Post by cheshireprofessor on Oct 21, 2010 15:43:16 GMT -6
"Oh! Mon Dieu!!! RAISE the retirement age TO 62! That is in-tol-er-oble!!! [French accent] The people must take to the streets! Anyone know what we did with those old Guillotines?"
The news being what it is may (likely) renew discussions regarding the United States Social Security program. Some has been in the press as of late anyway due to the upcoming mid-term elections, various articles about the growing US debt in general, and that Social Security is now (or soon) to start drawing upon its reserves for retiring 'Boomers'.
What follows is for those that may be interested in, or caught in a conversation about, Social Security topics on which they may not feel confidently clear about - but much may already be obvious or known to the reader.
The CheshireProfessor - Issues of Social Security Explained
Background:
Social Security was initially intended and throughout its existence has been constructed as a ‘defined benefit’ ‘deferred compensation’ retirement plan. Part of the ‘deferred compensation’ is paid directly by an employee’s employer and part is paid by the employee by means of a tax on wage income. That tax is separately itemized from general income taxes on one’s wage statements as FICA (a.k.a. OASDI) tax. The ‘defined benefit’ is a form of annuity effectively purchased by the ‘deferred compensation’ that later pays a percentage of average pre-retirement wage income to employees when retired.
Many misconceptions persist and are often promoted about how Social Security is implemented and many biases exist regarding it’s ‘fairness’, continued viability, management, etc. Fortunately there are many available and accessible credible resources (see references listed below). Unfortunately many people do not perform their own research before forming their opinions and conclusions regarding many issues. In all fairness, some aspects of Social Security are complex and an impediment to easily garnering a basic conceptual understanding. Given the availability of credible resources this writing is not intended to be a comprehensive and detailed description. This writing is intended only to provide a summary of some most common ‘talking points’ and provide a few simplified approximations one might apply to acquire a conceptual understanding of real or perceived complexities regarding Social Security.
Issues of Social Security Explained:
1. Social Security is not a Ponzi, a.k.a. ‘pyramid’, scheme. Some critics contend that Social Security is a Ponzi scheme, and thus implicitly destined to eventually fail, because of one shared similarity where funds collected from current workers are not ‘invested’ but are directly used to pay the benefits of retired workers, i.e. current subscribing payers essentially pay the previous payers turned receivers’ benefits. However, a ‘pyramid’ scheme requires (emphasis requires) an increasing (emphasis increasing) number of paying subscribers because it generates an increasing number of receiving subscribers, e.g. a ‘chain letter’. Social Security does not generate an increasing number of receiving subscribers as a function of its structure and thus does not require an increasing number of paying subscribers to be sustainable.
Social Security is a PAYGO (Pay As You GO) type funding system that only requires a fairly static number of current vs. retired workers to remain financially viable with all other aspects remaining the same. Social Security’s benefits funding structure is then more of a ‘pipeline’ or ‘pillar’ and not a ‘pyramid’.
(The arithmetic of how this basically works is presented later by a simplified approximation).
The Social Security PAYGO funding and ‘pipeline’ payout system will produce intermittent surpluses and shortfalls naturally as a result of changing demographics. At different times the ratio of required current vs. retired workers may not exactly exist. Any differences produce either shortfalls or surpluses in the tax revenues designated to pay benefits.
The CBO (Congressional Budget Office) estimates and projects Social Security funding so policymakers can adjust tax and fiscal policy to accommodate anticipated persisting shortfall or surplus trends. The CBO makes high, mid, and low estimates of which the one that most supports any particular speaker’s agenda is the one that speaker references. Policymakers tend to promote the lower revenue and higher payout scenario estimates as rationale, and/or opportunity, to advocate increasing taxes. Generally, from their perspective, it is preferable to have surpluses from tax revenues (any kind of tax revenues :).
In the history of Social Security it has had periods of both funding deficits and surpluses. Some deficits were resolved by later surpluses, and some surpluses have been eroded by later shortfalls. Some deficit projections were ameliorated by legislation that increased revenues and/or restructured benefits. Conversely, some surplus projections may have been diminished or deficit projections exacerbated by legislation that increased or expanded Social Security benefits, eligibility, and benefit payouts.
There were immediate deficits in Social Security funding at its inception that were borrowed from the government (either from other general budget surpluses or through government issued debt) and later repaid. It has had, and currently has, surpluses that are loaned to the government that are now equivalent debt obligations. It is generally accepted that it probably will run an overall deficit in the (some) future (anywhere from 2035 to 2085) that the government will have to fund or reduce either through higher Social Security tax revenues, or general taxes, or debt, or reductions in benefit payouts. Regardless, the benefits that are determined to be paid are effectively national debt obligations like any other and it really doesn’t matter except from perspectives of equity and budgeting what funding source pays them.
2. Some critics argue that Social Security surpluses previously ostensibly held in a specific ‘Trust fund’ have been raided and used by the government to fund other budget shortfalls or expansions in general federal government spending, and that the ‘Trust’s’ holdings were replaced with only government IOUs.
