Social Security reform should be a very popular issue.  More than 80% of the voting public thinks that without reform the system is heading for crisis.  The problem is that the support for reform is highly fragmented across dozens of ideas and concepts.   

The driver of that fragmentation is simply myths about the system.  It is difficult to ignore the impact of myth on the Social Security debate, and the strength that myth holds on the voting public.  And it isn't just the numbers of people, but the dogmatic belief.  In one email, the myth holds that Social Security would be voluntary.  Taxes aren't voluntary in this world.

One can see not only the belief, but the intensity, in the comments sections of articles, and the ratings of comments.  When you look at the most popular comments, they are invariably grounded in myth.  In an article about Obama’s offer to include a change to CPI portion of the benefits formula, the most popular comment was : “why not come up with a plan to repay the money stolen from SS !”  It received 2,476 thumbs up versus 38 thumbs down.  Those numbers mean that there are 65 people who thought it was a good comment for every one that thought the comment was inaccurate or irrelevant.

Here are the facts.  The Social Security system has a 20.5 trillion dollar shortfall assuming that every penny in the Trust Fund is repaid with a generous assumed interest rate.   (Page 15 of the 2012 Trustee Report) There is no one seriously suggesting the money won’t be repaid.  There is no serious person who says that repaying the money will change the outcome of the system.  After every penny is repaid, the system will still have 20.5 trillion in unfunded obligations, and will still be unable to pay full benefits in 2033 - and that is in a good economy. 

Another comment garnering 50 to 1 support: “Leave Social Security alone, its not your money, its not the gov. money. It is our money, we have paid into it, its not the government checking account.”   The money that is held in the Trust Fund is reserved for future benefits, and it is outweighed by the promises of the system by 10 to 1. 

Any comment that blames LBJ, Reagan, Clinton, or Bush for stealing the money is guaranteed to get support of 40 to 80 to 1 depending upon who is blamed.  The fact is that 90% of all money ever collected by the system was distributed to beneficiaries.  Until Congress changed the system in 1983 to collect excess cash, the system was a paygo system that produced almost no money to ‘steal’.  The system did not reach the 100 billion mark until 1988, when Reagan left office.  No: Social Security did not pay for Vietnam, Starwars, unfunded wars, welfare, section-8 housing, or any of the other obligations of the general fund.

The problem is simple.  Politicians have always enjoyed promising more than they can deliver.  Social Security is no different.  Politicians have altered to the system to generate more promises than it collects in cash, a difference that grows every year and amounts to trillions of dollars.  That comment will get voted down 100 to 1.

Sen. Bernie Sanders (I-Vt.) reintroduced legislation which would increase the amount of wages subject to payroll taxes.   His website provides material describing the bill, here.

In the five years that Sen. Sanders has pushed this legislation, the core problem with it has not changed.  This legislation diverts tax resources away from deficit reduction to Social Security.  Every penny collected under this tax provision could be raised as income taxes that would go to the general fund to either reduce the deficit or reduce the outstanding debt.  This idea is no different than putting your 401K contribution on your child’s credit card.

Over that time, though, the Senator’s promises have severely deteriorated.  Originally he promised that this change would make the system ‘solvent’ for 75 years.  Now he is promising to make the system ‘strong’ for 50 years.   Instead of basing his statement on current information, the news release points to research that is two years old.  He uses old data because Social Security has lost trillions of dollars of solvency over the past two years.  (To understand the difference between 'Fixed' and 'Solvent', here) 

The one thing that has not changed is the willingness of Sen. Sanders to support his ideas with word-games and sound-bites that have no factual basis.  His unique definition of words like ‘pay’, ‘owe’, and ‘cost’ tells the reader that not even the system’s strongest supporters actually believe in the system anymore.  If he still believed in the system, he would not be compelled to mischaracterize what the Trustees have said about the system.

