An unbelievable amount of rhetoric has been spent on Social Security reform. Almost all of it is irrelevant. The most prolific commentators appear to have no concept about which they speak or are deliberately trying to confuse the issues. Two major misconceptions permeate the discussions; population demographics and insurance vs savings. The year in which the current system will reach crisis is misrepresented because only the Social Security Administration (SSA) is considered. When the Treasury is included in the analysis the crisis occurs much sooner.
The solutions proposed by the politicians and commentators assume the problem with social security must be solved entirely within the SSA. Many of the proposals will probably make the crisis worse. Some highly effective solutions may be found outside the SSA.
Demographics are developed from the US Census Reports for population estimates from 1900 to 2000 with projections to 2050. In this analysis three segments are defined; potential workers 20 to 65 years, retired over 65 and youths under 20. I use the 20 to 65 segment to represent the workforce although not all are actually working. But many in the under 20 and over 65 segments are working. While not completely accurate, my assumptions should provide a reasonable picture of the social security demographics and the financial analysis of the situation.
The following statement by the SSA may be correct but it is definitely misleading. This statement represents only two segments of the population; the very large third segment is completely ignored.
"Today about 3.3 people pay into Social Security for every one person receiving benefits. By 2030, this ratio is expected to decline to about 2.2 to 1. SSA now collects more in taxes than it pays out in benefits. According to the 2004 Trustees Report, Social Security expenditures are expected to exceed tax revenues starting in 2018. If there are no changes in the law, the trust funds are projected to become exhausted in 2042 and the taxes would thereafter be insufficient to cover the full cost of the program."
The SSA statement reflects only the workers and retirees. When the youths are included a very different picture is evident. The under 20 population has been declining (except for the baby boom bump from the mid 40s to the mid 60s) from about 45% in 1900 to a projected 25% in 2020. The Census Bureau does not predict substantial change in the under 20 segment from 2020 to 2050. Since workers are supporting the entire population, ignoring the under 20 segment grossly distorts any financial analysis. While the SSA statement may be rationalized from an internal bookkeeping prospective, the youths must be included when formulating national policy.
A more realistic picture can be presented by combining the under 20 and over 65 population into a single non-working segment. The ratio of working and non-working is fairly constant from 1900 through 2050. One interesting observation is that the ratio is presently the highest (58%) that it has ever been. The projection is that it will reach 61% by 2012 and decline slowly to 53% in 2050. While, based on internal accounting, social security may be facing a crisis in 2042, the nation as a whole should not. However the management policy for the SSA trust funds may create a national crisis long before there is a SSA crisis.
The decline in the ratio after 2012 could be prevented by delaying the retirement age. Retirement age would have to gradually increased to 70 by 2030 and to 75 by 2070 to prevent the ratio dropping below 60%. This could be achieved only if the health and physical condition of the 60 to 75 age range were increased dramatically. Major investment will be required to even approach these retirement ages.
Insurance vs Savings
Most people treat Social Security as if it were simply a savings plan without considering the inherent insurance provisions. The SSA report clearly indicates that this is not the case. A substantial portion of the SSA operations is purely insurance.
"Few government agencies touch the lives of as many people as the Social Security Administration. About 52 million Americans - one out of every six - receive monthly cash benefits from Social Security or Supplemental Security Income (SSI), the major programs that we administer. Through their payroll taxes, almost all workers are earning valuable Social Security coverage for themselves and their families. The following table provides the number of beneficiaries for the Social Security Old-Age and Survivors Insurance (OASI), Disability Insurance (DI), SSI programs and the combined programs. Over the period from September 1995 to September 2004, the number of OASI beneficiaries has grown by 6 percent, DI by 34 percent and SSI by 15 percent."
"DI Program: To qualify for DI benefits, an individual must meet a test of recent covered work before becoming disabled. Disability benefits provide a continuing income base for eligible workers who have qualifying disabilities and for eligible members of their families. About 9 out of 10 persons age 21 through 64 who worked in covered employment in 2002 will receive benefits if they become disabled. Workers are considered disabled if they have a medically determinable physical or mental impairment that prevents them from engaging in substantial gainful activity."