From the perspective of a Social Security participant and potential or current beneficiary it really doesn’t matter where any surplus funds are or went. One’s current and/or near future benefits are owed as a debt obligation by the government in general not just the Social Security Administration, (well, maybe not technically legally but certainly practically and morally). The legislature could reduce benefit payouts but doing so for any current or near future beneficiary is akin to default on a contract or debt payment. So, and still, one should not fall to complacency on this issue as a voter.
What the government has exercised by ‘borrowing’ Social Security surpluses to fund other general spending really isn’t any different than what most individuals would prudently exercise in their own financial management. Suppose you established a fund with annual contributions designated to pay for home maintenance and repairs. You keep putting some money in your left pocket and pay for everything else with most of your other money that goes in and comes out of your right pocket. For a while everything is fine and money builds up in that left pocket but then you run out of money in your right pocket. Maybe your car got stolen and replacing it cost more than what your insurance covered, or maybe you decided to get premium cable channels. The question of ‘need’ regarding those right pocket expenditures is deferred here to focus on the fact that money is depleted from your right pocket and to consider what you would do. Would you borrow money from an external source or might you ‘borrow’ from that left pocket? If you borrowed from your left pocket and didn’t repay before needing a new roof you might then have to borrow from an external source to repay your ‘debt’ obligation to your left pocket so that left pocket could then provide payment(s) to the roofer. Eventually you are going to rely on future household income to repay that debt either external or to your left pocket or roofer. And so with Social Security’s obligations, ‘trust fund‘ or not, one pocket or another, it has to come from revenues generated by taxes that are effectively some percentage of national GDP eventually no matter what. Increase GDP (income) and any increased debt gets repaid without a budget change, otherwise you must economize.
3. Social Security is not intended or constructed to necessarily pay back what an individual has paid in. First, its benefit structure is formulated with a bit of a ‘benefit redistribution’ weighting. (Some take issue with this aspect as a form of socialism but that is another topic). It pays lower contributors a higher percentage and higher contributors a lower percentage of average pre-retirement wage income, but higher contributors still receive more than lower contributors. Second, it is implemented like an insurance life annuity and so similar to other life related type insurance it is a bet of your money on your life expectancy against another’s bet of their money on their life expectancy - live long and prosper, live not and lose. Third, on average total payouts are greater than what workers have paid as total tax amounts and actually are approximately equivalent or even greater in present value (inflation adjusted) terms.
(The arithmetic of how this basically works is presented later by a simplified approximation).
4. Social Security is not intended or constructed to produce an ‘investment return’ but it does provide a ‘defined benefit’ that is relative to what one has paid as similar to an insurance life annuity and many private pensions. Social Security benefits are paid according to a relative percentage of earnings history and adjusted for inflation by annual COLAs so the benefit ‘returns’ remain approximately inflation neutral. As primarily intended as a ‘deferred compensation’ plan, its taxes and benefits are a relative percentage of prior wages and on average approximately both equivalent in present value (inflation adjusted) terms.
(The arithmetic of how this basically works is presented later by a simplified approximation).
Some people take issue with the implementation of Social Security as a form of annuity claiming that they could realize greater retirement funding if allowed to personally control and direct the investment of their own Social Security tax payments. That may be true for some but that issue leads into the social and economic considerations that created, evolved, and still largely justify Social Security in its present form.
5. Social Security was created in large part because most wage earners, and mostly the lower paid, were not very good at providing for their retirement on their own and employers weren't interested nor could they be trusted to reliably do it for them. Also, as the nation’s economy changed from agrarian to industrial based, workers lost much in the way of adequate personal social networks and resources to rely upon for ‘retirement’. The prospect that many workers might fail to sufficiently provide for their own retirement and potentially become wards of the government and thus by extension wards of the more ‘sufficient’ providers was (is) perceived as socioeconomically unjust. So Social Security was (is) primarily a mandated ‘deferred compensation’ retirement (‘safety’) plan implemented as a ‘defined benefit’ annuity administered and secured by the US government (and so to help reduce, rather than be, ‘welfare’).
IRAs and 401ks, etc., as personally directed and invested ‘deferred compensation’ plans were later enacted in part to address, as an augmentation or supplement to Social Security, the issue of those that wanted to exercise their own personal retirement funding and management with the opportunity to receive benefits based more directly upon what amount was contributed and how it might have been invested at their direction. These ‘self-directed’ programs have mostly proved the first point having been underutilized or relative failures by most and successes most only by a relative few and generally the higher paid.
6. Employer sponsored defined benefit plans are sometimes perceived as no cost to workers whereas Social Security taxes are visible costs paid by workers. True in terms of visibility and transparency but anyone who believes that ‘employer paid’ retirement benefits are not actually paid by employees is naive as to how employers account for total employee (‘total compensation’) costs. Employer sponsored retirement plans are constructed and implemented much the same as Social Security. However, they carry a much higher risk of default to employees as has been experienced in many cases. This higher risk of default also exists with privately purchased personal life annuity retirement products.
7. Not all wage earners pay Social Security taxes and thus are not eligible for (full/any) benefits. At its inception some groups of workers were excepted and later more were included. A growing number of substitute (or ‘alternative’) privatized programs are currently allowed, often even mandated by terms of (usually government) employment. One can check the Social Security website and see how benefits if any are due are adjusted by such substitute plan benefits. Perhaps somewhat ironically, those that desire more ‘privatized’ Social Security administration should seek employment in the ‘public’ sector.