 “Through good times and bad, Social Security has paid out every benefit owed to every eligible American”

Sen. Sanders can make this claim because Social Security can reduce what it owes to beneficiaries.  Social Security hasn’t paid out every benefit promised – just every benefit owed.  In 1983 Congress reduced what Social Security owes to people – substantially.  People who were owed benefits at 65 are now owed benefits at 67.  People who saved for retirement now face a means-tested claw-back against what they are owed.  

Sen. Reid, a co-signer, said “assuming that the only way to strengthen Social Security is to take away benefits that seniors have earned, or raise taxes on the middle class.”  According to the Supreme Court, Flemming V Nestor, Social Security benefits are not earned.  In its ruling, "the Court established the principle that entitlement to Social Security benefits is not contractual right" - (source www.SSA.gov)  In other words, Social Security does not in fact owe anyone anything.

 “Social Security officials say that simple change would yield about $85 billion a year to keep the retirement program strong for at least another 50 years.”

The $85 billion a year could be used to reduce the annual deficits which run nearly a trillion dollars a year.  Pushing this $85 billion to Social Security means that our children will face $85 billion dollars a year in more debt plus interest.  This isn’t a tax on billionaires.  It is a tax on our children. 

 “The most successful government program in our nation's history has not contributed to the federal deficit.”

Sen. Sanders does not let facts get in the way of a good sound bite.  The payroll tax holiday cost the general taxpayer nearly $250 billion dollars of dollar for dollar deficit spending.  The EITC which was designed to offset the high cost of payroll taxes on lower-wage workers is projected according to Forbes to cost $326 billion over the next five years. 

 “It has a $2.7 trillion surplus, and it can pay out every benefit owed to every eligible American for at least the next 20 years, according to the Social Security Administration.”

This is another statement that is factually inaccurate.   The Trustees of the system have said in the 2012 report that the system’s financial resources may last as long as 20 years provided that we have a good economy.  On page 58 of the Trustees Report, the Trustees warn that the system resources maybe depleted in as little as 14 years.  These are what the Trustees call the ‘high cost’ assumptions.  While the report calls them high-cost, fertility, interest rates, and wage growth assumptions actually seem fairly optimistic.

What any reader should see in the news release is a sense of panic in supporters.  They no longer use facts to explain solutions because these ideas aren’t really about fixing Social Security as much as postponing the collapse until the senator leaves office.

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.

Milton Friedman once observed, “If the government ran the Sahara, in five years there would be a shortage of sand.”  He is right.  The government has run Social Security for 70 years, and now there is a shortage of security.   Today more than 80% of Americans believe that Social Security is heading for crisis if the government does not implement a major reform.  So a system that is supposed to provide security, now it only provides uncertainty for the vast majority of Americans. 

Friedman’s quip about the Sahara is an amusing look at government.  The comment about Social Security on the other hand is rather frightening.  The difference between these similar outcomes is that few people depend upon sand in the Sahara; where as Social Security has become a sinkhole of dependence with millions dependent upon a system which is comically broken.

Just how broken is the Social Security system?  While people argue about the solvency of the system, the Social Security Trust Fund’s assets are managed with a 70 year-old investment policy that has underperformed the equity markets by nearly 50 to 1 during that time.  As a consequence, we are debating raising taxes which will be subsequently invested in bonds with a yield of less than 3%.

One day, economists will study this comedy because Social Security is the perfect storm of economics.  It blends the inefficiency of monopolies, with the incompetence of government, with the indifference of absolute pricing power.  This concoction isn’t just headed for failure.  It is headed for massive failure.

People tend to think of the Post Office as the poster-child of government ineptitude, but it is well run compared to Social Security.  The reason for its relative success is that the Post Office has to compete with private sector companies.  No one is forced to use the United States Postal Service.  We communicate by phone, email, and best of all private sector mail services which drive innovation into the business model of USPS.

Social Security competes with no one.  It could be the purest monopoly in the world.  While thousands of firms offer investment products, Social Security does not compete with any of them.  Social Security gets more than half a trillion dollars every year regardless of what happens in the outside investment world. 

