Sixteen Men on a Dead Man’s Chest…Social Security and the Facts of Life

Guest post by Dale Coberly

Sixteen Men on a Dead Man’s Chest Yo Ho Ho
Social Security and the Facts of Life

Sen. Mark Warner (D-Va.) said on Sunday the “Gang of Six” senators is “very close” to a deal on deficit reduction, suggesting the plan would impact Social Security that most Democrats have said is off limits.
Asked by host Bob Schieffer to clarify that the group will take on Social Security, Warner said, “Part of this is just math: 16 workers for every one retiree 50 years ago, three workers for every retiree now.”

What we have learned in ten years of watching the Social Security “debate” is that when someone says “it’s just math,” he is lying. Unless, of course, a United States Senator simply doesn’t know what he is talking about.

The “16 workers for every one retiree” is one of those true facts that doesn’t mean anything… and is therefore used by liars to mean what they want it to mean.
The Senator does not read Angry Bear, but in the hope that one of his friends will try to explain it to him, I offer the following simplified model.

Update: The Atlanta Fed Macroblog from 2006 includes Dean Baker, pgl, Ken Houghton on this issue.

Imagine that the voters of America look around themselves and see a crisis where millions of people approaching retirement age have lost their savings by no fault of their own. Perhaps a Great Depression or something like that. There is no time for all these older workers to again save enough to retire on. Workers who have already reached retirement age are receiving “welfare.” But the voters don’t like the idea of a permanent “welfare establishment” as the “normal” way for workers to get through their retirement years.
So they decide to try a simple plan.. a retirement insurance system based on the idea of pay as you go. And here is how it works.. worked. Remember I said this is simplified.

Imagine that in the first year of the plan there are 40 million workers, one million in each age cohort… that is, one million aged 25, one million aged 26, … etc. up to one million aged 64. So far there are NO retirees in the system. If each worker pays a “tax” of one percent of his income, there will be enough money so that..

In the next year one million people become 65 and retire. And one million who were 24 last year become 25 and get jobs and start paying the tax. And of course each cohort moves up to the next year.

Now there are forty million workers and one million retirees, a ratio of forty workers for every one retiree . And if each worker is paying 1% of his income into the system, there will be enough money to pay-as-you-go each retiree 40% of the average income of all the workers. The 40% is called “the replacement rate.” it will be roughly enough to replace 40% of the average lifetime monthly income of each of the retirees.. adjusted for the average increase in wages over 40 years. )
The next year, another million will retire, bringing the ratio of workers to retirees to 40 to 2, or 20 to 1 (remember that every cohort moves up a year, and one million new workers enter at age 25 replacing those who retire at age 65. Now it will be necessary to raise the “tax” to 2%.

At this point the Senator Warners of the world get hysterical.. “A doubling of the tax. We’re all going to die!” And the “non partisan experts” project that if this keeps up, in only 30 years the tax will be ONE MILLION PERCENT!.
But the workers say, two percent isn’t so bad and it goes for a good cause. So they keep paying as they go.

The next year the ratio of workers to retirees becomes 40 to 3 (13 to 1). and the tax goes up to 3%. Note that we have already passed the 16 to1 ratio without even noticing it.

The next year the ratio becomes 40 to 4, or 10 to 1, and the tax goes to 4%
And the next year the ratio becomes 40 to 5, or 8 to 1. Or does it? Well, sadly, no. By this time some of the retired workers have begun to die off… so the number of retirees does not increase by the full million new retirees, but by some number like one million new retirees minus some hundred thousand older retirees who have died And while the ratio of workers to retirees will continue to decline, it won’t continue to decline at the rate it did for the first few years.
In fact, if the life expectancy of retirees is about 12 years… half of them will die by the age of 77… the ratio of workers to retirees will stabilize at around 3 to 1. ( The ratio of workers to retirees depends very much on the ratio of working years to retirement years for each worker. )

This will require a tax rate of about 12% in order to pay that replacement rate of 40% of a workers average lifetime adjusted income… or, which is the same thing, 40% of the current average income. Note that sneaky “adjusted” income. That is the secret of pay as you go. By adjusting the income of retirees to reflect the inflation and rise in real standard of living that shows up in the wages of those paying the tax, the retirees get an automatic effective “interest” on their tax… which now looks exactly like “savings.”

Meanwhile the workers are putting away 12% of their income (or 6% depending on who you think would get the boss’s share if there were no SS tax), and this is exactly what they would have had to save out of their income for a basic “if all else fails” retirement. This seemed like a good idea at the time… the people who were living then had seen what happens to “sure things on the stock market,” and they wanted a little insurance “just in case,” and they were smart enough to know they had to pay for it.

Now, what Senator Warner is so sure is going to cause the sky to fall on our heads is the prediction that we are all going to live a little longer… as much as twenty years in retirement, bringing the ratio of workers to retirees down to 2:1. Other things being equal, this would require that we save about 20% of our working income, if we are going to need about 40% of that income every month to see us through a long retirement.

Since we are making more than twice as much as our grandparents, you’d think we could afford this. But let me make it a little clearer. Suppose grandpa was making a thousand dollars a week real money and paying 120 dollars into his retirement fund, and expecting to live about 12 years after he retired. Now suppose that great great grandson will expect to live about 20 years after he retires. He will need to pay 20% to cover the expense of a longer life. But he is making twice what grandpa made. So out of his 2000 dollars per week, he needs to save 400 dollars in his retirement fund. But that leaves him “only” 1600 dollars to live on.
Compared to the 880 dollars grandpa had to live on. You can see the tragedy of this situation. Great grandchild has to get along on less than twice what his grandpa did, and all so that he can afford to live almost twice as long in retirement.

Oh the unfairness! Oh the financial ruin!

As I said, the above was a simplified explanation. The true fact is that in order to pay for their longer life expectancy, the workers would need to raise their own Social Security contribution by about forty cents per week per year… in today’s money. Eventually, two generations from now, this would amount to a 2% increase on the tax for the worker, and 2% for the employer. Out of an income that will be more than double what it is today. Leaving the worker with twice as much money “after taxes” as he has today. Plus he will get the money back, with interest, over a retirement that lasts almost twice as long as his grandparents’.