8. Social Security taxes are sometimes seen as a regressive (‘flat’) tax not consistent with other current progressive (‘graduated’) income taxes. Perhaps, but one might consider that other ‘graduated’ income taxes ‘buy’ the same (‘flat’) benefit whereas Social Security taxes ‘buy’ a ‘graduated’ benefit for the same (‘flat’) tax and thus are effectively ‘progressive’.
9. Social Security benefit payout COLAs have been the subject of some ongoing debate with some growing advocacy to change them to being based upon average annual national wage increases (the/a WPI) vs. the current relation to some measure of a CPI. (And some argue the converse for the inflation adjustments applied to qualifying prior earnings). Since payouts are intended to provide deferred wages it is argued that inflation adjustments be more justly based upon actual wage inflation. It is also argued that with benefits not kept closely tied to wages, the source of funding, there is a greater chance that differences in revenue vs. benefit payouts will continually arise or be amplified as a result. There is the possibility (probability) that such a change would reduce benefit payout increases (a major reason for its proposal). This would be due to declining wage increases relative to CPI, i.e. ‘wage deflation’.
10. Raising the benefits age at which workers become eligible to receive ‘full’ Social Security benefits is often proposed as a means to increase revenue and restrain increasing payouts due to increasing life expectancies. This has been done before in recognition of changing life expectancies and will probably be done in the future. However these changes have been, and any such additional changes are likely to be, or approximately be, on the order of two months for each year of later birth. A sudden change to age 70 or so is not likely. Alternately, payout (rate) reductions could redistribute the same total benefit over increased years, e.g. 80% would cover 25% more years (a projected future possible scenario).
11. Raising or eliminating the ‘earnings cap’ above which Social Security taxes are not levied is sometimes proposed as a means to increase revenue. Increases already occur as an inflation adjustment but could be increased greater still. Eliminating the ‘cap’ is a strong possibility as it was similarly done for Medicare funding. Also, popularly (generally) it is perceived as more ‘tax fair’ and politically more viable since it currently only applies to about 10% of wage earners. Higher ‘un-capped’ income contributors would then probably later receive higher benefits but the net effect would still provide general shortfall relief due to the redistribution aspects of the (and revised) Social Security benefit payout formulation. This change alone if implemented is estimated to fund more than half of future projected revenue shortfalls.
12. Subjecting non-wage forms of income to Social Security taxes as a means to increase revenue is a possibility since Congress could legislate such a change but it would be somewhat divergent from the original and current concepts and construction of Social Security primarily as a ‘deferred compensation’ retirement program by and for wage earners. It essentially would be a subsidy of wage earners by capital investors. Wage earners outnumber capital investors but capital investors have greater political influence and so it may be interesting if this kind of change is seriously proposed, promoted, and adopted.
13. Raising the Social Security tax rate itself is often promoted as a means to increase revenue and has occurred somewhat regularly in the past. Some tax rate increases were scheduled even at its inception. Some most recent tax rate increases were legislated partly in recognition of the ‘baby boom’ demographic bulge and an anticipated funding shortfall that benefit payouts to retiring ‘boomers’ would eventually otherwise create. At that time it was more politically viable to have that generation of workers pay higher taxes than alternatively plan to reduce their future benefits. In effect, that generation of workers ‘elected’ conceptually to fund more of their own actual future retirement benefits. That then helped produce the current existing surplus that will (now) be drawn upon to offset the revenue shortfall resulting from that generation’s retirement. It is questionable if raising the Social Security tax rate in the current environment is politically viable. Such a change would (truly) increase taxes on all wage earners and current economic conditions and trends are already reducing real net wages. Also, many current workers are more aware that any increased Social Security taxes they would pay would not be funding their own future benefits so much as funding their parents (and everyone knows that kids hate (giving money to) their parents :).
14. Illegal aliens are not entitled to Social Security benefits without it being fraud but any legal worker registered with the Social Security Administration that pays or has paid a certain level of Social Security taxes is entitled to some level of Social Security benefits. Any rhetoric to the contrary is either referencing the existence of some fraud or a distortion of facts or an outright fabrication. Interestingly, it is estimated, undocumented workers make a positive Social Security funding contribution that benefits legal workers.
15. The ‘other’ than retirement pension benefits that Social Security provides and at times have been legislatively expanded are often attributed as being responsible for much of any current and/or anticipated Social Security funding shortfall. These ‘other’ benefits include disability, dependent, and spousal benefits, etc. There have also been changes to some eligibility requirements for various benefits that are attributed as significantly impacting funding shortfalls. Such do inarguably make a contribution (or rather subtraction?) to the issue. (Another point that muddles this issue is that the Social Security Administration administers Supplemental Security Income (SSI) which is a Federal income supplement program funded by general tax revenues but not Social Security taxes.) The aggregate impact is really rather ‘small’ as a percentage of total benefit payouts, and to really a rather ‘small’ number as a percentage of total benefit recipients. However, defining ‘small’ is potentially subjective and so the reader is invited to independently view the breakdown reports provided by the Social Security Administration and published on its website as an aid to deciding the level of significance of impact these ‘other’ benefits and recipients impart.
