Coberly on Social Security

This post is by Coberly, and was written for inclusion in the upcoming Facing Up blog carnival on Social Security.

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The idea that Something Needs To Be Done About Social Security is rooted in three fundamental misunderstandings. A misunderstanding about the very nature of Social Security, a misunderstanding about what the Trust Fund is, and a misunderstanding about the numbers: how big they are and what they mean.

It’s as if your doctor, your boss, and your financial planner all came into your office and announced they had good news and they had bad news. Your doctor says he is going to extend your life expectancy by six years. Your boss says he is going to give you a 300 dollar per week raise.

“So what’s the bad news?”

Your financial planner tells you that you are going to have to save an extra 20 dollars a week in order to pay for that extra six years in retirement.
Of course this is not usually the way the news is presented. Instead a nice man in a suit tells you he is a “non partisan expert” and “SOCIAL SECURITY IS GOING BROKE! FLAT BUST! IT’S GOING TO BE A CRUSHING BURDEN ON YOUR CHILDREN!”

The source of this misunderstanding is that most people don’t read, can’t read, or deliberately misread the Social Security Trustees Report. [The 2007 Annual Report of the Trustees of the Federal Old Age and Survivors Insurance and Federal Disability Insurance Trust Funds. A web copy can be found here.

Here are the facts: The Social Security Trustees report a projected deficit in Social Security finances of 4.7 Trillion Dollars over the next seventy five years [Trustees Report, page 2]. A good place to begin understanding what this means is to make a rough calculation of approximately what it might mean to you: There are about 200 million taxpayers in America, so 4.7 Trillion divided by 200 million is 23,500 dollars per taxpayer, divided by 75 years is 313 dollars per taxpayer per year, or about six dollars a week.

This is just back of the envelope, but it should give you a sense of the scale of the problem: not very big. The Trustees do the hard arithmetic, using “present value” and all the right details about timing and interest rates, and… tell you what the answer is: An immediate increase in the combined payroll tax of 1.95% would close the deficit [Trustees Report, p 3]. But that’s combined. What you would see is about 1% for you and 1% for your boss. Average pay is about 37,000 dollars per year, or about 700 dollars per week. 1% of 700 dollars is 7 dollars per week.

However, the Trustees know we can’t start paying for the projected deficit right away because, well, because it hasn’t happened yet. And paying more now would just increase the amount of the national debt… those “worthless iou’s” in the Trust Fund are debt, after all. So they dolefully point out [p 16 of the report] that if we wait until the money actually comes due, in about 2040, it would require an increase in the combined payroll tax of about 4% … or 2% (about 14 dollars a week) for you, and 2% for your boss. They don’t point out, but you can find it if you are a careful reader, that by 2040, assuming, as they do [p 87], an increase in real income of 1.1% per year over that time, the average real wage will have increased by 300 dollars a week (to about 1000 dollars per week, or 50,000 per year)….and of course the tax on the larger income will be bigger… about 20 dollars per week. So there’s your crisis: 30 years from now a 20 dollar per week increase in the tax on an income that is 300 dollars per week larger.

And that money, those extra 20 dollars per week, is not thrown into a government black hole: You get it back, with enough effective interest to cover inflation (and more, depending on the rise in real wages) when you need it most. The reason for the raise in the tax is that you are going to be living longer, spending a larger percent of your life retired, so you will need to save a larger percent of your income. But that “larger” is 2%, not 50%, not 100%, not “the value of all the property in America” as Peter Peterson likes to say.

Another way to look at this: The Trustees say that by 2041 under current tax rates they will only be able to meet 75% of promised benefits [p16]. This means taxes would have to be raised 33% to meet all promised benefits. But that is 33% of a 6.2% tax. or about 2.1% of payroll. 2% of 700 dollars is 14 dollars per week. But by then you will be making 1000 dollars/week. 2% of 1000 dollars is 20 dollars.

I am repeating this because I want to be sure you get it. We are talking about a twenty dollar per week tax increase… on an income that is 300 dollars more per week than you have today… in order to pay for your own longer retirement. This is not a crisis. It is not even a problem.

The Trustees suggest that instead of paying the 2% tax increase, we could cut benefits by 25% [p 16]. But benefits are about 1000 dollars per month. Cutting them by 25% would leave you trying to get by on 750 dollars per month. No fun.
Ask your financial planner what makes more sense… raising your tax by 60 dollars per month (using today’s values) out of an income of 3000 dollars per month, or cutting your benefits 250 dollars per month out of a pension of 1000 dollars per month?

Some say we should raise the retirement age. That’s easy to say when you are young, or have a really good job. But the fact is that most people, when they have a choice, choose to retire early rather than late, even if it means getting less money. And it conveniently ignores the fact that these old people WILL HAVE PAID FOR THEIR OWN RETIREMENT.

These are the choices, but the fast talking man in the suit isn’t going to give you a chance to think about them. Once you have got the SIZE of the problem fixed in your mind, you are ready to think about the other two fundamental misunderstandings.

The first of these is the Trust Fund. The Trust Fund is NOT Social Security. When Bush tells you that Social Security will be “broke, flat bust,” he is lying. The current Trust Fund was created so the Baby Boomers could pay in advance for their own retirement. The Trust Fund was always intended to run out of money… go “broke”…at about the time the last of the Boomers were dying off. It looks like it will have done its job by about 2040. When the Trust Fund is fully paid out, Social Security returns to pay as you go. It can never run out of money…as long as America stands, as long as the workers want a safe way to save for their own retirement.

In fact, the Trust Fund doesn’t matter very much. The cost of paying it off will amount to a tax raise of ONE DOLLAR PER WEEK each year from 2016 to about 2036 [p 44 TableIV.B1.], during a time when the average wage is increasing TEN dollars per week each year.

The last fundamental misunderstanding is the nature of Social Security itself. Social Security is not welfare. The rich do not pay for the poor. The young do not pay for the old. It is not “government money.”

There is a certain magic to pay as you go with wage indexing that only the Federal government can accomplish. The government can guarantee you get your money back safe from inflation, safe from market gyrations, safe from illness or theft. It can even insure you against failing to make enough money over a lifetime to have saved enough for basic needs in retirement. But no one pays any more into Social Security than they expect to get back.

Pay as you go is fundamentally no different from putting your money into the bank or buying a stock. The day you put your money in, it goes right out the back door to pay for someone else’s expenses. And when you are ready to take your money out… it has to come in the front door from someone else who is buying your stock, or buying your company’s products so the company can pay you dividends.

Under ANY retirement plan it is always “the young” that pay for “the old.” The young do it because they know that it is a good deal for them: one day they will be “the old.”

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This post is by Coberly, and was written for inclusion in the upcoming Facing Up blog carnival on Social Security.