Alas!  The final piece of the Social Security puzzle we’ve been putting together.  In Part 3 of “Social Security or Calamity” we discussed the reform option of partial privatization.  It is difficult to find a “right” solution to the great financial security problems our nation has, however, it is the hope of many economists to start thinking about good solutions; solutions that will alleviate the great financial burden placed on the generations to come.

Why Change The System?

The leading opponent to full or partial privatization is the American Association of Retired Persons (AARP).  The AARP represents the portion of the population that is currently receiving benefits from Social Security and has the most to lose by changing the current system.  For this aging population the Trust Fund will stay solvent.  Reform is not their main concern.  Of late, the AARP has released a report called “What’s the Big Idea?,” which outlines several reasons not to privatize, which are mentioned throughout this report, and gives a list of revenue raising and cost cutting solutions to keep Social Security solvent for future generations.

Cartoon: THK

The following are simplified summaries of the revenue raising suggestions set forth by the AARP: remove the arbitrary cap of taxable income at $90,000.00; increase the payroll tax rate by 2.6% over 70 years; tax higher income beneficiaries; instead of phasing out estate taxes, divert the taxes to social security; and lastly, invest some of the Trust Fund in index funds that yield higher returns.  The AARP suggests a combination of several revenue raising proposals and the following cost cutting proposals:  raise the retirement age; index benefits to price, not wages. These adjustments to the current system have the potential of postponing insolvency up to a 75 year forecast.  Unless some greater reform action is taken to permanently fix these problems, the future generations can expect to deal with them again, but with more severity and less room to negotiate.

Who Wants The Change And What Should It Be?

Between major political parties and groups there is rarely consensus on how severe the problems facing Social Security really are.  The lack of consensus about the need for urgent policy changes, and the political unpopularity of advocating any such reforms, have left Social Security issues on the back burner of the nation’s political agenda.  The risks of changing the system are too great and the policy makers and majority voters are closer to retirement age than the younger generations who have the most to lose from non-action.  In the next 20 years, as this situation escalates, many citizens will be put to the test.  Quoting President Kennedy from The Coming Generational Storm, “the hottest places in hell are reserved for those who in a period of moral crisis maintain their neutrality.”

It is clear that the fiscal challenges this country faces are not going away.  If anything, they are getting worse with each tax cut and new social program that gets developed.  As former Chairman of the Fed Alan Greenspan suggests, “timely action is what this country needs”.  The longer we delay action the worse the situation gets and the more difficult it will be to resolve.  The most detailed and credible analysis and discussion on the subject of Social Security was completed by Kotlikoff and Burns.  Their suggestions for reform seem to be the solution to our problems.  The difficulty is convincing conservative politicians that such a drastic and risky transition is what this country needs.

Kotlikoff and Burns have done a superb job of developing a plan that considers all the objections and concerns regarding their proposals.  Are their proposals the best for our country?  Or, is it enough to just raise revenues and cut costs to keep Social Security solvent for the short-term?  How better-off will Americans be from partial privatization?   These questions need to be evaluated and precisely answered by the influential people of our time before we can move forward with reform.

It is my belief that the best solution to the Social Security dilemma is the program that Kotlikoff and Burns advocate.  It conquers many adversities; leaving the future generations better off, making the government more efficient and ensuring the retirement of current beneficiaries.  The solutions Kotlikoff and Burns suggest need to be adopted.  “Our country has spent decades piling up astronomical bills for the next generation to pay.  Forcing them to do so will destroy their lives and ruin our country.  The only solution is to radically, but rationally, reform our social insurance institutions and take other critical steps to prevent our nation’s bankruptcy.” (Kotlikoff and Burns)

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From the comments I received in Part 2 of “Social Security or Calamity?”, I am confident that full-privatization is not a viable solution for Social Security reform in America.  It seems, as Greenspan recently put it, that we can no longer trust the managers in a free market to operate in the best interest of their stakeholders.  We know that it is bad business to neglect the stakeholders of an organization, so where does the motivation come from to make selfish, short sighted decisions?  Let’s get back to the subject at hand here.  In this post I’ll introduce the idea of partial privatization as a reform option.

Partial Privatization

A hybrid of the highly privatized system Milton Friedman envisioned, and one that encompasses the inefficiencies of today’s system and ensures government control, is partial privatization.  President George W. Bush established the Commission to Strengthen Social Security (CSSS) in 2001 to evaluate and propose plans for Social Security reform.  In 2005, after the State of the Union Address, Bush suggested Model 2 of the CSSS report to be considered and debated by Congress for enactment.

Model 2 of the CSSS report proposes that 4% of taxes, up to a maximum of $1,000.00 be diverted from FICA to individual private investment accounts.  Beginning in 2009 growth in benefits under the current system would be indexed to growth in price rather than wage; on average wage exceeds the price level.  The new “progressive indexing” would reduce the growth in benefit payments to current recipients, but other measures in the report are proposed that reduce this loss.  By 2052, new retirees would expect to earn 59% greater returns on benefits than the current system provides.