16. Social Security is sometimes perceived as an ‘entitlement’ program that needs to be reduced or eliminated lest it bankrupts the nation. Social Security benefit payouts are an entitlement to its beneficiaries in the same (emphasis same) sense as are any private insurance annuity benefits to which its beneficiary is morally, legally and contractually entitled and about which few for that case would dispute or question their legitimacy, equitability, and inviolability. The word ‘entitlement’ as a descriptor has somehow evolved to being used or interpreted in the lexicon as imparting some negative connotation or as a euphemism for ‘welfare’ which Social Security is not. In terms of the general national budget, no matter what magnitude the obligations of Social Security benefits may pose, or what percentage of total national budget they may comprise, they are approximately equivalently (as discussed in 1.) budget neutral as (when) self funded by Social Security taxes.
Past (current) Social Security surpluses were in effect ‘loaned’ to (or ‘borrowed’ by) the government by reason of the Social Security Administration being restricted to invest only in (or a form of) US Treasuries, i.e. the safest (internationally recognized) investment backed by the full faith and credit of the United States of America (not an unreasonable or imprudent ‘investment’ for funds intended for retirement).
So Social Security benefit obligations are only additions to the general national budget shortfall and possible general deficit in two ways. The first is if (when) benefit payouts exceed tax revenues and have depleted any surpluses. This impact is limited to the extent and time period (unless a trend) of differences (emphasis differences) in benefit payouts vs. tax revenues. The second is as debt owed Social Security (as discussed in 2.) by the general budget (regardless of any accounting controversies along with the merits or failings of debt and deficits in general that are another topic entirely) for ‘borrowed’ Social Security surpluses. This is analogous in private personal finance to having to borrow from an outside source to repay a ‘loan’ you made to yourself from another purposed personal account from which funds are now needed. Regardless, any and all debt relies upon GDP for its sustainment or eventual resolution.
Social Security is not a significant (if any) cause of debt and it is not a cost or tax weighing upon GDP. Social Security is primarily just ‘deferred compensation’ wages that purchase a ‘defined benefit’ annuity that happens to be administered and secured by the United States government (rather than AIG :).
References:
www.ssa.gov/history/index.html
en.wikipedia.org/wiki/Social_Security_(United_States)
www.fairmark.com/retirement/socsec
www.snopes.com
Social Security funding is basically and approximately based on average on workers and their employers paying about 12.5% of wages for about 40 years, and retired workers living about 15 years on average past their ‘full’ retirement age. Summing 12.5% of wages over 40 years is equivalent to 5 years of wages.
Dividing 5 years of wages as if accumulated from 40 years of Social Security taxes by 15 years of retirement results in approximately 33% of pre-retirement annual wages per year which is approximately what Social Security is currently constructed to pay on average to workers retiring at ‘full’ retirement age.
Workers that retire earlier receive a reduced benefit payout scaled to the earlier number of years basically just redistributing the average expected benefit over the longer payout period.
Social Security redistributes benefits such that a lowest wage contributor actually receives about 40% of pre-retirement wages when they retire at ‘full’ retirement age, and a highest wage contributor receives about 25% of pre-retirement wages when they retire at ‘full’ retirement age – the average being still 33%.
Inflation is not counted, or rather is incorporated and offset, because as a ‘pipeline’ system it is the tax on current valued wages that actually pays current valued benefits. Assuming the ‘value’ adjusted for inflation of previous wages is equivalent to the current wages paid for equivalently valued work then the benefit payout is automatically equivalently adjusted for inflation.
Interestingly and importantly, with current workers contributing 12.5% of their income, it then requires approximately 2 and 2/3 workers on average to pay 33% of benefits on average to each retired worker (33 divided by 12.5). If you check some statistics you may find that this is pretty close to actual recent conditions when Social Security funding is (was) approximately ‘in balance’.
A worker paying maximum taxes throughout 40 prior working years paid average taxes of approximately 10%* on the current (recent) maximum equivalent of about $100,000 thus totaling about $400,000 in present value (inflation** adjusted) terms, from about $225,000 in actual cumulative tax amounts paid.
(*past tax rates averaged less than the current 12.5%). (**derived then as approximately a 3% average).
That worker as retired is currently scheduled to receive about $25,000 per year for on average 15 years thus totaling approximately $375,000 in present value terms (assuming continued COLAs are fairly commensurate to inflation), approximately equal in value to payments.
A worker recently earning $15,000 per year paid taxes throughout 40 prior working years totaling about $60,000 in present value (inflation adjusted) terms, from about $35,000 in actual cumulative tax amounts.
That worker** as retired would currently receive benefits of about $6,000 per year for on average 15 years thus totaling approximately $90,000 in present value terms (assuming continued COLAs are fairly commensurate to inflation), or about 1.5 times the value of payments.
Note that these simplified approximations are acceptably accurate as a ‘first order approximation’ model as validly representing the real system for conceptual purposes to a reasonable margin of error. (**Lower than median earners actually realize a higher net benefit than portrayed by this approximation).
