January 05, 2005
Social Security, A Slightly Different Take
There has been quite a bit of wrangling lately about whether or not there is a Social Security crisis and if there is, exactly when it becomes a crisis. Instead of wading in to that again, I’m going to talk about how Social Security has changed, and how it could change again. (If you are interested in a good take on ‘crisis’ I suggest this post by Jane Galt.)
For purposes of this post, I will be talking about the old age portion of Social Security. I'm aware that there is also a disability portion. It is conceptually severable from the old age portion. I'm aware that it exists, but it isn't what I'm talking about.
At its inception, Social Security was politically positioned as a pension-like program. You would work, pay into it, and if you got lucky you might get a little bit out of it when you retired. The retirement age was set such that most men died before they would collect a single check and most of those who retired would collect checks for less than three years. This made many choices about how to set up the program look very easy. It made funding it in a pay-as-you-go fashion very attractive because there were dramatically more workers than there were pensioners. Making it a universal program despite rhetoric about it as a safety net was a cheap way to broaden political support because most people didn't live very long after retirement. In short, Social Security was designed around a number of assumptions which are no longer true. Talking about changing it is not an attack on The New Deal. It is a reevaluation of ideas which where enacted under a set of assumptions which do not apply to modern Social Security. The heart of Social Security is protecting people from poverty in their old age. The way it is set up now helps protect people from old-age poverty while paying tens of billions of dollars every year to retirees who are not poor.
Even if it needs changing, why would we change it now? If it isn't a crisis now, why not wait? The answer to that is simple. The system as currently set up, even if not immediately in crisis, represents a huge and growing portion of government expenditures. It is also something that people make their long term retirement plans around. If you are ever going to make changes to a program like this, it makes sense to phase them in over a long period of time so that those who have made plans under one set of assumptions are not damaged by the shift to another set of assumptions. Social Security is exactly the kind of program for which if it is going to be in crisis in 40 years, you want to start phasing in the changes now. The conceptual framework of workers paying into Social Security as we go along is not going to work 40 years from now to pay off all the benefits unless we have hugely unexpected amounts of long term economic growth. If that happens, we have no problem under almost any proposal. But if it does not, we will have more money going out of the program than coming in, a position which cannot continue indefinitely. There are many ways which we could correct that imbalance. We could dramatically raise the retirement age. We could almost double the amount of payroll taxes taken in. We could do something else. The thing to remember is that there is no free lunch. When more money is going out than is coming in, something has to give eventually.
We have allowed the mechanics of Social Security to get away from us by drift instead of intention. A plan which was designed to protect against old age poverty now give tens of billions of dollars a year to people who are not poor. A plan which was designed to avoid paying most people by making a high retirement age now has a retirement age which can leave huge numbers of people in the system for more than a decade. A plan which was designed with a 15-to-1 worker to retiree ratio faces a 3-to-1 worker to retiree ratio. These changes have creeped up slowly but have changed the underlying deal dramatically.
My proposal would be as follows. Please realize that the concepts are more important than the precise numbers. In other words the democratic process could negotiate the details. First, an old-age poverty program doesn't need to pay wealthy and upper middle class retirees. The cheap political cover isn't cheap any more. It now costs tens of billions of dollars per year. The mechanics of the current system (as influenced by the political pretense that it is a pension program) mean that the highest paid workers--those who are best able to plan and care for their retirement future--also get the highest benefits. There is a slight climbdown from this by making the highest benefits taxable, but this does not change the underlying fact that richer people are getting higher payouts. Much of this is tied into the conceit that this is a retirement or pension program. The analogy with a pension program explains why people who make higher incomes get higher benefits. It doesn't really make sense given the underlying justification for the program.
Retired Americans are typically much more wealthy than their peers. In each quintile of wealth, they are more wealthy (both with and without home equity) than all of their peer except those in the most wealth producing working years, 55-64. (See Table F in the Census Report on Net Worth and Asset Ownership of Households). They also have more wealth than those under 55 in the quintile above them. So when I talk about the wealthiest quarter of retirees I am talking about a population significantly wealthier than the top quarter of the general population. According to Table D, those in the the fourth quintile had an income of between $3,364 and $5,416 per month. That is a very liveable income, especially if you own your own house which a large percentage of these retirees do. Those in the fifth quintile of course have more income. (Note about census household statistics: elderly households are noticeably smaller than younger households so their per-capita wealth and income are understated by these statistics).