Cartoon: Taylor Jones | Hoover Digest

Opponents to Bush’s proposal argue that the net effects of the reform are neutral; due to the high cost of implementing new government bureaucracies to manage private accounts and the diversion of taxes from the current system to fund private investments.  The details of Bush’s proposal are undisclosed and proper analysis is not available to determine its effects on the economy.

In “The Coming Generational Storm,” Kotlikoff and Burns present their analysis of the current welfare programs in America, and develop a detailed solution to the problems of Social Security through a form of partial privatization, which differs from Bush’s Model 2.

Kotlikoff and Burns propose a highly detailed and drastic reform to the tax and welfare programs of America; which they conclude is the best reform possible.  First, they propose to replace the personal and corporate income tax, payroll tax, and gift and estate tax with a 33% federal retail sales tax plus rebate.  The rebate would be paid monthly to households based on their demographic composition, allowing poverty stricken households to effectively pay no sales tax.  Their analysis shows that this new tax would provide the government with enough revenue to cover their current spending needs, including the transition cost to their “New New Deal.”  The 33% sales tax they propose represents 21% of the GDP in 2000.

Second, Social Security is replaced with a Personal Security System (PSS).  Under this proposal, current retirees would receive their full benefits, and current workers would receive benefits based on their covered wages prior to the date of reform.  The PSS accounts would function like PRA’s, but the Social Security Administration would have control over the investments in a global index fund of stocks, bonds, and real estate securities.  The passive fund would have low management fees, which helps smooth opponent concerns about high management costs that trigger the conflict of interest with Wall Street.  The return at retirement, based on the performance of the global fund, would be equal among all participants and the government would guarantee that contributors would get the money they invested adjusted for inflation, no matter what happens with the real value of the global fund due to price movements.  Finally, their proposal abandons Medicare and Medicaid, replacing them with a universal Medical Security System that promotes private health care competition and a voucher system to subsidize the costs to citizens.

Stay tuned for the finale of this exciting adventure into Social Security reform; an adventure that all Americans need to think about taking…

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TeachStreet is home to a large community of Washington-based yoga teachers, yoga studios and yoga students that are getting hit by a three year old tax amendment that places yoga studios within the realm of physical fitness services; which need to collect a sales tax from their customers.  Over the weekend, our friends at 8 Limbs Yoga Centers in Capitol Hill started issuing a sales tax for their services.

So, why the recent buzz?

Over the last several months the state has been auditing yoga studios, and to the surprise of most studio owners, they are being told they owe over three years in back taxes.  Some of the first cases appeared as early as January of this year.

Creative Commons | judepics

This is an untimely audit push by the Washington State Department of Revenue.  Yoga students are expected to pay on average $100 more per year for the same services.  This tax is especially hard on the unsuspecting yoga studios that now owe over three years in back taxes.  On average, that is about $27,000 in taxes that an audited studio needs to come up with; 30% of their annual revenue!  I think the last thing our local economy needs is even less consumption and higher unemployment due to this tax being enforced during a great economic downturn.

Interested parties may want to take a look at this part of the Washington Administrative Code that defines physical fitness services, and clearly exempts yoga as a taxable service under the law:

“(l) “Physical fitness services” include, but are not limited to: All exercise classes, whether aerobic, dance, water, jazzercise, etc., providing running tracks, weight lifting, weight training, use of exercise equipment, such as treadmills, bicycles, stair-masters and rowing machines, and providing personal trainers (i.e., a person who assesses an individual’s workout needs and tailors a physical fitness workout program to meet those individual needs). “Physical fitness services” do not include instructional lessons such as those for self-defense, martial arts, yoga, and stress-management. Nor do these services include instructional lessons for activities such as tennis, golf, swimming, etc. “Instructional lessons” can be distinguished from “exercise classes” in that instruction in the activity is the primary focus in the former and exercise is the primary focus in the latter.”

We want to hear from you.  Anyone out there that is affected by this tax.  Please leave your comments and concerns.

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It is times like these where the great proverb, knowledge is power, rings truer than ever. Not power over others, rather the power to guide our own destinies. The decisions we make today about where to put our money and who to trust to deliver knowledge to our kids on important subjects like business, science, language and arts, depends also on the knowledge we have and share with others.

In Part 1 of “Social Security or Calamity?”, the vulnerability of the Social Security system in America was exposed by its condition of insolvency for future generations, and possibly even the generation of baby boomers preparing to enter retirement today. In this post I will discuss just one of a few solutions to the Social Security crisis. The other solutions and grand conclusion will come in the next two posts.

Privatization

“I don’t understand why the government should tell me how much money I should save for the future, but not tell me how much of my money I can spend for food. And I believe that the current Social Security system is in certain ways fundamentally unjust.” From a 2001 interview with reporter Bill Steigerwald, Milton Friedman expresses his frustration and concern about America’s welfare programs. Friedman gives an anecdote for why he feels that Social Security is not only an economic failure, but also a moral one; “here’s a young man, a man of 35 or 40 who has AIDS and is told that he has got five or 10 years to live at the most. And the government comes along and says, ‘You’ve got to put aside 13 percent or something like that of your income to save for your old age.’ That seems to me to be cruel and unjust.”