As a consequence, innovation is driven by managers at the Social Security Administration rather than by market needs.  The Social Security Administration chose to add things like automated check deposit.  But it didn’t have to offer that service.  The Social Security Administration offers a website, but it didn’t have to offer one. 

So how bad is letting government drive innovation?  Only the government could create a retirement tool that is completely insensitive to risk appetite.  Social Security allocates risk in a one-size-fits-all model that is not only expensive but dangerous.  Imagine, the nation is engaged in a discussion about the solvency of a system, which has no way to allocate the risk associated with insolvency.

Can government innovation get worse?  Social Security is supposed to provide insurance, and yet it has no mechanism for price discrimination.  Survivor benefits are difficult to price – so we make them free.  The unhealthy cardiologist with a family of four pays exactly the same rates that a single person does.   According to the Social Security Administration, survivor benefits basically double the cost of benefits - but the benefits are given away for free.

Actually it can be worse still.  The Social Security system cannot invest in higher yielding assets because some critics feel that the financial markets are too risky.  As a consequence, Social Security invests 100% of its excess assets in a single issuer within an asset class that has enjoyed a 30 year bull market.  The issuer is the US government which has Debt/Annual Revenue of more than 500%.  But the financial markets are too risky.

In short, Social Security could be the only retirement product in the world that cannot allocate risk.  It is likely the only insurance product in the world that can’t price risk.  And it has an investment strategy which brings together low returns and maximum risk.  Social Security is broken because there is no private market where innovators can drive incompetence out of business.

In the private sector, profit and loss regulate the decisions of such managers.  Government has no way to incorporate profit and loss into its decision making process.  In the mind of its managers, positive cash flow is profit regardless of what happens to unfunded liabilities.  This is not a joke.   Politicians of both parties generally agree that Social Security has not contributed to the deficit, ie it makes money.   So Social Security will not be a problem until it is a catastrophe.

The consequence of absolute pricing is that no one who runs the system cares about whether the product is any good.  If the system runs out of money, the managers simply raise the price and shrink the box.  In terms of Social Security, raise the price and shrink the box means raising taxes and lowering benefits.  In the last 70 years, we have never had a single discussion about how to fix the system.

Today some actually argue that we should raise taxes and lower benefits because “Social Security is the most successful government program ever.”  It would be funny if millions of people did not depend upon the system.  As a system, Social Security does not attract money well.  It does not manage what resources it has well.  And it does not allocate its resources well to serve its purpose.  Social Security is horribly broken.  Our leaders don’t want to fix a broken system they want to convince us to pay for one.

That is not funny.

The budget deficit is the greatest threat to Social Security.  As deficit increases, interest costs create an increasing footprint on our tax base.  As interest costs go up, the ability of workers to pay into Social Security goes down.   

Some think that the problem with Social Security is the number of workers to retirees.  The flaw here is that workers do more than support retirees; specifically they pay income taxes which support the deficit.  Today, the average worker is carrying almost $100,000 of look-through debt from the federal government alone.  The additional debt burden means that the worker today is not comparable with the worker of 2000.

We are kidding ourselves if we believe that Social Security doesn’t add to the deficit.  Senator Sanders is going to introduce a bill to increase payroll taxes.  If we can raise taxes, we should raise taxes to lower the deficit, rather than to fund a retirement account.

I am a boomer, and we have left our children a staggering debt.  We shouldn’t be surprised if they resent the obligation to take care of our debt and the people who created it. 

This quote is pretty standard in the arsenal of the privatization supporters.  The quote is used to suggest that younger workers’ retirement benefits would be higher if they were able to invest their payroll taxes privately.  The data is used out of context, and can lead to faulty conclusions particularly about low-income workers.

The flaw in the reasoning is that the rates of return for individuals within the group will vary a lot from the return of the group as a whole.  Low-income workers get significantly better returns than high-income workers.  More importantly, group returns include workers who die without collecting a dime.  So the expected return of someone who reaches retirement is substantially higher than 1 to 2 percent. 

