Sunday, December 19, 2004

Saving Social Security

Michael Kinsley has made a bleg through Andrew Sullivan (HT: TM Lutas of Flit TM) for input on President Bushes privatization of provisions for Social Security. His theory is that it is mathematically impossible for the proposal to succeed. But he does not really define by what he means by success, he implies that he means increased benefits. Other suggestions would be maintaining the solvency of the fund or protecting the ability of the beneficiaries to receive some money when the main trust fund goes belly up.

Aside from the fact that long term Social Security is in the hole, the questions he asks do not seem to reflect a useful understanding of how the Trust Fund works. But, then in the last two presidential elections, the president made comments about the trust fund that were so general as to be meaningless and the opposing candidates, members of the Senate with multiple years of experience, said things that were just plain dumb. As a former employee of the SSA who later took graduate courses in Government finance, accounting and budget; I always find these discussions entertaining. For that reason I am not going down his questions point by point. However the main issues I discuss are related to his questions.

First of all:

Can Republicans even pass a reform bill

I do not think so.

The only time there has been a major overhaul of Social Security was in the Jimmy Carter Administration. This reform was a major reduction in future benefits, though that was not the primary argument used to sell it to the public. The argument for public consumption was that there were inequities (and there were) between several groups of beneficiaries. The reform was to correct them. The reform did remove the inequities but when the new tables came out the actual reduction in benefits for every one was amazing. The people who disadvantaged by the inequity would have been better off without the reform. You will almost never hear it said that Jimmy Carter and the Democrats are the only people who reduced SSA benefits but that is what happened.

This is how Social Security will be reformed the next time. The Republicans always explain the actuarial tables saying the benefits need to be reduced to save the system. There supporters fall asleep listening to the accountants. They are always slaughtered in the “you’re destroying Social Security” response. Bushes personal account plan is in part a way to avoid the trap; I have serious doubts he can pull it off. The next time there is Democratic President, he/she will announce a reform to remove inequities or some such thing, and not advertise it slashes benefits. Whatever support it loses from a minority of Democrats who see the catch, will be made up from Republicans who see the actuarial tables. The other possibility is that the Democrats will make a counter proposal which will get some Republican support “as the best that can be done” which will slash future benefits.

The Mechanics of the Trust Fund

Despite what some pundits say, there is a Social Security Trust Fund. There is a safe someplace that holds the paperwork. Every year SSA public relations sends out a press release that shows a picture of someone holding the paperwork. The Trust Fund is controlled by the Social Security Commission, which consists of the Secretaries of the Treasury, and Health and Human Services and the Social Security Commissioner. These are “at will” positions that serve at the pleasure of the President. The President and two of the members also have major responsibilities for managing the General Fund. The Trust Fund by law loans its assets to the General Fund. This is a massive conflict of interest. A private pension fund set up like this would quite properly result in people going to jail.

Social Security Taxes are paid into the trust fund. The Trust Fund buys Government bonds. Originally these were no interest bonds. In the 1950’s the Republicans forced a change in the law that requires paying interest. I forget the formula but the interest rate is less that the average rate for bonds sold on the open market. The money borrowed from the Trust Fund is part of the National debt and the interest part of the debt service. Benefits are paid from the interest and taxes. The fund will be considered bankrupt when general revenue funds and not interest payments are used to pay benefits.

The Legal Status of Social Security Benefits.

Back when the Roosevelt Administration set up Social Security, it chose to make Social Security contributions a tax which one is obligated to pay, like any other general tax, without imposing any obligation on the government. Payments are an entitlement, granted at the pleasure of the government, but to which you have no right when the government elects to change them to your disadvantage. However the Roosevelt chose to sell it to the US population as Social Insurance that lead most people to believe they had a had genuine retirement insurance with a right to the benefits. If you have a contract with an insurance company and they unilaterally change the benefits to your disadvantage, you can go to court and enforce the contract. Social Security is set up so this cannot happen. Part of the current problem with the trust fund is that Congress (usually the Democrats but the Republicans helped) increased benefits several times with out a proportional increase in Social Security taxes, leaving the Trust Fund in the hole. But since the beneficiaries have no right to the benefits this wasn’t a problem, Congress could always adjust them back. If there were a right to the benefits this would have been a big problem.