The news being what it is may (likely) renew discussions regarding the United States Social Security program. Some has been in the press as of late anyway due to the upcoming mid-term elections, various articles about the growing US debt in general, and that Social Security is now (or soon) to start drawing upon its reserves for retiring 'Boomers'.
What follows is for those that may be interested in, or caught in a conversation about, Social Security topics on which they may not feel confidently clear about - but much may already be obvious or known to the reader.
The CheshireProfessor - Issues of Social Security Explained
Background:
Social Security was initially intended and throughout its existence has been constructed as a ‘defined benefit’ ‘deferred compensation’ retirement plan. Part of the ‘deferred compensation’ is paid directly by an employee’s employer and part is paid by the employee by means of a tax on wage income. That tax is separately itemized from general income taxes on one’s wage statements as FICA (a.k.a. OASDI) tax. The ‘defined benefit’ is a form of annuity effectively purchased by the ‘deferred compensation’ that later pays a percentage of average pre-retirement wage income to employees when retired.
Many misconceptions persist and are often promoted about how Social Security is implemented and many biases exist regarding it’s ‘fairness’, continued viability, management, etc. Fortunately there are many available and accessible credible resources (see references listed below). Unfortunately many people do not perform their own research before forming their opinions and conclusions regarding many issues. In all fairness, some aspects of Social Security are complex and an impediment to easily garnering a basic conceptual understanding. Given the availability of credible resources this writing is not intended to be a comprehensive and detailed description. This writing is intended only to provide a summary of some most common ‘talking points’ and provide a few simplified approximations one might apply to acquire a conceptual understanding of real or perceived complexities regarding Social Security.
Issues of Social Security Explained:
1. Social Security is not a Ponzi, a.k.a. ‘pyramid’, scheme. Some critics contend that Social Security is a Ponzi scheme, and thus implicitly destined to eventually fail, because of one shared similarity where funds collected from current workers are not ‘invested’ but are directly used to pay the benefits of retired workers, i.e. current subscribing payers essentially pay the previous payers turned receivers’ benefits. However, a ‘pyramid’ scheme requires (emphasis requires) an increasing (emphasis increasing) number of paying subscribers because it generates an increasing number of receiving subscribers, e.g. a ‘chain letter’. Social Security does not generate an increasing number of receiving subscribers as a function of its structure and thus does not require an increasing number of paying subscribers to be sustainable.
Social Security is a PAYGO (Pay As You GO) type funding system that only requires a fairly static number of current vs. retired workers to remain financially viable with all other aspects remaining the same. Social Security’s benefits funding structure is then more of a ‘pipeline’ or ‘pillar’ and not a ‘pyramid’.
(The arithmetic of how this basically works is presented later by a simplified approximation).
The Social Security PAYGO funding and ‘pipeline’ payout system will produce intermittent surpluses and shortfalls naturally as a result of changing demographics. At different times the ratio of required current vs. retired workers may not exactly exist. Any differences produce either shortfalls or surpluses in the tax revenues designated to pay benefits.
The CBO (Congressional Budget Office) estimates and projects Social Security funding so policymakers can adjust tax and fiscal policy to accommodate anticipated persisting shortfall or surplus trends. The CBO makes high, mid, and low estimates of which the one that most supports any particular speaker’s agenda is the one that speaker references. Policymakers tend to promote the lower revenue and higher payout scenario estimates as rationale, and/or opportunity, to advocate increasing taxes. Generally, from their perspective, it is preferable to have surpluses from tax revenues (any kind of tax revenues :).
In the history of Social Security it has had periods of both funding deficits and surpluses. Some deficits were resolved by later surpluses, and some surpluses have been eroded by later shortfalls. Some deficit projections were ameliorated by legislation that increased revenues and/or restructured benefits. Conversely, some surplus projections may have been diminished or deficit projections exacerbated by legislation that increased or expanded Social Security benefits, eligibility, and benefit payouts.
There were immediate deficits in Social Security funding at its inception that were borrowed from the government (either from other general budget surpluses or through government issued debt) and later repaid. It has had, and currently has, surpluses that are loaned to the government that are now equivalent debt obligations. It is generally accepted that it probably will run an overall deficit in the (some) future (anywhere from 2035 to 2085) that the government will have to fund or reduce either through higher Social Security tax revenues, or general taxes, or debt, or reductions in benefit payouts. Regardless, the benefits that are determined to be paid are effectively national debt obligations like any other and it really doesn’t matter except from perspectives of equity and budgeting what funding source pays them.
2. Some critics argue that Social Security surpluses previously ostensibly held in a specific ‘Trust fund’ have been raided and used by the government to fund other budget shortfalls or expansions in general federal government spending, and that the ‘Trust’s’ holdings were replaced with only government IOUs.
From the perspective of a Social Security participant and potential or current beneficiary it really doesn’t matter where any surplus funds are or went. One’s current and/or near future benefits are owed as a debt obligation by the government in general not just the Social Security Administration, (well, maybe not technically legally but certainly practically and morally). The legislature could reduce benefit payouts but doing so for any current or near future beneficiary is akin to default on a contract or debt payment. So, and still, one should not fall to complacency on this issue as a voter.
