Saturday, February 9, 2013

Social Security Sustainability

Any retirement system, when faced with increasing life spans, must resort to at least one of the following:

1:  Delayed retirements / increasing the retirement age
2:  Lower payments during retirement
3:  Higher savings rates or taxes when working

There is nothing wrong with this.  This is simply an obvious result of longer lifespans, and is equally true whether the retirement system in question is public or private.

Thirty years ago, Ronald Reagan and the Democratic Speaker of the House Tip O'Niell made a deal with regards to Social Security in order to deal with the gradual increase of life spans that had accumulated to that point, thus extending Social Security's actuarial balance into the 2030's by building up a reserve for the retiring baby boomers.  This was accomplished by a mix of tax increases and raising the retirement age, which was set to gradually increase to age 67 by 2022.

Thirty years later, we can see farther.  Our lifespans have increased even more, and therefore we either have to save more, retire still later, or try to spread the same amount of retirement dollars over a larger number of years.  What are Social Security's options for insuring its long-term stablity?  Actually, they are not all that bad, requiring modifications no worse than what Reagan and O'Niell chose.  There are plenty of options, such as raising the Social Security tax by 1% for both employer and employee, elimination of the earnings cap (currently $113,700, above which income you do not pay Social Security taxes), raising the retirement to 70, and a host of other smaller changes such as changing the cost-of-living-adjustment to be less generous, changing the payout formulas in order to reduce benefits to higher income workers, bring state and local government workers into the system, a straight benefit cut, etc.  Of course, these can be mixed and matched in any number of ways in order to hit the target.  For example, raising the retirement age one year, phasing in a 0.5% tax increase on both sides over ten years, and raising the cap 20% would put Social Security into balance for the entire 75 years that its actuaries calculate.  A group of policy wonks could crank out a bi-partisan, balanced solution over lunch. Given that Democrats hold the presidency and half of congress, and polls strongly indicate that the public prefers tax increases to benefit cuts in this matter, a fair deal would probably focus on the tax side.  The public, wisely in my opinion, realizes that this program is extremely valuable in ensuring a basic retirement for all, and is worth the price.

In the long run, Social Security can be thought of a system that transfers about 5% of the national income from current workers to current retirees.  It is self-evident that this is forever sustainable.  The only question is whether it would be better to shift this to around 6%, in order to maintain benefits at their current levels as the number of retirees increase, or whether to keep it at 5% and spread the money thinner.  Either way, Social Security is forever....or at least as long as we want it, which I hope is the same.


  1. I agree with everything you're saying. I think that removing the cap on high-earners, and increasing the retirement age are both going to happen. The one that kind of bugs me is "changing the payout formulas in order to reduce benefits to higher income workers," a.k.a. means-testing. This is the one that's going to get me. Look, I understand how fortunate I am to have a well-paying job that allows me to save for my future. But I can't help but think that I'm also going to be punished for being frugal and responsible in saving my money. Meanwhile, people who made just as much (or more!) than I did will get their full social security benefit, just because they didn't save for retirement. This just seems wrong, but I guess I'll just have to look at it this way--I'm paying for my parent's retirement. Any money I get from social security will just be a bonus. I'm not actually counting on getting a single dime back of all that I'm paying in.

  2. There are actually two ways you could cut benefits for high earners. One is means testing, which itself could mean several things. The other is to move the bend points lower (bend points are basically tax brackets in reverse). "Means testing" could either mean cutting benefits based on income, which would effectively increase marginal taxes on the elderly and discourage them from working, or reducing benefits based on wealth, which would require the government to set up a new bureaucracy to measure and would discourage saving. Of the three, moving the bend points is least bad, as it cuts benefits on high earners without affecting incentives much and without requiring the overhead of measuring wealth.

    Personally, I would avoid benefit cuts entirely. We can stabilize SS indefintely with a mix of an across-the-board tax increase, say 0.5% phased in over ten years (for a typical American, that would be an extra $25 dollars this year, and extra $50 next year, etc, up to an extra $250), combined with moving the cap up and/or applying a surtax on all income above the cap.

    I do not like chained-CPI, for two reasons. One, the CPI has little to do with the actual inflation faced by retirees, which is much higher. Second, chained-CPI leaves benefits for early retirees untouched but slams older retirees, who finally feel the accumulation of years of sub-par COLAs. If anything, we need to do the reverse, and lower initial benefits in order to discourage early retirements, and raise benefits for the very elderly, who are most likely to have run out of money.

    You should, however, count on the dimes you are going to get. The worst case for SS is that Republicans just refuse to fix it, and around the time you and I retire, we have to eat about a 25% across-the-board benefit cut. Given your job, your current promised benefit must be around $2500/month (in today's dollars). Even in the worst case, you will get something like $1800/month. That's not Richie-Rich but it will be enough to keep the lights on and your belly fed, which is SS's core purpose.

    I actually think you are better to plan assuming that 75% SS benefit. Think of your SS money as a bond fund, as it probably has a similar risk profile. In this case, SS allows you to overweight your non-SS portolio towards stocks and bring in a higher return. That ~$$1800/month benefit would be equivalent to something like $600,000 in upfront cash (2013 dollars) with which you could buy an inflation-protected annuity similar to your SS benefit.

    Guys like us don't win with SS. We pretty much just get our money back with an inflation adjustment. But I am glad it is there, because with it, I don't have to worry about my many family members who could not or for whatever reason did not save enough on their own. If earning no interest on a third of my retirement porfolio is the price I have to pay in order to be sure that my little old grandmothers will be able to pay their bills not matter what, I consider the sacrifice well worth it.

    Thanks for being my first commenter. I bequeath you one free beer next time I pass your way.