We could slowly phase out the Social Security benefits of the top quarter of income earners and come to a very large savings in Social Security outlays. I would suggest phasing benefits out at 3 1/3% per year over thirty years. Since the top quarter of Social Security beneficiaries earn more than the top quarter of benefits, this would save more than a quarter of old-age Social Security benefits. Gaming the system could be minimized by reducing the benfits on a less than 1 to 1 ratio compared with income. The income situation for those retiring more than 30 years from now should be better than just the current income situation minus social security benefits for the top quarter as upper middle class and wealthy people save more to compensate for the knowledge of reduced benefits.
What about privitization? I like the idea of the government encouraging privately controlled accounts in theory, but I am skeptical of it in practice. The major benefit of privitization plans is that it gets people used to actually being involved in decision-making regarding their retirement. I am skeptical about privitization plans for very conservative reasons--I think such plans would lead to nearly inevitable government attempts to tinker with market outcomes. Our financial system is not perfect, but it has a fair degree of efficiency. I am loathe to put that at risk. Even after a medium downturn of relatively short duration (say the market from 1999-2001) the pressure to meddle would become immense. At least one of the following two things would happen:
1. The government would intervene directly in the markets, ultimately making the markets much less efficient at exposing market weaknesses; and/or
2. The government would make up the shortfall, eliminating many if not all of the projected savings from privitization. Knowing this, some people may take especially risky investments, knowing that if they fail the government will bail them out.
I'm not interested in a scheme which I suspect will lead either to little savings or extreme government meddling with the financial market structure.
UPDATE: My initial link to the Census Report appears to be non-functional. The link can be found here.
Posted by Sebastian Holsclaw at January 5, 2005 03:55 AMSocial Security should be abolished. Unfortunately, President Bush and the Republican congress have no intention of doing so.
Posted by: Joe at January 5, 2005 07:17 AMI like the idea of the government encouraging privately controlled accounts in theory, but I am skeptical of it in practice.
As you should be. From the New York Times today (may require free registration).
The Bush Eyes Plan Using Bulk of Payroll Taxes
Posted by: Joseph Briggs at January 5, 2005 09:11 AMSebastian, as I began reading, I thought I kept seeing items to take issue with and started making notes. However, by the time I finished, I realized there was nothing in your article to take issue with. In my opinion, your facts are correct, your reasoning sound, and conclusions insightful and original.
After debating this subject at length here at WB, I was a little surprised to learn even more from reading your article. Thank you.
It does only make sense for fiscally sound reasons to curtail benefits over a period of time to those who don’t need to be insured against poverty, ultimately ending such payments altogether. Actuarials can actually establish what the rate and duration of curtailment should be in order to move the deficit spending horizon out into the future significantly.
Your article addressed only the retirement pension aspects of SS. I would add, that the single greatest thing that could be done to insure longevity of the insurance dimensions of SS is to devise means of reducing health care costs without losing accessibility. The liberals are simply going to have to compromise on tort reform, at least in regard to medical malpractice, if they want to preserve the insured aspects of SS. That is because rising health care costs are the greatest threat to that aspect of SS.
Additionally, survivor benefits should also be curtailed to those who are adequately insured otherwise and who by virtue of wealth, can easily provide for their dependents after the loss of the wage earner. I consider it the price of living in a nation NOT lined wall to wall with the “great unwashed” and beggars, as is found in places like India.
Posted by: David R. Remer at January 5, 2005 09:19 AMJoe, what plan would you put in place that would insure against 10’s of millions of Americans falling into poverty, disease, loss of access to the health care system, abuse, and all of the other social ills that are nourished by poverty? Simply abolishing it with no replacement plan sounds anarchist. Are you an anarchist?
Posted by: David R. Remer at January 5, 2005 09:22 AMSebastian -
Brilliant piece. Any time you get effusive comments out of both me and David, you know you’re doing well :-)
I only wish that the average journalist had your grasp of the issues.
Joe Briggs -
I read your recommended NYTimes article, but there’s a glaring mistake in the math used to come up with the headline. As anyone debating this issue should know, the 6.2% payroll tax paid by the employee is only half of the total payroll tax - another 6.2% is paid by the employer. It’s basically a sneaky way of making the tax look smaller. So instead of about two-thirds going into individual accounts, as the article states, it would actually be 1/3; much less.
Great article,
My only comment would be;
Before you raise the retirement age you really have to think about that. It may look good on paper, but those writing the paper are setting at a desk, not working construction, factory labor, or other phyically hard labor.
They should try laying blocks at 65, let alone 70, then get back to me on that one!
Posted by: Beagle at January 5, 2005 10:30 AMMy initial link to the census information doesn’t appear to work. The corrected link appears at the end of the post.