What the government has exercised by ‘borrowing’ Social Security surpluses to fund other general spending really isn’t any different than what most individuals would prudently exercise in their own financial management. Suppose you established a fund with annual contributions designated to pay for home maintenance and repairs. You keep putting some money in your left pocket and pay for everything else with most of your other money that goes in and comes out of your right pocket. For a while everything is fine and money builds up in that left pocket but then you run out of money in your right pocket. Maybe your car got stolen and replacing it cost more than what your insurance covered, or maybe you decided to get premium cable channels. The question of ‘need’ regarding those right pocket expenditures is deferred here to focus on the fact that money is depleted from your right pocket and to consider what you would do. Would you borrow money from an external source or might you ‘borrow’ from that left pocket? If you borrowed from your left pocket and didn’t repay before needing a new roof you might then have to borrow from an external source to repay your ‘debt’ obligation to your left pocket so that left pocket could then provide payment(s) to the roofer. Eventually you are going to rely on future household income to repay that debt either external or to your left pocket or roofer. And so with Social Security’s obligations, ‘trust fund‘ or not, one pocket or another, it has to come from revenues generated by taxes that are effectively some percentage of national GDP eventually no matter what. Increase GDP (income) and any increased debt gets repaid without a budget change, otherwise you must economize.
3. Social Security is not intended or constructed to necessarily pay back what an individual has paid in. First, its benefit structure is formulated with a bit of a ‘benefit redistribution’ weighting. (Some take issue with this aspect as a form of socialism but that is another topic). It pays lower contributors a higher percentage and higher contributors a lower percentage of average pre-retirement wage income, but higher contributors still receive more than lower contributors. Second, it is implemented like an insurance life annuity and so similar to other life related type insurance it is a bet of your money on your life expectancy against another’s bet of their money on their life expectancy - live long and prosper, live not and lose. Third, on average total payouts are greater than what workers have paid as total tax amounts and actually are approximately equivalent or even greater in present value (inflation adjusted) terms.
(The arithmetic of how this basically works is presented later by a simplified approximation).
4. Social Security is not intended or constructed to produce an ‘investment return’ but it does provide a ‘defined benefit’ that is relative to what one has paid as similar to an insurance life annuity and many private pensions. Social Security benefits are paid according to a relative percentage of earnings history and adjusted for inflation by annual COLAs so the benefit ‘returns’ remain approximately inflation neutral. As primarily intended as a ‘deferred compensation’ plan, its taxes and benefits are a relative percentage of prior wages and on average approximately both equivalent in present value (inflation adjusted) terms.
(The arithmetic of how this basically works is presented later by a simplified approximation).
Some people take issue with the implementation of Social Security as a form of annuity claiming that they could realize greater retirement funding if allowed to personally control and direct the investment of their own Social Security tax payments. That may be true for some but that issue leads into the social and economic considerations that created, evolved, and still largely justify Social Security in its present form.
5. Social Security was created in large part because most wage earners, and mostly the lower paid, were not very good at providing for their retirement on their own and employers weren't interested nor could they be trusted to reliably do it for them. Also, as the nation’s economy changed from agrarian to industrial based, workers lost much in the way of adequate personal social networks and resources to rely upon for ‘retirement’. The prospect that many workers might fail to sufficiently provide for their own retirement and potentially become wards of the government and thus by extension wards of the more ‘sufficient’ providers was (is) perceived as socioeconomically unjust. So Social Security was (is) primarily a mandated ‘deferred compensation’ retirement (‘safety’) plan implemented as a ‘defined benefit’ annuity administered and secured by the US government (and so to help reduce, rather than be, ‘welfare’).
IRAs and 401ks, etc., as personally directed and invested ‘deferred compensation’ plans were later enacted in part to address, as an augmentation or supplement to Social Security, the issue of those that wanted to exercise their own personal retirement funding and management with the opportunity to receive benefits based more directly upon what amount was contributed and how it might have been invested at their direction. These ‘self-directed’ programs have mostly proved the first point having been underutilized or relative failures by most and successes most only by a relative few and generally the higher paid.
6. Employer sponsored defined benefit plans are sometimes perceived as no cost to workers whereas Social Security taxes are visible costs paid by workers. True in terms of visibility and transparency but anyone who believes that ‘employer paid’ retirement benefits are not actually paid by employees is naive as to how employers account for total employee (‘total compensation’) costs. Employer sponsored retirement plans are constructed and implemented much the same as Social Security. However, they carry a much higher risk of default to employees as has been experienced in many cases. This higher risk of default also exists with privately purchased personal life annuity retirement products.
7. Not all wage earners pay Social Security taxes and thus are not eligible for (full/any) benefits. At its inception some groups of workers were excepted and later more were included. A growing number of substitute (or ‘alternative’) privatized programs are currently allowed, often even mandated by terms of (usually government) employment. One can check the Social Security website and see how benefits if any are due are adjusted by such substitute plan benefits. Perhaps somewhat ironically, those that desire more ‘privatized’ Social Security administration should seek employment in the ‘public’ sector.
