traditional 75-year forecasting horizon. He’d also say that the 75-year fiscal gap is far smaller. All true. But today’s newborns will be 75 in 75 years and expecting to collect benefits for the rest of their lives – benefits they paid for. Hence, there is no economic logic to truncating the financial analysis. Again, take it from the Nobel Laureates and other economists who endorsed infinite horizon fiscal gap analysis at www.theinformact.org as the only valid way to assess fiscal sustainability, be it for a country as a whole or a given fiscal system.
The Purple Social Security Plan
It’s time to fix Social Security from the ground up without sacrificing its key objectives. If we are going to ask younger generations to pay most, if not all, of the current system’s unfunded liability, let’s give them a modern Social Security system that is simple, transparent, fair, efficient and fully funded. In conjunction with my tax and healthcare reforms, my Purple Social Security Plan eliminates our fiscal gap.
My plan deals with the retirement portion of Social Security. Here are its 11 provisions:
- Grandfather in current Social Security beneficiaries. That is, pay them the Social Security benefits they’ve already earned over time. Finance these payments from Social Security FICA tax proceeds, which will be expanded under my tax plan. Over time, these revenues will be added to general revenues as the accrued liabilities of the existing system decline relative to the size of the economy.
- Freeze the current Social Security system by filling zeros in workers’ earnings records for years after the reform begins. This means just consider the earnings records of workers during the year before the reform.
- Require all workers under 60 to contribute 10 percent of their wages to Personal Security Accounts (PSAs). This 10 percent compulsory personal saving contribution is in addition to the 12.4 percent FICA tax.
- Allocate each worker’s contribution 50-50 to his/her own PSA and to his/her spouse/legal partner’s PSA.
- Government contributes to the PSAs of low-income workers, the unemployed and the disabled.
- All PSA balances are invested in a global market-weighted index fund of stocks, government bonds, corporate bonds and real estate trusts.
- From ages 61 to 70, all PSA balances for each cohort (defined by year of birth) are gradually sold to purchase TIPS (Treasury Inflation Protected Securities).
- All investing, sales, purchase of TIPs and provision of benefits is done by a single government computer at zero cost. Wall Street plays no role and collects no fees.
- The government guarantees that PSA balances when they are sold and converted to TIPS equal at least what was contributed adjusted for inflation. I.e., the government guarantees PSA participants against real losses.
- PSA participants who die prior to age 70 bequeath unconverted balances to their heirs.
- Starting at 62, each cohort-specific pool of TIPs is used to make payments to surviving PSA participants in proportion to their share of PSA assets used to purchase that pool of TIPS.
My plan’s system of Personal Security Accounts, progressive government contribution-matching, contribution sharing among spouses/legal partners, uniform investment returns, a government zero real return guarantee and collective cohort-specific annuitization represent a modern Social Security system. It is, I believe, what we would choose to establish if we could start Social Security from scratch today. But we can’t start Social Security from scratch. We can simply freeze the existing system, pay off all benefits owed under the existing system as they come due and run the PSA system in parallel.
How will this reform help reduce the country’s fiscal gap? First, payroll tax revenues will continue over time even though the old Social Security system is being phased out. Indeed, since I eliminate the payroll tax ceiling as part of my tax reform, payroll tax revenues will be substantially higher. Second, no one will accrue additional benefits under the old system. Hence, the government will only need to pay Social Security’s accrued benefit liabilities, not its projected benefit liabilities. Its accrued liabilities are, I understand from speaking to Social Security actuaries, roughly $60 trillion less than its projected liabilities.
Some might view the 10 percent compulsory contribution to PSA accounts as a disguised tax. That’s not my view. The PSA accounts are the private property of each account owner. Yes, the government will be forcing us to save 10 percent of our wages. But it won’t be handing that money to others. It will be investing our money in a fully diversified global portfolio, plus providing a guarantee against experiencing any losses on a cumulative basis. That’s an investment anyone would want. And it will pay out our money to us in the form of real annuity payments that depend on our cohort’s realized mortality.
Furthermore, we should all be saving at least 10 percent of our pay for our retirements anyway. We Americans are very poor savers. Our decades-long experiment with tax-favored retirement accounts makes that clear. Far too many of us chose not to contribute to retirement accounts or not to contribute very much. That’s, in part, why the Baby Boom generation, of which I’m a member, is so poorly prepared for retirement. Having the government force us to save is what Social Security is in large part about. The PSA system forces us to save for ourselves. What it doesn’t do is force our kids to pay for our benefits.