random rants and references

A local newspaper caught my eye with two letters that panned the President's plan to improve Social Security and characterized Personal or Individual Accounts as “Risky Gambles”. They didn;t discuss the underlying problems with Social Security that are addressed by those accounts. Instead they offered only some tax increase options. Since I hold a different view, I thought I'd try my hand at articulating the Social Security issue as I see it with no claim of doing a complete analysis.

This is a big issue for me since, like many others, I'm old enough to collect a check from social security and to have sons and daughters-in-law paying into the system. I'd like to see a solution that that works as well for them (and my grandchildren) as it does for me. Looking at the current Social Security system, it seems clear that the best hope for a real self-sustaining and long-term solution is the Bush proposal that blends Individual Accounts into the existing system.

So what are the big underlying problems with today’s system?And why can't we fix them, as suggested by the two letter writers, by increasing the wage tax cap or adding state employees ? Well, I see three big problems: 1) the “Pay as You Go” (or PayGo) financial structure; 2) our national demographic and longevity trends; and 3) the Trust Fund Shame (or illusion?).

PayGo simply means today’s workers pay FICA taxes that go to today’s retirees as benefit checks. As long as more taxes come in than benefits go out, this can work as it has for years; but it gets tougher as the number of workers shrink and the number of retirees grow. The worker to retiree ratio was pretty high in the 1930’s, but has been the constant victim of national demographic and longevity trends ever since. Over the last 100 years, life expectancy has increased from under 50 to over 75 years and advances in health sciences should see this trend continue. After World War II, we began the 20 year Baby Boom. These Boomers turn 65 in the years 2010-2030, making another big drop in workers and surge in retirees. The result of these trends is that the worker to retiree ratio dropped to 16-1 about 50 years ago; and now stands at 3-1 heading to 2-1 in the not so distant future. The good news is we’ll have longer lives and more retirees; the bad news is there will a lot fewer workers to pay the benefits, and recent birth rates indicate this trend will continue. So, it’s a Big problem Now.

Raising taxes by increasing the wage cap or by adding state workers, does not solve the Big Problem caused by PayGo and longevity trends as they combine to spiral us into an ever deeper financial hole. At best, they postpone our immediate problem into a bigger one for our kids. Why is that? Adding new workers may seem to help in the short run, but they will eventually retire and draw benefits from that same shrinking pool of workers to retirees, making for a worse problem later. (And not much later either, since these people are all in the same age range as current workers!) Taxing higher wages, under current system rules, means these high earners/ high taxpayers will become very high benefit receivers in future because the system bases their benefits on the amount of their wages as well as the number of years in the system. Given the longevity trends, these tax “solutions” may well become much bigger problems later. There’s another reason why these tax fixes may make the problem even worse. Those added tax payments now don’t go to pay today’s benefits, they become part of the surplus of revenue over benefits and the surplus funds go into the “Trust Fund” where they earn interest. Sounds good, huh? But not really!

The Trust Fund Shame (illusion?) is that the surplus FICA dollars are not really “saved”, they are spent immediately for the current operation of the Federal Government, just like any other tax. The Government does issue Bonds to the Trust Fund, but these are not real assets in the sense of an IRA or bank account or house that a person owns; think of it as one part of the government (Treasury) writing promises (Bonds) to pay another part of the government (Trust Fund) for benefits at a future date. But those payments can only be made WITH taxes or other revenue that it must raise then. The shame of the fund is that it requires massive future taxes or borrowing to pay its obligations to retirees. (Sort of a tax me now and tax me later scheme.) Adding new surplus taxes now only makes for a bigger tax problem later. Sure, these are government obligations, but they are not any form of real wealth for any person; just a promise to pay money in future, but nothing that you can borrow against or sell or leave to your heirs as you could with a personal trust fund. That’s the second part of the Trust Fund Shame – the illusion of a personal asset that's not really there.

OK, so how do we solve so huge a problem? Well, it took a long time to get here and the solution will probably need a long transition time too; but the sooner we start the easier it will be. I believe we need a serious structural reform that directly addresses the 3 big problems. The reform must shift us over time from PayGo and an illusionary Trust Fund to an improved Social Security (and Wealth) system that allows everyone to acquire real assets that they own, and which can provide a secure and financially better retirement than the current system. Personal or Individual Accounts are the key and essential means to do that; they capture the power of compound interest to grow real personal assets and wealth. The claim, that these accounts are “risky gambles”, flies in the face of the evidence from the past financial history of this country and its markets. For example, the government covers all employees under its Thrift Savings Plan (TSP) for retirement income (and real assets) based on employee choice of different market investment funds (cash, bonds, & stocks); the TSP common stock funds shows 12% annual growth over both its life and even the last 10 years, including the 2000-2003 bear market. By the way, the annual operating costs are down to about 0.06% now, less than 10% of the average mutual fund's costs. University employees have had a similar experience since the 1950’s with their TIAA-CREF retirement plans.

The TSP and TIAA-CREF plans do an excellent job of providing their participants with much better rates of return than does Social Security - and the funds are vested and can be left to one's heirs. Can't say that about today's Social Security. While I'm no expert, I do think President Bush's vision is right on target. His proposal lets younger people put some of their FICA Tax into Personal Accounts that build their own wealth for retirement, makes secure the current promises of payments for older workers and retirees, and reduces the system's future liabilities (i.e. the future tax burden on our kids). Of course, it will take work and negotiation to turn this vision into a real 21^st Century Social Security system. But big problems need big visionary solutions, not more patchs to a seventy year old system. So, how about some real Social Security Rejuvenation?

# posted by Gene @ 8:37 PM