Posted by: dstieglitz | May 31, 2011

Another Trillion Dollar Bailout

    A few months ago the Social Security Administration sent a notice saying I was eligible for full benefits now that I’m 66. The notice said my employers and I paid over $340,000 into Social Security and Medicare since my first job in 1962 stocking shelves in an A&P supermarket. That’s a lot of money – but Social Security is way ahead since my lifetime benefits will be far less than $340,000 plus 50 years of interest. I don’t take issue with the shortfall though, because one principle of Social Security is that high-earners subsidize low-earners. Even though I won’t get out what I paid in, I object strongly to the head-in-the-sand way that Congress is managing Social Security.

Lurking Monster.  These days everyone in Washington is talking about the debt ceiling and budget cuts. But lurking in the future is a monstrous Social Security bailout that would dwarf the banking, auto and insurance bailouts. At $680 billion per year, Social Security is our largest social program. Its costs grow annually, and its long-term projections are deteriorating. Possibly as early as this year, Social Security could change from a program that finances other federal operations to a program that sucks cash from the Treasury. Left to operate as it does today, Social Security will drain a trillion dollars a year from the Treasury in 30 years. 

Trust Fund Funny Money. Until recently, I was confident that Social Security would provide benefits for the rest of my life. Today, I get worried when I hear the president and Congressmen say that Social Security fixes can be deferred because the trust fund will last until 2036. That’s an accounting sleight-of-hand because the trust fund doesn’t own real assets like property, gold or blue-chip stocks. Instead, it holds $2.5 trillion in Treasury bonds, and those holdings will grow to $4 trillion. For example, in 2020 Social Security will receive roughly $200 billion less in payroll taxes then it will pay out in benefits. But on paper the trust fund will still grow $15 billion because it will “earn” $215 billion in new bonds as interest. Enron executives went to jail for bookkeeping like that! When Social Security takes in less than it needs to pay benefits, it will raise cash by cashing in Treasury bonds. This Ponzi scheme collapses in 2037 when payroll taxes aren’t enough to pay benefits and the trust fund has no bonds left to redeem. The scheme only lasts that long if the Treasury Department can borrow $4 trillion from commercial and international markets to redeem Social Security’s Treasury bonds! 

The Crisis Worsens.  Social Security faces a worse crisis today than in 1983, the last time Congress enacted changes. As recently as 2008, the Social Security Trustee’s Report projected a cash surplus of $87 billion this year and $88 billion next year. But persistent unemployment has reduced tax receipts and dropped the projections to $19 billion and $18 billion, respectively. Three other factors intensify the crisis. First, people are living longer and retiring earlier, so they collect higher lifetime benefits. Second, the large baby boomer generation is retiring, but following generations are smaller which reduces the number of workers that support each retiree. And third, the stock market collapse and decline in home values increases the dependence on Social Security. Social Security will be a majority of the income for nearly half of the baby boomers who will retire in the next 30 years. 

Life Expectancy.  When Social Security began in 1935, the retirement age was set at 65 and life expectancy was 62. Today, men live to 76 and women to 82 on average. Furthermore, if current cancer and heart disease research is successful, life expectancies could easily reach 100 years. Obviously, linking retirement age to life expectancy is essential to preserve Social Security. Having older people stay economically active longer has four huge advantages: (1) Workers earn more and can save more for retirement, (2) The government receives more in taxes and pays less in benefits, (3) Serving older workers would be a new market, and (4) The economy grows faster because there are more workers. It’s true that workers who do manual labor might not be able to work past 65, but that is less of a problem today because age isn’t a big factor in the service and knowledge-based jobs that dominate our economy. 

Ticking Time Bombs.  The growing number of baby-boomer retirees and increasing life expectancy are ticking time bombs. Congress must defuse those two issues today to prevent Social Security from becoming an economy-threatening trillion dollar bailout in 2036. You might ask: What’s the worst that could happen? If Congress did nothing until 2030, taxpayers would be contributing nearly $300 billion annually in additional income taxes to redeem the trust fund bonds required to pay Social Security benefits. In that situation, Congress would face a choice between reducing benefits and increasing taxes. Always willing to defer hard choices, Congress would likely choose to fund Social Security annually from the general revenue pool. That would be the end of Social Security as we know it because retiree benefits would thereafter have to compete with other federal spending priorities. Life expectancies approaching 100 years will have an even more explosive effect. Most 100-year old Americans will have spent their savings and need bigger social Security benefits just to survive. 

Simple Solution.  If Congress considered Social Security objectively instead of treating it like a sacred cow, they could write the solution on a cocktail napkin: (1) Index retirement age to life expectancy as we’ve already discussed, (2) Make payroll taxes progressive, and (3) Gradually shift the trust fund from 100% Treasury bonds to a balanced portfolio. These three fixes would preserve the program in perpetuity. Today, employees and employers pay Social Security tax on incomes up to $106,000. That means people who earn $100,000 a year pay the tax on every dollar, while someone who earns $1 million pays tax on only 10% of his/her income. It’s doubtful that Congress would impose the Social Security tax on all income because that would be a large tax increase on middle class households. Rather a donut-hole approach would be effective: keep the ceiling near $100,000, exempt income from $100,000 to $200,000 (for example), and reinstate the tax on all income above $200,000. That change alone would pretty much wipe out the 2036 shortfall all by itself. In addition, Social Security trustees should gradually redeem the trust fund’s Treasury bonds and invest in assets like blue-chip securities, properties, and high-grade commercial and state bonds. That way, interest/principal payments from companies and borrowers would cover Social Security’s cash needs, rather than Treasury borrowing money to pay benefits. Taken together, these three simple solutions would insure I receive the Social Security benefits that have been promised. More importantly, my children and grandchildren could rest comfortably knowing they will receive benefits someday, even if they have to work longer to get them.

Conclusion. President Obama and Congress face the most important strategic choice since choosing to put health care reform ahead of everything else. Financially, the U.S. is tittering on the edge of a cliff that jeopardizes the economic well-being of our children and grandchildren. Today’s economic debate centers on three issues: cutting expenditures, restructuring the tax code, and reforming entitlements like Social Security. All three are urgent, essential and politically explosive; but Social Security reform may be the easiest. Such reform would produce a more progressive and sustainable system, ensure the government can pay for the benefits it promises, and show global creditors that the U.S. really is capable of governing itself. It’s obvious that Americans must work longer before they retire, and that high-income retirees like me will see our benefits reduced. I don’t like that possibility, but it’s better than pushing the country into bankruptcy. With the detonator ticking on Social Security spending as baby boomers retire and grow older, the terms of the debate are clear: (a) What should we expect from government? (b) How much are we willing to pay? and (c) What are we willing to do without? Let’s answer these questions for ourselves and communicate our wishes to Congress in order to make their hard choices easier, thereby avoiding another trillion dollar bailout.

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