It was all so easy in 1908. Herbert Asquith introduced the British Old Age Pension, at 5 shillings (25 pence) a week, in the 1908 Budget, and didn’t even have to raise taxes to pay for it. It helped of course that the pension was payable from age 70, at a time when British life expectancy was under 50. If Asquith’s actuarial principles were followed, in the richer, longer lived United States of today, social security would pay around $100 per week, from the age of 90 — it would thus be entirely sound.
The above statement may sound startling, but in terms of the increased expectation of life, it is in reality a touch conservative. The British expectation of life at birth in 1908 was around 49; today the U.S. expectation of life (averaging males and females) is around 78. Some of that change, of course results from the decline in infant mortality, which was around 150 per 1000 in 1908 Britain. Knocking that out, the average expectation of life for those 1908 Britons surviving infancy was 57, so the pension was first payable 13 years after the post-infancy life expectancy, which would today give a first payment age of 91, not 90. As I said, if we followed Asquith’s actuarial principles, we would not today have a social security funding problem.
This is a somewhat unfair comparison. A 90-year-old today is not the equivalent of a 70-year-old in 1908, because progress against the diseases of advanced old age has been much less rapid than that against the diseases of youth and middle age. A 90-year-old today, for example, is far more likely to be suffering from some form of Alzheimer’s disease than was a 70 year old in 1908. The leaders of both political parties in 1908 prolonged their political careers well beyond 70 — Asquith resigned as Liberal Party leader in 1924, when he was 72, while Arthur Balfour, the Conservative leader, remained in the Cabinet until 1929, when he was 80. There are no current political leaders I can think of who are 90, or close to it — even in China, the retiring generation are mere striplings of 75 or so.
Nevertheless, it is also true that many in 1908 suffered debilitating diseases, well before 70, which today would be no more than a health hiccup, but then took them out of the workforce. Thus if the equivalent of 1908’s retirement age of 70 is not strictly as high as 90, it is difficult to argue that it is below 80.
The argument is important, because it highlights two quite different functions of a social security system, the distinction between which was deliberately obfuscated by the government-expanding Franklin Roosevelt administration when it set up the system in 1935, and was still more blithely ignored by the public spending junkies who expanded it in the 1960s and 1970s (the 20 percent increase in payouts in the 1972 election year, entirely without any provision to fund it, was irresponsible even by the lax standards of that era.)
On the one hand is the original Asquith concept of 1908, that social security is meant to provide a basic safety net for the very poorest among us when they are unable to continue working — such people may have been physically unable, because of their low earnings and intermittent work history, to save sufficiently to provide for their old age. In this concept, it is a form of welfare, different only in that there is no question, because of the recipient’s age, of the recipient being moved off the welfare rolls into the job market. This concept is intrinsically re-distributive; the benefits to the poorest must be funded primarily by the middle classes and to a lesser extent (because there are fewer of them) the rich.
On the other hand there is the concept of forced saving, best exemplified by Singapore’s Central Provident Fund, into which employees pay a substantial part of their salaries, which they then invest and can spend on old age, health care or housing finance. This concept does not need to be redistributive, indeed it should not be. It is simply a mechanism whereby mankind’s natural optimism and preference for gratification now is curbed in the interests of ensuring that the employee’s old age needs, both for sustenance and health are looked after.
Once social security is broken into these two distinct components, the solution to its post-2008 funding problems becomes clear. On the one hand, a minimum safety net needs to be provided, funded out of general taxation, to ensure that the most basic needs of the old and infirm are met. As I mentioned above, Asquith’s scheme, updated to reflect the much richer U.S. economy in 2002, would provide about $100 per week from the age of 90 (and $150 for married couples; a “marriage penalty” that we may not wish to emulate — maybe $90 per head, without regard as to marriage, would be fairer.) Make the age limit 80 rather than 90, index the payments for inflation, and provide a mechanism whereby both the payment and the age limit are updated every 5 years to reflect increasing wealth and lengthening life expectancy, and you have a scheme that is both readily fundable from taxation, and adapts itself easily to demographic and wealth changes. Since this scheme is a welfare-type minimum, it should on no account be increased randomly in election years; indeed, the legislation establishing it should specifically provide against such increases.
On the other hand, you have a savings scheme that should not contain any element of redistribution, but should be funded on an actuarially sound basis. Since the “bare minimum” scheme is being funded out of general taxation, there will no longer be a demographic deficit to address; each person’s current entitlement will be the amount they have paid into the scheme, as calculated currently by the social security commissioners, indexed for inflation. This entitlement can be provided immediately to account-holders, at least in the form of inflation-indexed government bonds.