"SSI Program: SSI is a means-tested program designed to provide or supplement the income of aged, blind or disabled individuals with limited income and resources. SSI payments and related administrative expenses are financed from general tax revenues, not the Social Security trust funds. Children, as well as adults, can receive payments because of disability or blindness."
About 21% of retirees currently have no other source of income. For many of these who were formerly employed a low wages, the OASI payments is below the poverty line. But they have to pay income tax on what they receive. Some of them also receive SSI. Income taxes could be eliminated for OASI payments to retirees below the poverty line, with partial exemption up to twice the poverty line.
"OASI Program: The OASI program is financed by the OASI trust fund. To qualify for OASI benefits, a worker must have paid Social Security taxes (Federal Income Contributions Act and/or Self-Employment Contributions Act) for at least 10 years (or 40 credits) over the course of his/her lifetime. Nine out of 10 working Americans can count on benefits when they retire, with reduced benefits payable as early as age 62. Benefits are also paid to certain members of retired workers' families and to survivors. 91 percent of people age 65 or over in calendar year 2004 were receiving benefits. The largest category of beneficiaries over age 65 is retired workers. About 97 percent of persons aged 20-49 who worked in covered employment in 2003 have acquired survivorship protection for their children under age 18 (and surviving spouses caring for children under age 16)."
The DI and SSI account for over 21% of the SSA payments and are clearly insurance . They are also growing much faster than OASI. OASI is a mixture of insurance and retirement savings. The SSA report does not provide a clear separation or OASI insurance and retirement disbursements. My rough estimate is 15 to 20%. The total insurance-type payments are probably about one-third of the SSA total. Even the OASI retirements have the aspect of insurance. OASDI retirement provides the equivalent to a lifetime annuity for an individual and surviving spouse. The cost to purchase a equivalent personal annuity at age 65 is between $250,000 and $300,000 for maximum benefits.
SSA Financial Position
The SSA income is currently greater the its expenses. The excess is invested in a "Trust Account." The trust account is invested entirely in government securities. The 2004 value of the account exceeds $1.6 trillion. This is almost two thirds of the 2005 federal budget. The trust fund if forecast to grow to about $3.9 trillion in 2018; then decline to zero in 2042.
The government securities in which the trust funds are invested are not covered with any assets except the taxing power of the US government. Stated otherwise, the trust fund is an unfunded obligation on the US government. When it is redeemed, the funds will have to be paid out of general revenues. The crisis will occur in 2018 when general taxes will have to be increased or additional borrowing is implemented to redeem the trust account.
A potential investment management strategy is to transfer part of the trust fund to commercial investments. This would permit diversification of the investments. How this could be done is a very sensitive question. Any attempt to transfer any major the trust fund in one step would be financial disaster for the country. It would cause inflation while the government would have to raise taxes dramatically or borrow from the commercial market. A more realistic approach would be to invest part of the future income in the commercial market.
An attractive approach is to permit every SSA contributor to develop their individual investment strategy. Several investment funds would be devised wit different strategies (conservative, balanced, aggressive as a minimum) with the present government securities as the most conservative. Each individual could allocate his/her contribution across the investment funds. At retirement, the SSA pay out would be based on the overall performance of the individual's investments, higher or lower than standard.
Private accounts have been proposed as part of the SSA reform. The nature of these accounts have not been defined. The common assumption is that they would be "401x" accounts; that is 401k with very few restrictions and conditions. While the investment of private accounts would probably perform better than government securities, performance is probably not the feature that attracts most people. I expect that the most attractive features are the flexibility of withdrawing funds and the capability to pass these funds to their heirs. I do not believe either feature should be implemented. Since OASI is intended to provide retirement income, the private accounts should be converted to an SSA annuity at retirement. Investors would have some flexibility in investment opportunities, but no flexibility in withdrawal and no pass through to heirs.
Here are some recommendations from my personal prospective.
SSA income: Increase payroll deductions, but provide a reasonable exemption for people with dependent children.
Income taxes: Implement an income tax exclusion for retirees below the poverty line.
SSA investments: Start a gradual transfer of part of the trust fund from government securities to the commercial market. Individual option for participation in this is essential.
Private accounts: Develop a strategy to permit individual participation in investment options. Multiple investment funds would be best but private accounts with only an SSA annuity pay out could be a viable option.
Revised May 2008
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