Bushes proposals can be debated under a number of substantive and technical items, but one of the effects would be to make part of Social Security benefits an enforceable contract rather than an entitlement. I think that is Bush’s unstated success standard; that when Social Security goes bankrupt part of the benefits will isolated from the regular trust fund, titled to individuals, and not available to the government. Thus retirees will have an assurance of some benefits beyond the discretion of Congress. This is probably the most important result to be achieved from Bushes proposal. Possibly with a gradual shift from a single trust fund to individual accounts the collapse of the social security system can be avoided.

How Long Will the Social Security Trust Fund Last?

Assuming that the Social Security Trust fund is to be treated like a genuine insurance trust fund (which it legally isn’t, though there is considerable political pressure to do so) the actuarial statistics depend primarily on the rate of inflation. Low inflation means that long-term revenue will be more in line with outgo. With high inflation, the cost of living increase payments will rise much faster than income increases. This will probably hold true with any reform. When you see an estimate of how long the trust fund will last, the speaker is using an (often unstated and/or unrealized) inflation rate to suit his/her rhetorical purpose. The general consensus of the data I’ve seen is that 2 or 3% inflation the Trust Fund will last 30 or 40 years. At 20% and more maybe 5 years. The tables I’ve seen very widely, this is the general pattern but I would put not faith in any single table. Even more important than any reform is keeping the inflation rate low!

Demography is Destiny

Essential to the program is that there are more workers paying in than retirees taking out. It was about seven or eight when the law was passed it is currently approaching two. A number of factors created this, however the only real way to have prevented it would have been to outlaw contraception and abortion in 1973. There would now be an additional twenty to thirty million workers supporting the system. Even if the Supreme Court were to say preserving Social Security is a “government interest that outweighs the privacy interest of Griswold and Roe” it is most likely too late for the resulting population increase to compleatly correct the problem. And I know the chances of that happening are slim and none. I think there are some who would rather see Social Security go down. But with in the limits of political acceptability we need to increase the birth rate and promote immigration of younger people who will hold jobs and pay into the system if the system is somehow to survive.

It’s the Economy Stupid.

Part of a solution is to maximize economic productivity, employment, profits, wages, and business growth all without increasing inflation. This is what produces the economic activity that pays Social Security taxes. The tax revenue income will come in long before the workers are due the benefits delaying the problem for decades, with enough population growth and minimum inflation an actuarial equilibrium might be reached. Basically higher productivity per worker can reduce the required ratio of persons paying in to those paying out. Unfortunately, the strongest proponents of the current system are the most likely to hate the hyper capitalism required to save the system.

What will happen if part of the trust fund is invested outside the Federal government?

The Social Security taxes going to personal accounts will not be available for loan to the general fund. But the general fund will not have to pay interest. If the interest rate was the true rate at which the government borrows money this would be a net gain to the general fund in a few years, and probably is over a few more years at the actual rate, the money saved on interest will outweigh the value-received on a loan from the Trust Fund. However on a one-year basis the General fund will usually be behind, and Congress budgets annually. On a long term average the combined personal accounts/trust fund will receive more money than if it had loaned to the general fund because there will be a higher average rate of return, especially at the below market rates paid the trust fund. But remember the long-term average includes some years when where there will be a loss.

The probable effect of investment outside of the government will be to help stimulate the economic productivity, if it is invested in that job and industry creating activities, that will pay more taxes including Social Security taxes, and reduce benefits paid if it creates an incentive to retire later. This would increase tax revenue to both trust fund and the general fund.

In a strict economic sense, depending (a big IF) on how it is set up investing some of the Social Security Taxes outside the Government should be a long-term net gain to both the Trust Fund and the General Fund.

What is really WRONG with the privatization proposal?

All the above misses the biggest objection to the proposal. Sooner or later the government will end up with a voting stock proxy on a major portion of US industry. If it is not part of the original law, it will be added in 5 or 20 or more years, the money and power involved is to big of a temptation for this not happen. Major economic and business decisions will be made based on transient political considerations. Given the track record of nationalized industries elsewhere the productivity gains necessary to keep the fund solvent will be lost. There are most likely ways to avoid this, most of the proposed plans initally assign this to the individual. That the government will never hold the Proxy's need to be put in, ironclad, up front.

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