Going forward, if necessary with a transition period, social security contributions will be invested in a manner similar to Individual Retirement Account contributions currently; the investor will have control over that investment, and will benefit from or be penalized by the returns on the investment. Instead of financing random government spending, as at present, this saving will be invested productively, thus greatly reducing the savings deficit of the U.S. economy as a whole, and reducing its dependence on “hot” foreign capital.
The social security funds were originally funded on a “pay as you go” basis, and are thus in substantial actuarial deficit, compared with the benefits currently promised. However, by allowing people access only to the contributions they have actually made (indexed for inflation) and by providing the “bare minimum” subsistence pension only from an advanced age, and on a minimalist basis, the actuarial deficit is minimized, and the soundness of the system is assured going forward.
Inevitably, there is a substantial transition problem, of people who have been promised benefits that the system cannot afford. Whatever approach is taken, that problem will remain; while it is unreasonable to expect a person of (say) 75, whose working life is over, to adapt to a new system, it is certainly reasonable to expect a person of 50 to do so.
The baby boomers, those born in 1946-64, are the main problem facing the funding of the current system. These are people who have benefited over their life history from the constant attention and coddling of their elders, from school funding in the 1950s, to the economic boom of the 1980s and the 1990s. It is therefore appropriate that this generation should take care of its own pension funding deficit. Accordingly, the transition, from the current social security system to one in which, above the bare minimum pension payable from age 80, people fund their own retirement needs, should take effect for all those born on or after Jan. 1, 1946. The existing system should provide for those born on or before Dec. 31, 1945, and should prove adequate to do so, since it will be relieved of the burden of the baby boomers.
Most people born in the early years after 1946 will have accumulated substantial funds in the current system, and so will be well on the way to funding their retirement.
However, from this point on, beyond the bare minimum (which will not kick in, in any case, until 2026 for the earliest cohort) these people — among the early cohorts of whom I am one — are on their own. As soon as possible, say Jan. 1, 2004, they should be given individual retirement accounts, similar to existing IRAs, containing tradable TIPS inflation linked government bonds to the value of their past social security contributions, indexed for inflation. They will then have the right to invest future social security payments in their IRA, and will be able to make withdrawals and provide for their old age as they please. Later, they will have the right to the bare minimum pension as they pass 80, or the retirement age as it then develops.
Actuarially, the period from 2004 (if the new provisions begin then) until 2025 should be spent funding from general taxation the social security deficit (above their past and remaining future contributions) relating to the pre-1945 cohort, who remain in the existing social security fund. This is a finite problem, only moderately sized because of the birth dearth of the 1930s, which should be sorted out during this period before the new “bare minimum provision” funded from general taxation, begins to be paid from 2026.
The cost of the “bare minimum provision” will initially be small, but will rise rapidly, as the post-1946 cohorts pass the age limit and begin to draw their “bare minimum” pensions. However, just as the Asquith old age pension was well within the funding capabilities of 1908 Britain (though paying for both it and eight new Dreadnought battleships required a tax increase in the famous People’s Budget of the following year) so too should the new provision require only a modest change in general taxation. Today $90 per week represents 14.4 percent of U.S. per capita gross domestic product, and 3.5 percent of the population are over 80, thus the cost of the basic pension provision would be 0.504 percent of GDP, or about $52 billion per annum, an amount that is relatively easily funded (given 23 years to prepare).
Provided the age limit and payment are adjusted to reflect trends in economic growth and demographics, the cost of the bare minimum provision should remain modest, though it will increase somewhat around 2030, when the proportion of over 80s is projected to rise to 5.2 percent of the population (but as life expectancy will have increased by then, the age limit in 2030 will presumably be at least 81 or 82, reducing the cost correspondingly.)
It is thus I hope clear that social security’s demographic problem has been caused by irresponsible and un-funded benefit increases, and by a foolish mixing of the savings and anti-destitution rationales for the social security system. It can be solved fairly easily, at moderate cost, by a scheme such as that outlined here, that separates clearly the two rationales for the system, while giving even those worst affected (those unlucky enough to have been born in the early days of January 1946) the benefit of their past contributions, plus the ability to invest future contributions productively, plus a bare minimum payment in their old age.
Or the problem can be allowed to fester, resulting in the bankruptcy of the entire system, and severe destitution, some time before 2040.
The solution requires a President and Congress that can work together, and who have the political courage to withstand the inevitable howls from those adversely affected by the change. Hopefully, we currently have such a combination.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.