In 1983, Social Security was insolvent.  Every penny ever collected for Social Security had been distributed to beneficiaries.  The revenue collected from payroll taxes was insufficient to cover the annual benefits of current recipients.  Social Security was forced to borrow money so it could pay the promised benefits – and the politicians went to work.

Most of the reform was based on the work of The Greenspan Commission which was formed in 1981.  It was chaired by Alan Greenspan, the man who would overtime bring us the housing crash.  The recommendations consisted of raising taxes and cutting benefits.   The politicians applauded the hard-fought compromise, and told the country that the system was fixed.

Like other fixes, the fix was short-lived.  The system now has 20.5 trillion dollars of unfunded liabilities¹.  That means that the system has roughly $10 of promises for every dollar of asset.  One can see clearly that the system isn’t fixed at this time.  One can argue that it wasn’t fixed in 1983. 

Understanding this failure is essential for anyone who hopes to save the system.  The failure is actually very simple to understand.  The country pushed the legacy costs of Social Security disproportionally on to non-voters with the assumption that they would cover the increasing costs.  Non-voters received substantially larger benefit cuts and substantially larger cost increases.  Now these people can vote, and there is no way to bind them to the terms of the 1983 agreement.

Over time, these people who had no vote in 1983 have grown into a massive voting block.  In fact, 2010 was the first year in which a majority of voting aged-Americans could expect to have benefits reduced as the Trust Fund runs dry.   This voting block results from two factors.  People who were non-voters have gotten older.  In 1983 someone who was 17 is now 46.  The other factor is that the promises of DC are proving optimistic.  Over the last 5 years, Run-Dry Date has dropped by 8 years.  As that run-dry date gets closer, it will affect more and more Americans, and they will vote accordingly.

Summary Of The Greenspan Commission

The people who were non-voters at the time of the 1983 changes could expect to pay the higher rates of taxes than any generation and were subjected to larger cuts in benefits. 

Increased tax rates :

“Advances scheduled increases in Social Security tax rates. Social Security tax rates (which include the Hospital Insurance tax rates) for employers and employees will increase to 7.0 percent in 1984, 7.05 percent in 1985, 7.15 percent in 1986-87, 7.51 percent in 1988-89 and 7.65 percent in 1990 and thereafter.”

Today Social Security’s portion of payroll taxes is 10.6% of the 15.3%².  If you started work in 1990, you expected to face 49 years of peak rates.  If you were 40 in 1983, you could expect to face 26 years of peak rates.  If you were 45 in 1983, you could expect to face 20 years of peak rates.

Adjustments to retirement age:

“Raises the age of eligibility for unreduced retirement benefits in two stages to 67 by the year 2027. Workers born in 1938 will be the first group affected by the gradual increase. Benefits will still be available at age 62, but with greater reduction.”

In 1984, the retirement age of someone who was 45 was unaffected.  Someone born in 1938, faced a modest increase in retirement age.  Someone born in 1960 and later got the full increase of two more years of work.  So the majority of the savings comes at the expense of non-voters in 1983.   

Introduction of means-testing :

“Beginning in 1984, includes up to one-half of Social Security benefits as taxable income for taxpayers whose adjusted gross income, combined with half their benefits and any tax-exempt interest they may have exceeds $25,000 for a single taxpayer and $32,000 for married taxpayers filing jointly. Benefits received by married taxpayers filing separately are taxable without regard to other income. Appropriates amounts equal to estimated tax liability to the Social Security trust funds.”

“Changes the earnings test for beneficiaries age 65 and over so that $1 in benefits will be withheld for each $3 of earnings above the annual exempt amount, beginning in 1990”

In 1984, this rule did not affect many people.  The problem is that these limits have not been changed for inflation.  These rules also have a greater impact on people who saved for retirement with IRAs or 401Ks.  Today it affects up to 1/3^rd of retired Americans.

The Lesson Of 1983

The lesson is simple.  You can't solve the legacy burden of Social Security by voting to put the costs on non-voters.  Overtime, these people will grow into voters that will not honor the terms of the agreement.  By sheltering one voting block at another’s expense, we opened Pandora’s Box.  Every generation will feel entitled to shift the costs that were given to them to the next generation.  When a generation says 'no', it will create a very difficult transition.

1, 2012 Social Security Trustees Report Page 15

2. The payroll tax holiday reduces OAS rates from 10.6 to 8.6% on a personal basis.  It raises an offseting amount from the general taxpayer.  So FICA really mains at 15.3% of wages.

Some people have come to the conclusion that the Social Security system cannot be saved.  They believe that Social Security is mathematically certain to fail.  Some analysis is limited to the size of the unfunded liability that exists today.  Others point out that the mathematics of the system are unable to succeed regardless of what we do to taxes and wages.

Our general opinion is that we should fix the structural problems within the Social Security system before we come to that conclusion.   But it is difficult to fault anyone who bypasses this step given the gridlock in politics today.  So the question is: what makes one phase-out plan better than another?

Our goal is to ensure that the system does not meet an unplanned end.  We believe the worst versions of this idea enable groups to exempt themselves from the cost of dismantling the system. As voting blocks change so will the exemptions until a voting block emerges that simply votes the whole thing away.  This is a national problem, and the cost of unwinding the system must be shared equally by all Americans.

An unplanned end will have significant repercussions.  The lesson from the financial crisis of 2008 is that our economy is interconnected.  As one part fails, another part of the economy suffers.  When one bank failed in NY, an auto dealer in Georgia was forced to lay-off employees.  Social Security is more than a trillion dollar business, directly affecting more than 50 million Americans.  The interconnectivity of that failure will be much larger than that of the Financial Crisis of 2008.

We believe that the majority of these plans face a significant problem. Virtually all of these plans all depend upon young workers continuing to contribute to Social Security fully knowing that they will get nothing.   Today, Social Security taxes are loosely connected with benefits in the mind of the taxpayer.  Even if it is a terrible deal, workers believe that they will get something back in return.  The view of payroll taxes will change once we sunset the system.  The view will change from it is a bad deal to it is a tax. 

We envision that this change in perception will foster a considerable amount of inter-generation tension at the ballot box.  Every year, the voter's perception will get worse has you add young workers who experience a tax, and a declining number of people who still get benefits.  Voters will already blame retirees for the budget deficit that the workers have to support.  In conjunction, we envision Social Security coming to an unpredictable end as the most likely outcome.

Here are the things that we look for in a sunset-plan:

First, and most importantly, if these people are correct – and they well may be – Social Security is a national problem.  The solution must be passed on to all Americans; not a narrow group. 

Second, the shared-solution must persist over time.  We strongly believe that no voting majority should be able to insulate itself from the pain of unwinding process. If such protection occurs once, it will occur again once the mix of the majority changes.  The worst solutions imaginable are those that protect the beneficiaries today.  This will only shift the costs of dissolving the system to other Americans.  If the burden is placed on younger workers, we envision that they will become a voting majority overtime, and vote the whole system away.

Third, the solution should recognize that today’s workers have contributed significantly more to the system than any other generation.  Their contribution has largely created a pocket of lost-retirement savings.    

Fourth, in 2008, the nation learned about the interconnectivity of the economy.  The problem for the economy wasn’t the failure of one bank, but the failure of parts of the economy which failed because of the failure of one bank.  It is not possible to sunset a trillion dollar business without seeing connectivity to other parts of the economy.  The plans should take into account how sunsetting Social Security will affect other industries.