The “reform” of social security is supposed to be necessary because in 2038 the Social Security Trust Fund runs out, after which retirees will have to suffer a 28% benefit cut. Big deal – they’ve got 33 years to prepare for it. Much better to suffer that than the trial balloon “reform” floated by Senator Lindsey Graham (R.-S.C.) and receiving considerable bipartisan support, which would involve large and damaging tax increases today.
The whole problem arises because politicians like inventing new actuarially unsound entitlement programs that appear for decades to give voters something for nothing, but eventually come back and bite the voters’ descendants in the backside. This is a bipartisan failing – the 1974 Employee Retirement Income Security Act (setting up the imminently insolvent Pension Benefit Guaranty Corporation) and President George W. Bush’s 2003 Medicare prescription drug plan were Republican examples of such boondoggles.
In the whole of U.S. history, the only major attempt to put these programs on a sound basis was the 1982 Greenspan Commission on social security, which resulted in a 2 year delay in retirement age from 2026 and a huge loss to the incumbent Republicans in the 1982 midterm elections.
In the case of both Social Security and Medicare, the problem arises because people are living longer. Retirement and entitlement ages were set in 1935, in the case of Social Security, and 1965, in the case of Medicare, but we live much longer now, and so retirement and entitlement ages should be correspondingly later. In Medicare’s case, there is an additional problem from the inexorable advances in medical technology, which increase both costs and life expectancy and thus make the actuarial problem worse in both directions at once.
The retirement of the “baby boomers” from 2008 is also popularly supposed to be a problem, but it shouldn’t be. Since entitlement programs, including education, favor the young and the old at the expense of the working population, if the population rises steadily or declines steadily they should remain approximately constant as a share of Gross Domestic Product. A rising population will make education relatively expensive and retirement security cheap; a declining one will do the reverse.
Only if the population trend changes direction will entitlement program spending be out of whack – if it first declines, then rises, you will have a period when small birth cohorts containing few people are in the workforce, supporting an army of old and young. Conversely if population first rises, then declines it’s the other way about, a huge army of workers will support relatively few old and young.
For the last 20 years, the United States has benefited from the latter situation; the great bulge of “baby boomers” has been supporting only a few Depression-baby retirees and a few Gen-X and subsequent children. High immigration has also helped in the short term, since the U.S. has been receiving an effective subsidy from the Third World countries which educated the immigrants, the costs of whom will only arise when they retire.
The United States therefore has got two entitlement programs, Social Security and Medicare, that were never particularly actuarially sound, have been artificially helped during the last 20 years by a short term baby boom in 1946-64, are running into big actuarial trouble because we’re living longer (and medical costs are remorselessly rising) and now need to be put on a solid basis. This can be done in three ways: by increasing taxes to pay for them, by cutting benefits, or by delaying the age at which benefits become payable. Senator Graham’s “compromise” trial balloon involves doing the first; I would suggest that is the wrong direction to go, and in any case cannot solve the problem in the long run.
The idea behind Senator Graham’s proposal, which we are told is a “compromise” that can be supported by moderate Senate and House Democrats, is for a modest proportion of our current social security payments to be put into private accounts, in return for which the ceiling for payroll tax contributions will be raised from its current $90,000 to $150,000 or $200,000, depending on which account of the proposal you believe.
The problem with this is the very high marginal tax rates that would be created, particularly for the self-employed, for those in the $90,000-200,000 income bracket. The federal income tax rate, 15 percent or 25 percent at lower levels of income, is 28 percent or 33 percent at these levels. State income taxes are generally close to maxing out by this point, adding up to 9.5 percent to the rate. Thus a self-employed person in the 33 percent tax bracket, paying 8.5 percent state income tax, who did not itemize but half of whose 15.3 percent Social Security and Medicare tax was deductible against Federal income tax, would pay a marginal income tax rate of 54.3 percent. Clawback of allowances, a Clinton-era innovation that is simply beyond me to calculate, may make the marginal rate even higher in some cases.
Sounds pretty Swedish to me. Pretending that social security contributions at these higher income levels are anything more than a subsidy to the system is political posturing at its worst. At these income levels, additional social security payments into a system that is biased towards the lower paid are a tax, pure and simple, and will have all the anti-incentive effect traditionally associated with such a tax. In particular, the self-employed, whose income is normally far more uncertain and variable than those in paid employment, will pay these very high tax rates in “good years” when their income rises above $100,000, which they will not get back in the inevitable years of income drought when it doesn’t.
The other unattractive feature of the Graham proposal is its generational inequity. If higher returns are to be earned on privatized social security contributions, they will benefit mostly those whose contributions are in the system for the longest time, in other words people below 45 or so. Indeed, most of the proposals I have seen will not allow private contributions for those close to retirement, because of the likelihood that a bear market could wipe out the returns from contributions that had only been in the system a few years. However, people in the 45-65 age bracket will undoubtedly be subjected to the extra taxes; indeed, since such people are more likely to be “self-employed” than their younger brethren, having been forced out of regular jobs through ageism, they will suffer disproportionately from them.