8. Social Security taxes are sometimes seen as a regressive (‘flat’) tax not consistent with other current progressive (‘graduated’) income taxes. Perhaps, but one might consider that other ‘graduated’ income taxes ‘buy’ the same (‘flat’) benefit whereas Social Security taxes ‘buy’ a ‘graduated’ benefit for the same (‘flat’) tax and thus are effectively ‘progressive’.
9. Social Security benefit payout COLAs have been the subject of some ongoing debate with some growing advocacy to change them to being based upon average annual national wage increases (the/a WPI) vs. the current relation to some measure of a CPI. (And some argue the converse for the inflation adjustments applied to qualifying prior earnings). Since payouts are intended to provide deferred wages it is argued that inflation adjustments be more justly based upon actual wage inflation. It is also argued that with benefits not kept closely tied to wages, the source of funding, there is a greater chance that differences in revenue vs. benefit payouts will continually arise or be amplified as a result. There is the possibility (probability) that such a change would reduce benefit payout increases (a major reason for its proposal). This would be due to declining wage increases relative to CPI, i.e. ‘wage deflation’.
10. Raising the benefits age at which workers become eligible to receive ‘full’ Social Security benefits is often proposed as a means to increase revenue and restrain increasing payouts due to increasing life expectancies. This has been done before in recognition of changing life expectancies and will probably be done in the future. However these changes have been, and any such additional changes are likely to be, or approximately be, on the order of two months for each year of later birth. A sudden change to age 70 or so is not likely. Alternately, payout (rate) reductions could redistribute the same total benefit over increased years, e.g. 80% would cover 25% more years (a projected future possible scenario).
11. Raising or eliminating the ‘earnings cap’ above which Social Security taxes are not levied is sometimes proposed as a means to increase revenue. Increases already occur as an inflation adjustment but could be increased greater still. Eliminating the ‘cap’ is a strong possibility as it was similarly done for Medicare funding. Also, popularly (generally) it is perceived as more ‘tax fair’ and politically more viable since it currently only applies to about 10% of wage earners. Higher ‘un-capped’ income contributors would then probably later receive higher benefits but the net effect would still provide general shortfall relief due to the redistribution aspects of the (and revised) Social Security benefit payout formulation. This change alone if implemented is estimated to fund more than half of future projected revenue shortfalls.
12. Subjecting non-wage forms of income to Social Security taxes as a means to increase revenue is a possibility since Congress could legislate such a change but it would be somewhat divergent from the original and current concepts and construction of Social Security primarily as a ‘deferred compensation’ retirement program by and for wage earners. It essentially would be a subsidy of wage earners by capital investors. Wage earners outnumber capital investors but capital investors have greater political influence and so it may be interesting if this kind of change is seriously proposed, promoted, and adopted.
13. Raising the Social Security tax rate itself is often promoted as a means to increase revenue and has occurred somewhat regularly in the past. Some tax rate increases were scheduled even at its inception. Some most recent tax rate increases were legislated partly in recognition of the ‘baby boom’ demographic bulge and an anticipated funding shortfall that benefit payouts to retiring ‘boomers’ would eventually otherwise create. At that time it was more politically viable to have that generation of workers pay higher taxes than alternatively plan to reduce their future benefits. In effect, that generation of workers ‘elected’ conceptually to fund more of their own actual future retirement benefits. That then helped produce the current existing surplus that will (now) be drawn upon to offset the revenue shortfall resulting from that generation’s retirement. It is questionable if raising the Social Security tax rate in the current environment is politically viable. Such a change would (truly) increase taxes on all wage earners and current economic conditions and trends are already reducing real net wages. Also, many current workers are more aware that any increased Social Security taxes they would pay would not be funding their own future benefits so much as funding their parents (and everyone knows that kids hate (giving money to) their parents :).
14. Illegal aliens are not entitled to Social Security benefits without it being fraud but any legal worker registered with the Social Security Administration that pays or has paid a certain level of Social Security taxes is entitled to some level of Social Security benefits. Any rhetoric to the contrary is either referencing the existence of some fraud or a distortion of facts or an outright fabrication. Interestingly, it is estimated, undocumented workers make a positive Social Security funding contribution that benefits legal workers.
15. The ‘other’ than retirement pension benefits that Social Security provides and at times have been legislatively expanded are often attributed as being responsible for much of any current and/or anticipated Social Security funding shortfall. These ‘other’ benefits include disability, dependent, and spousal benefits, etc. There have also been changes to some eligibility requirements for various benefits that are attributed as significantly impacting funding shortfalls. Such do inarguably make a contribution (or rather subtraction?) to the issue. (Another point that muddles this issue is that the Social Security Administration administers Supplemental Security Income (SSI) which is a Federal income supplement program funded by general tax revenues but not Social Security taxes.) The aggregate impact is really rather ‘small’ as a percentage of total benefit payouts, and to really a rather ‘small’ number as a percentage of total benefit recipients. However, defining ‘small’ is potentially subjective and so the reader is invited to independently view the breakdown reports provided by the Social Security Administration and published on its website as an aid to deciding the level of significance of impact these ‘other’ benefits and recipients impart.
