What's Wrong with Social Security and Why it's Important to Gen X and the Millenniums- Part Two

We're all familiar with the payroll taxes that support Social Security, simply by looking at our pay stubs. FICA taxes, or required employee and employer payments under the Federal Insurance Contributions Act, provide the foundation of financial support for Social Security. 

The total FICA tax is evenly split between the employer and the employee, with each paying a tax equal to 6.3% of earned wages for a total of 12.6% (as of 2014). The payments are directed to the Internal Revenue Service and then paid into the Social Security Trust Fund (also known as the Federal Old Age and Survivors Insurance Trust) where they are administered by the Department of Treasury.

For many years, approximately 70, the system worked just fine with annual inflows to the Social Security Trust Fund from taxes and interest, exceeding outflows, in the form of benefits payments to retirees and the expenses of running the system. But in 2013 these lines would begin to cross as the number of program beneficiaries would rise to 62 million, and outflows would exceed inflows. The deficit of the Trust Fund in that year would total $75 billion, a level at which deficits are projected to continue through 2018 (whereafter they are projected to spike sharply upwards).

The problem with all of this is largely the basis of accounting by which the Trust Fund is managed and operated. Unlike defined benefit plans run by corporations and governed under ERISA, no such regulation guides the planning, management and investment of Social Security. Social Security today runs as it always has, as a PAYGO system. Revenue flows in from taxes paid by current workers (and employers) and flows out to retirees and services, each on an annual basis. In effect, we are borrowing from Peter (today's workers) to pay Paul (retirees). Some refer to this as a Ponzi Scheme, although that's perhaps a bit too harsh. Nonetheless, this is essentially how the system functions.

Under ERISA, companies are required to retain actuaries to quantify the present value of future, accrued benefits. They are then required to invest to meet those future liabilities. But this is not at all the way Social Security works. And it's this failure to to do so, that has allowed the Trust Fund to rise and fall with demographics. It's almost as if we knew this day of reckoning would come, when demographics would threaten the solvency of Social Security, but no one ever chose to address it.

Today Social Security reform is the third rail of politics. Everyone knows some level of reform is necessary, but to propose any modification prompts outright ridicule. Yet, with the median retirement savings of 55-64 year olds only $14,000 this generation, like those currently in retirement, will need to receive Social Security benefits just to make ends meet.

If you are interested in reading further about this topic, a full plan for Social Security reform is presented in my new book, "Up in Smoke: How the Retirement Crisis Shattered the American Dream". You can access it here.

CBO 2015 Long Term Budget Outlook

A new report of the Congressional Budget Office was just released. The report projects future budget deficits for the Federal Government through 2040. 

The report highlights future growth in spending on Social Security and health care as two principal drivers in growing deficits. Spending on these two programs alone is expected to grow from its current level of 10.1% of US GDP to 14.2% by 2040.

With current law unchanged, the CBO projects that total federal tax revenue will grow as a percentage of GDP from 17.7% in 2015 to 19.4% by 2040. At the same time, federal spending is projected to grow from 20.5% of GDP in 2015 to 25.3% in 2040. And therein lies the rub. Expenditure growth at rates considerably in excess of that of revenues. I guess you could say the government loses money on every dollar and can't make it up on volume. 

Annual budget deficits are projected to grow from 2.7% of GDP in 2015 to 5.9% by 2040. With growing deficits, the CBO forecasts that total federal debt will exceed 107% of GDP by 2040. Now this raises an important point about how various government agencies and economists measure total US debt and its relationship to GDP. 

According to data of the Federal Reserve Bank, as shown in the chart above, total debt to GDP already exceeds 100%. So why is there a discrepancy in the CBO report? It's a question of whether debt is measured on a gross or net basis. Since a healthy chunk of US Treasury debt is owed to Social Security and other federal programs, like Medicare, this portion of the debt is often netted out, under the theory that "we" owe it to ourselves.

Well, perhaps, but if you are now or are expected to be a recipient of Social Security or Medicare benefits, then it's owed to you. The Social Security Trust Fund is now the world's largest holder of US Treasury obligations, some $2.7 billion of them. The CBO report projects the Trust Fund to become insolvent by 2029. In the CBO's 2008 long term outlook, Social Security was expected to remain solvent until 2050. 

Please see my new book Up in Smoke: How the Retirement Crisis Shattered the American Dream, on Amazon now.

What's Wrong with Social Security and Why it's Important to Gen X and the Millenniums- Part One

The Social Security Administration (SSA) in its 2014 report to Congress, projects the Trust Fund supporting the Social Security System will be insolvent by 2033. The SSA has provided reports like these for many years, with its 2010 report showing a projected date of insolvency of 2040. A 1983 report pointed to a date of 2058. By now, you can see where this is headed.

The Trust fund supporting Social Security is actually referred to as the OASDI fund, and covers both Social Security benefits and also payments under Disability Insurance. With a rapid escalation of disability claims over the past number of years, the disability portion of the Trust Fund is now projected to reach its point of insolvency next year (a date pulled in from 2018 in the 2010 report).

Both programs have seen rapid growth and accelerated outflows since 2008, explained, only in part by demographics and an aging population. Disability has grown dramatically, with roughly ten million people claiming benefits under the program. Its share of the adult population has doubled over the past twenty years, despite advances in medicine and a generally healthier population. Today, the Federal Government spends more on disability payments than on food stamps and welfare combined.

The growth in Social Security claims, as well, can only partially be explained by the aging baby boomer generation. Benefit claims following the financial crisis grew at a rate exceeding forecasts of the Social Security Administration based upon their demographic models. Despite the steep discount to future payments by taking early benefits, this trend has also now been underway for several years.

Many members of Generation X dismiss the whole notion that Social Security will be there for them in their retirement, or that a retirement as most know it, will even be available.  They often fault the baby boomers for the problem, citing over-spending and under-saving as contributing to the retirement crisis. While, in part, this may be true, the problems with Social Security are much more dramatically a problem of mathematics - or demographics, specifically.

In 1940, soon after Social Security began, there were roughly 35 million workers paying into Social Security and only 222,000 beneficiaries (or a ratio of workers to retirees of 159 to one). By 1950, that ratio had fallen to 16 to one, and by 1990, the ratio had declined to three to one. By 2031, it's projected that only two workers will pay into the system for each person collecting benefits.  

All of this, of course, had been forecast by the Social Security Administration many years earlier. But Congress, increasingly focused on their own needs and less and less on the job of actually running the country, largely chose to ignore it. Concerns about an aging population and its impact on Social Security emerged as far back as the early 1980s. Congress then acted to pass HR 1900, the Social Security Amendments of 1983 in an effort to shore up the system. Payroll taxes were raised and benefits, for the first time, became subject to taxation. While they were at it, Congress also thoughtfully moved to add benefit coverage under Social Security to members of Congress, the White House and other executive level appointments. 

But no sooner did surpluses materialize, then Congress found a way to spend the new found cash flow, by borrowing back surpluses of the Social Security Trust Fund, and swapping special issue Treasury Bonds in its place. In fact, this has been the practice for many years. In good years, when Social Security is recording a surplus, the extra cash is borrowed against Treasury bonds. In deficit years, as the Trust has seen for the last several, the shortfall is funded, once again, with Treasury bonds.

It's little wonder then, that the world's largest holder of US Treasury obligations is not China or Japan. It's not even the Federal Reserve. It's the Social Security system. And lest we forget, a Treasury bond is nothing more that a promise to pay from future tax revenue. What that means is that the government will need to raise tax revenue in the future to make good on its promise to pay some $2.8 trillion of obligations to the Social Security system, just for the program to remain on track for insolvency in 2033.