A further problem of principle with the Graham approach is that if you include Medicare we can’t afford it. A Medicare that is available at 65 is projected to absorb close to 20 percent of GDP by 2070; those projections are no doubt inaccurate but they highlight the fact that, without structural reform and with the prescription drug benefit, the costs of Medicare bid fair to outrun the tax capacity of the nation. Tort reform, bringing down the deadweight costs of lawsuits and doctors’ liability insurance, may help this, but it is unlikely to be sufficient to close the funding gap.
The correct solution to the Social Security problem was demonstrated by Margaret Thatcher’s government in Britain in 1980, when she de-indexed the British retirement pension to earnings, indexing it only to prices. This allowed the pension system to absorb a lower and lower percentage of GDP as the decades passed, and permitted Britain to weather its equivalent demographic crisis of aging baby boomers more easily than the United States.
Earnings indexation, whether before or after retirement, is unrealistic, because it does not recognize that for many people, earnings do not increase in a predictable pattern. At one end of the social scale, automobile and steel workers earned more in real terms in 1973 than they do today, so earnings in those blue collar sectors have not increased with earnings in the economy as a whole. At the other end of the scale, the average starting remuneration for a Harvard Business School graduate in 2004 was $140,000 per annum (inflated by investment banking and consulting). Once such a graduate is 10 years out of B-school, he will find himself competing in the workforce with newer graduates, so if he has not achieved the Nirvana of an investment banking partnership, a dot-com Initial Public Offering or corporate top management, his earnings pattern after he reaches 40 may well be intermittent, and generally at a considerably lower level than he started, since he has had to join the real world with the rest of us.
In both these cases, indexing “social security earnings” (on which the pension is calculated) by national average earnings, over a 35-40 year period, will produce an entirely fictitious figure for the employee’s early years’ earnings, far in excess of anything he ever actually earned.
The solution, for Medicare even more than for Social Security, is to delay benefits, in line with the increase in life expectancy since the systems were inaugurated. If birth life expectancy in the United States has increased from 62 to 78 since the Social Security system was inaugurated in 1935, then a pension payable at 81 would be equivalent to the system’s original promise. If birth life expectancy has increased from 72 to 78 since Medicare was introduced in 1965, then Medicare availability at 71 would be equivalent to the system’s original promise.
In practice, every calculation I have seen suggests that a Social Security retirement and Medicare availability age of 70, brought in incrementally between 2026 and 2040 so that those currently under 45, who would be affected by the change, have plenty of time to get used to it, would, if combined with rigorous tort reform get pretty close to rebalancing both systems, at least for the remainder of the 21st century until life expectancies increase again. (If raising the retirement age was combined with prices indexation, the Social Security system would move into actuarial surplus, which surplus could be used to fund any remaining deficits in Medicare.)
If we are to work until 70, however, the insidious force of ageism will have to be removed from the workplace. The Harvard Business School graduate straight out of B-school is not really worth $140,000, but his scarcity bids up his remuneration to that level. His 55 year old predecessor, on the other hand, is not given credit for his fancy degree (which may be appropriate, since it is now 25-30 years out of date) but nor is he given the credit for the intellect that got him to Harvard in the first place, nor beyond a certain point for the experience he has gained, much of which may have been gained in providing services that no longer exist.
Have you noticed that job advertisements NEVER specify more than 10-15 years’ experience, and very often put a maximum, thus automatically ruling out applicants of more than a certain age?
Ageism remains socially acceptable, in a way that racism and sexism are not. If we are to expect people to work till 70, we must eliminate the prejudices that hinder them from getting a new job once they have passed 40 – in today’s uncertain economy, it is quite impossible for employees to find a post at their last employable age of 39 that can be guaranteed to last them until retirement at 70.
Conversely, we must stop overpaying traders, “hotshot” managers, salesmen and entrepreneurs under 40, to the extent that they can retire early – if they are the U.S. economy’s most productive citizens, the economy needs them to work a full life, and not quit half way through their careers.
A good healthy recession, with a high cost of money and the Dow below 5000, such as is long overdue, will return the overpaid hotshots and dot-com whiz-kids to the ranks of the mortals they truly are, and decimate the value of their stock options and their vulgar McMansions. Unfortunately it will do nothing whatever for the 55 year old auto worker or ex-executive who needs another job.
The Bush administration would do well to solve the problems of Social Security and Medicare by the simple expedient of increasing the eligibility ages for both, but it also needs to move against the transient get-rich-quick society that has made ageism so universal. But THAT would no doubt play really badly in Karl Rove’s opinion polling!
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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.