Posted by: Sebastian Holsclaw at January 5, 2005 10:47 AMChops, good observation on the 1/3 vs. 2/3. But, it begs the question, can SS be strengthened or saved by removing 1/3 of its revenues. It is obvious to me that such a plan has only one outcome, killing SS and all of its insurance against poverty and survivorship and disablility aspects.
Posted by: David R. Remer at January 5, 2005 11:44 AMYou are most certainly correct, Chops. I actually heard the $1300/yr cap quote on NPR this morning on my drive into work this morning so I just looked in the first few news outlets I thought would have the story. And as I was cutting and pasting the title, I wondered why the word, “bulk” was in the title.
I was actually thinking the other way around. I was thinking the 1300 a year cap was way low and that the program would still be insufficient for most. I realize the proposal, as vague as it is, is not meant to produce a bunch of lower-class day traders, but it certainly won’t be adding very much to anyone’s retirement accounts to justify both the risk to all who participate and to the system itself.
Out of all of Bush’s plans for second term, I thought this one had the best potential, but if all he is going to do is work on some facile legacy program, then screw it. It’s not facing imminent doom as they say, and their program is extremely controversial, so why not wait until we get a truly viable plan before monkey-wrenching the poor thing.
Posted by: Joseph Briggs at January 5, 2005 12:04 PMYou don’t wait till the motor in your car blows up before you change the oil.
Time to fix this system once and for all.
People who are wealthy enough ( by there own admission can’t even opt out ) how stupid is that! There should be limits better than there are now. The top third should see a reduction.
The age should be increased again.
Younger workers should be allowed to set aside a portion of there contribution and not just a donation to the general fund. Which is how it has been since inception.
Americans need to be educated about the payroll tax, by paying it monthly separately from there paycheck and you’ll hear the screaming in the streets. There is no shortage of blame on this monster, both sides of the isle created this budget busting behemoth.
Posted by: Chris at January 5, 2005 05:14 PMChris, Social Security is what stands as a major difference between the streets of America and the streets of India. America does not have wall to wall beggars and poverty stricken masses selling their children to eek out an existence. The Wealthy should indeed pay a premium for living in a society where the wealthy are not hated, constantly threatened, and where conspicuous wealth is not spit on, arsoned, and the target of terrorist attacks, by organized groups of poor.
If they don’t like the price of keeping America populated with middle class masses instead of poverty stricken masses, they can try India, Pakistan, or China. They have many choices and can afford to choose. So far, I haven’t seen an exodus of the wealthy from our shores to those. Hence, the price of living in the greatest nation on earth is, according to free market forces, not too high.
Posted by: David R. Remer at January 5, 2005 05:32 PMSo far, I haven’t seen an exodus of the wealthy from our shores to those.
The jobs of their employees are a different story, though. :-p
Posted by: ceejayoz at January 5, 2005 05:41 PM“Social Security should be abolished”
It’s nice to see a liberial wanting a liberial program abolished.
The initial article is quite thoughtful and insightful. (And, it is probably more honest and intelligent than what we will soon hear out of all the cable news barking dogs and most of the elected DC politicians.)
The concept of Social Security as insurance, as opposed to entitlement—similar to car or health insurance—if you need it, you can receive it, because you have paid your premiums, comes to mind. Means testing would be a comparable concept.
As for the latest Bush proposal of privatization—take a financial calculator and crunch the numbers—it doesn’t in any way begin to solve or help the retirement situation of 20-35 year olds of today. If the historical market return assumptions are correct, at best, it might buy these workers one more year of retirement funding. It really just doesn’t add up. The lawmakers need to all go back to the drawing board on this one and come up with something better.
James Meister, it is nice to see folks like Sebastian and yourself doing their homework on this issue. I am encouraged in believing the President’s plan will not pass muster by enough Congress persons in his own party. As you say, when the numbers are crunched, the plan does not do what it portends to do.
And a lot of conservative constitutents out there are smart enough to relate to that number crunching once it has been widely disseminated. Less than 2 years to Congressional elections is going reteach Bush that no amount of political capital is going to be enough to pass an ill-reform of the third rail of politics. Only a real reform that saves the damn program instead of killing it, will have a chance of deelectrifying its reform.
Posted by: David R. Remer at January 6, 2005 03:13 AMExcellent ideas Sebastian. I’m willing to consider any plan that will strengthen Social Security for those who need it.
Bush’s scam is just an obvious step towards completely “privatizing” (dismantling) the system.
