The Day of Reckoning

“I am a firm believer in the people. If given the truth, they can be depended upon to meet any national crisis. The great point is to bring them the real facts.” — Abraham Lincoln.

There are two important dates that dominate the debate on the future of the Social Security System: 2016 and 2038. At present, Social Security receipts exceed the amount required to pay benefits to current retirees. The excess funds go to the Social Security Trust Fund, essentially government IOUs. In 2016, as more of the baby boom generation retires, Social Security receipts will be inadequate to cover the outflow of benefits. By 2032, the youngest cohort of the baby boomers will finally be retiring. Projections indicate that by 2038 the total paid out in excess of receipts will exceed the amount presumably accumulated in the Social Security Trust Fund. Those who choose to deliberately ignore inevitable Social Security short falls suggest that we have nothing to worry about since the day of reckoning is two generations away. The truth is otherwise.Essentially, the Social Security Trust Fund is a contrivance where one part of the government gives another part of the government an IOU without changing the net obligations of government. During the hearings held by the President’s Commission to Strengthen Social Security a useful analogy was drawn explaining this accounting chicanery.

Imagine a person attempting to save money towards his own retirement. Let us call him Joe. Assume that Joe has difficulty in maintaining the necessary discipline for retirement savings. Joe spends current income on current expenses and maybe even pays down his credit card debt a bit. To maintain his retirement fund, Joe writes himself IOUs. He, after all, has good credit. He trusts himself. When Joe retires he has a handful of IOUs to himself. However, the only way to redeem these IOUs is for Joe to generate current income. This is no different than if Joe had not bothered to conjure up the fiction of IOUs at all.

By analogy, the only way the government can pay future retirees once Social Security revenues exceed outlays is to reduce liability or increase income. Reducing benefits, increasing taxes, borrowing money, or all three can accomplish this. The year of reckoning is 2016, give or take a year or two, not 2038. For those who are 50 years old today, Social Security will begin to lack funds to meet benefit payments when they begin retirement. There is not much time for these people to make adjustments.

The longer we take to make adjustments to the system, the more wrenching the inevitable changes will be. Under the current Social Security structure, the average two-earner couple will have to pay an additional $860 per year to meet the Social Security shortfall in 2020. The amount grows to $2,100 by 2030. If the annual short fall is met by decreases in benefits alone, in 2020, a couple would have to receive $2,227 lower annual benefits. By 2030, the benefits would fall by $4605. (Draft report of the President’s Commission to Strengthen Social Security, July 23, 2001.)

To reduce the unfunded obligations of government there are number of relatively painless steps that can be taken now.

  1. The consumer cost of living index over estimates the true changes in cost of living for the retired. Former Senator Patrick Moynihan suggests that reducing the cost of living adjustment by 1% (e.g. a 2% inflation increase if the inflation rate is 3%) would decrease long-term Social Security costs while maintaining benefits at the real current level.
  2. When the Social Security System was created, life expectancy was considerably lower. In the age of retirement were tagged to life expectancy, the age of maximum Social Security benefit would be over 70 years. If we gradually adjust the retirement age upward, working people would have time to adjust their retirement plans while the long-term instability in Social Security would be alleviated.
  3. We should means test Social Security benefits. There is little social good achieved by subsidizing the retirement of the very affluent with income from young working families. Over the last few decades, the major transfer of wealth has been from the young to the elderly.
  4. We need to allow individuals to elect to invest a portion (say 2% of 12%) of the income going to fund Social Security into private retirement accounts roughly comparable to 401(k) or 403(b) accounts. Future Social Security benefits for those who make such a decision would be proportionately reduced. Others could elect to remain fully vested in the Social Security System. Any current short fall in revenues could be at least partially offset by increasing the income level at which Social Security taxes apply.

Demographic changes are inevitable. In this century, a time is rapidly approaching when there will be only two workers for every retiree. Many Republicans are afraid to explicitly mention the costs involved in reforming the Social Security System so that it becomes actuarially sound. Many Democrats eschew the reform of Social Security so that they can maintain a club with which to beat Republicans over the head during elections.As a Democrat with a large mountain of political capital and in the last years of his second term, former President Bill Clinton was in an excellent position to begin the necessary reforms. He declined. It now remains to his successor to exercise the necessary leadership.

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