Social Security or Calamity? (Part 1 of 4)

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 classes 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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