It would be more accurate to say that some workers get will benefit more from a privatized account while other workers will lose benefits if they leave the existing Social Security system.  This outcome presents a serious problem for privatization. learn more

While Ryan’s plan does not specifically state the source, the data appears to come from the ““Internal Real Rates of Return under the OASDI Program for Hypothetical Workers,” report from the Social Security Administration. (Office of the Chief Actuary, Actuarial Note no. 144)

WHY DO WE SAY SOCIAL SECURITY IS BROKEN

Today more than 80% of Americans believe that Social Security is heading for crisis if we do not implement a major reform.  Where is the 'security' in that?  learn more

WHY SOCIAL SECURITY IS IMPORTANT

The FAA can close and no one will notice.  Social Security serves a group of people who do not adapt well to change.  The core audience is the elderly and the disabled.  If we have a crisis in Social Security, it will affect those most who can adapt the least.    

WHY WASHINGTON CAN’T MANAGE SOCIAL SECURITY

Washington lives on 2 year election cycles.  The short-term mindset in Washington is completely incompatible with the long-term nature Social Security.  The focus on short-term objectives will at some point create a long-term crisis in Social Security.

WHY WASHINGTON’S SOLUTION WILL MAKE THE SYSTEM WORSE – MUCH WORSE

Specifically, Washington believes that more taxes and lower benefits are the answer.  The problem in Social Security is what you get for what you give.  You can’t fix that problem with higher taxes or lower benefits.  You will make the problem worse.  At some point, a generation will say no. 

WHY WASHINGTON IS WRONG

The experts think that the problem is demographic – ohhhh  we have too many retirees.  The problem is economic.  It is jobs, wages, and savings.  Demographics are a 2030 problem.  Jobs are a problem today. 

THE DEFICIT IS BIGGEST THREAT TO THE SYSTEM

I am a boomer, and we have left our children a staggering debt.  You can’t be surprised if our children resent the obligation to take care of our debts and us as well.  As the cost of the deficit increases, it will push us closer to the day when the working generation will have to choose between supporting the deficit and supporting the retirees.

As the cost of finance the deficit grows, America will be able to spend less on everything else – including Social Security. 

INNOVATION IS THE ANSWER

When business is in trouble, it innovates, making new products and existing ones better.  When government is in trouble it raises the price and shrinks the box.  We need to fix a broken system rather than pay for one.learn more

Milton Friedman once observed, “If the government ran the Sahara, in five years there would be a shortage of sand.”  He is right.  The government has run Social Security for 70 years, and now there is a shortage of security.   Today more than 80% of Americans believe that Social Security is heading for crisis if the government does not implement a major reform.  So a system that is supposed to provide security, now it only provides uncertainty for the vast majority of Americans. 

Social Security is theoretically an insurance product which provides supplemental income for people so that they do not outlive their savings.  This is how the Social Security administration describes payroll taxes "The payroll taxes collected for Social Security are of course taxes, but they can also be described as contributions to the social insurance system that is Social Security."  Insurance is essentially about trust, the trust that the insurer will make good on the payment.  More than 80% of Americans do not believe that Social Security will.  If Social Security is insurance, it is an abject failure.

If Social Security is not insurance, it is very difficult to tell you what it is.  It cannot be a Public Good.  First, the system benefits a selection of Americans not the entire public.  Millions of Americans neither pay into Social Security nor can they collect from Social Security.  Second, it creates nothing.  While it keeps some seniors out of poverty, it creates longterm poverty in the working generation.  The cost of Social Security to the average American is more than $500,000 in lost savings.  This is why people arrive at retirement in poverty.  I fail to see creating poverty as a Public Good.

Social Security cannot be a welfare program.  While the system can incorporate a bias into the formula to give advantages to lower income workers, the system has no idea whether beneficiaries are in need of public assistance.  Over 40 years of work, the workers situation may have radically changed.  So while Social Security may distribute a certain level of welfare, it has no idea whether the welfare served the public good or not.

So let's go back to the original theory.  Social Security is theoretically an insurance product which provides supplemental income for people so that they do not outlive their savings.  At insurance, Social Security is an abject failure.