16. Social Security is sometimes perceived as an ‘entitlement’ program that needs to be reduced or eliminated lest it bankrupts the nation. Social Security benefit payouts are an entitlement to its beneficiaries in the same (emphasis same) sense as are any private insurance annuity benefits to which its beneficiary is morally, legally and contractually entitled and about which few for that case would dispute or question their legitimacy, equitability, and inviolability. The word ‘entitlement’ as a descriptor has somehow evolved to being used or interpreted in the lexicon as imparting some negative connotation or as a euphemism for ‘welfare’ which Social Security is not. In terms of the general national budget, no matter what magnitude the obligations of Social Security benefits may pose, or what percentage of total national budget they may comprise, they are approximately equivalently (as discussed in 1.) budget neutral as (when) self funded by Social Security taxes.
Past (current) Social Security surpluses were in effect ‘loaned’ to (or ‘borrowed’ by) the government by reason of the Social Security Administration being restricted to invest only in (or a form of) US Treasuries, i.e. the safest (internationally recognized) investment backed by the full faith and credit of the United States of America (not an unreasonable or imprudent ‘investment’ for funds intended for retirement).
So Social Security benefit obligations are only additions to the general national budget shortfall and possible general deficit in two ways. The first is if (when) benefit payouts exceed tax revenues and have depleted any surpluses. This impact is limited to the extent and time period (unless a trend) of differences (emphasis differences) in benefit payouts vs. tax revenues. The second is as debt owed Social Security (as discussed in 2.) by the general budget (regardless of any accounting controversies along with the merits or failings of debt and deficits in general that are another topic entirely) for ‘borrowed’ Social Security surpluses. This is analogous in private personal finance to having to borrow from an outside source to repay a ‘loan’ you made to yourself from another purposed personal account from which funds are now needed. Regardless, any and all debt relies upon GDP for its sustainment or eventual resolution.
Social Security is not a significant (if any) cause of debt and it is not a cost or tax weighing upon GDP. Social Security is primarily just ‘deferred compensation’ wages that purchase a ‘defined benefit’ annuity that happens to be administered and secured by the United States government (rather than AIG :).
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References:
www.ssa.gov/history/index.html
en.wikipedia.org/wiki/Social_Security_(United_States)
www.fairmark.com/retirement/socsec
www.snopes.com
Social Security Funding Simplified Arithmetic Approximation:
Social Security funding is basically and approximately based on average on workers and their employers paying about 12.5% of wages for about 40 years, and retired workers living about 15 years on average past their ‘full’ retirement age. Summing 12.5% of wages over 40 years is equivalent to 5 years of wages.
Dividing 5 years of wages as if accumulated from 40 years of Social Security taxes by 15 years of retirement results in approximately 33% of pre-retirement annual wages per year which is approximately what Social Security is currently constructed to pay on average to workers retiring at ‘full’ retirement age.
Workers that retire earlier receive a reduced benefit payout scaled to the earlier number of years basically just redistributing the average expected benefit over the longer payout period.
Social Security redistributes benefits such that a lowest wage contributor actually receives about 40% of pre-retirement wages when they retire at ‘full’ retirement age, and a highest wage contributor receives about 25% of pre-retirement wages when they retire at ‘full’ retirement age – the average being still 33%.
Inflation is not counted, or rather is incorporated and offset, because as a ‘pipeline’ system it is the tax on current valued wages that actually pays current valued benefits. Assuming the ‘value’ adjusted for inflation of previous wages is equivalent to the current wages paid for equivalently valued work then the benefit payout is automatically equivalently adjusted for inflation.
Interestingly and importantly, with current workers contributing 12.5% of their income, it then requires approximately 2 and 2/3 workers on average to pay 33% of benefits on average to each retired worker (33 divided by 12.5). If you check some statistics you may find that this is pretty close to actual recent conditions when Social Security funding is (was) approximately ‘in balance’.
Some Other Interesting (Approximate) Arithmetic:
A worker paying maximum taxes throughout 40 prior working years paid average taxes of approximately 10%* on the current (recent) maximum equivalent of about $100,000 thus totaling about $400,000 in present value (inflation** adjusted) terms, from about $225,000 in actual cumulative tax amounts paid.
(*past tax rates averaged less than the current 12.5%). (**derived then as approximately a 3% average).
That worker as retired is currently scheduled to receive about $25,000 per year for on average 15 years thus totaling approximately $375,000 in present value terms (assuming continued COLAs are fairly commensurate to inflation), approximately equal in value to payments.
A worker recently earning $15,000 per year paid taxes throughout 40 prior working years totaling about $60,000 in present value (inflation adjusted) terms, from about $35,000 in actual cumulative tax amounts.
That worker** as retired would currently receive benefits of about $6,000 per year for on average 15 years thus totaling approximately $90,000 in present value terms (assuming continued COLAs are fairly commensurate to inflation), or about 1.5 times the value of payments.
Note that these simplified approximations are acceptably accurate as a ‘first order approximation’ model as validly representing the real system for conceptual purposes to a reasonable margin of error. (**Lower than median earners actually realize a higher net benefit than portrayed by this approximation).
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