Cartoon: Jim Day | Las Vegas Review-Journal

Privatization of Social Security proposes a transition of the current system to Private Retirement Accounts (PRA).  Like an IRA, a PRA allows the individual to make decisions on how to invest their money.  The argument is that payroll taxes should be invested in real financial assets; not government promises to raise future taxes.  The PRA would earn higher interest (8.5%) than non-marketable Treasury securities (2.5%).  Over a 25 year period, a $1,000.00 contribution to the PRA would earn the retiree $6,013.00 more than that same contribution to the pay-as-you-go system.

The major concerns with transitioning to the PRA system are the high cost of starting and managing the new systems (approximately $2 trillion), the windfall profits that Wall Street could earn from managing the investments, the problem of continuing to provide benefits for soon to be and current retirees, and the presupposition that the general public will make the best possible investment decisions for themselves.  Partial privatization is an approach that controls several of these concerns.  Some economists say partial privatization is the only way to phase in complete privatization and save our nation’s retirement system.  Part 3 of this four part post discusses this in more detail.

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In recent years, the uncertainty about our government’s ability to take care of us in old age has led to a great inquisition and desire to learn about personal financial planning and wealth management in our society–at least we hope.  The due diligence of many economists, financial analysts and politicians in evaluating the Old Age, Survivors, Disability and Health Insurance Act (OASDHI), which will simply be referred to as “Social Security” in this four part post, has uncovered serious concerns about the future viability of our nation’s largest retirement programs.

• How critical is the need for Social Security reform?
• Which approach to reform should be adopted?
• What are the implications of each approach?

Economists have looked at these questions and developed various approaches to Social Security reform from full privatization (Milton Friedman), to partial privatization (George W. Bush: the Commission to Strengthen Social Security 2002; and Laurence J. Kotlikoff and Scott Burns: “The Coming Generational Storm” 2004), and other revenue raising and cost cutting reforms that do not require dramatic changes to the Social Security system.

This blog series presents the research of various advocates and opponents of Social Security reform.  The discussion uncovers various issues threatening the future viability of Social Security, introduces and examines the debate between various suggestions for reform and the economic implications of each, and finally, the evidence presented herein is used to make a suggestion for reform that ensures the most effective and permanent retirement system for the years to come.

Comic: Tom Toles | Washingtonpost.com

What’s Really Going On?

At first glance, the Social Security system today looks to be quite healthy, however, that is far from the truth.  Social Security is commonly referred to as a pay-as-you-go pension system; where the tax revenue from current workers (based on 12.4% of income up to $90,000.00) is used to fund the benefits of current recipients.  The revenue from payroll taxes, or Federal Insurance Contributions Act (FICA) taxes, greatly exceed payments to beneficiaries and represents a hefty $2 trillion current surplus in the Social Security Trust Fund.  By law, any surplus in the trust fund must be invested in long-term non-marketable Treasury securities; proceeds of which are used for government deficit spending.  In essence, the government is borrowing the money citizens pay toward their social security, using the proceeds to fund completely unrelated federal programs, then paying back all the money they borrowed, plus interest, when it is needed by us, the tax payers.  This would be fine if we all agree that the government’s use of that money is creating enough value in our economy, to offset the more than $2 trillion dollars they will inevitably have to add to the government deficit when we need the money back, and most likely by printing more money.  This in itself is another major part of the story I will not elaborate on here.

Total Social Security spending is expected to rise from 6% of gross domestic product (GDP) to 20% by 2080.  In order for the Social Security Administration to cover these obligations without increasing payroll taxes, reducing benefit levels, increasing earnings on the trust fund’s investments or delaying the age at which new retirees are eligible for full benefits, the federal budget deficit will need to rise drastically.  Didn’t we just hit an all time high on national debt?

It is expected that by 2017, nine years from now, tax revenue will no longer exceed benefit payments and the trust fund will be drawn down to cover the difference owed to beneficiaries.  In 2017, as 78 million baby boomers retire, the value of the trust fund is expected to slowly decline; eventually reaching total depletion by 2041.  The major cause for the future insolvency of Social Security is the large growth of retirees relative to the working population which supports their retirement.  This demographic transition is caused by changes in life expectancy and birth rates; birth rates are dropping and life expectancy is rising at unprecedented levels.  By 2017 the ratio of tax payers to beneficiaries will be reduced from 3.3 to 1 to about 2.2 to 1.  In light of the aging U.S. population, future projections show us how vulnerable the current Social Security system really is.  Chairman of the Federal Reserve Board, Ben S. Bernanke, expresses the urgency for reform in his recent speech to the Washington Economic Club.  “The imperative to undertake reform earlier rather than later is great.  As illustrated by the simulation I discussed earlier, the longer the delay in putting our entitlement programs on a sound fiscal footing, the heavier the burden that will be passed on to future generations.”……TO BE CONTINUED…..

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