mage67 (mage67) wrote,

Social Security 101

People keep asking me about Social Security, so I'm answering the questions I get asked the most in this blog

Q: Is Social Security going bankrupt?
A: If the system continues going the way it is, yes it will go bankrupt. However that doesn't mean it will end if it goes bankrupt. People misunderstand what it means for Social Security to go bankrupt. It means that Social Security will have no reserve funds. However Social Security is unique in that it doesn't depend so vitally on its reserves. So if it goes bankrupt, it can still function very well.

Q: Why is bankruptcy not a bad thing for Social Security?
A: It's not good and it would be devastating for any other insurance program. Social Security is unique in that it's the only insurance program in the USA that's allowed to have insufficient funds available to pay all future benefits (within reason). Social Security only has the next 2 years of outgoing payments in reserve. The government gets away with this, because the US government claims they can never go bankrupt, so they don't have to protect against it.

Because SS has insufficient reserves, payments for current retirees are made by the people currently working. Therefore even without any reserves, the payments can be still made by those currently working.

Q: So what are the consequences if SS goes bankrupt?
A: The US government will either have to do at least one of the following:
1. Cut retirement benefits so that it reflects the incoming money (This wouldn't be a huge cut. In a worst case scenario it would be a 25% cut)
2. Increase SS taxes
3. Borrow money to pay for costs it can't pay

Q: Why is Social Security so badly run?
A: It's actually one of the most efficiently run insurance programs that ever existed. They keep costs remarkably low. The problems with it are not how it's run or managed.

Q: So if Social Security is run so well, why is it going bankrupt?
A: The problems with it are fundamental to how it was conceived. The current retirees are getting benefits paid for by those currently working. When Social Security started, there were 16 working people for every retiree receiving benefits. However, the baby boom generation created an abnormally large surge in population in one generation (those born between 1946-1964). Also, people are living longer. Now there are 3 working people for every retiree collecting benefits. When the baby boomers start qualifying for early retirement, it will be shifting towards 2 working people for every retiree. Since 2 working people cannot reasonably support one retiree at the current level of benefits on average, the reserve will be drained until it goes bankrupt. So it's the demographics that are causing Social Security to fail.

Q: So what are possible solutions?
A: The US government will have to do at least one of the following:
1. Cut retirement benefits (which almost no one wants)
2. Increase SS taxes (an increase of 1% in contributions rates will make SS solvent for the next 75 years alone)
3. Borrow money to pay for costs it can't pay (which almost no one wants)
4. Increase the retirement age (which Reagan did during his administration. Right now the normal retirement age is 65 years, 4 months. It will slowly increase to 67 under currently existing laws. Raising the retirement age to about 70 should make Social Security stable again)
5. Invest the reserves in a higher paying investment (the current reserves pay a very low interest rate in government securities because they are very safe and will only default if the US government goes bankrupt. If the US government ever went bankrupt, US Currency would be worthless anyway, so it would be a moot point if SS goes bankrupt)
6. Remove the cap on SS contributions. Only the first $90,000 as of 2005 has SS tax applied. If there was no such cap, then the problem would be solved. Even raising this cap to a higher amount that is finite would solve the problem. (This goes against the very nature of the concept of insurance. People making more than $90,000/year would be paying for benefits they won't receive. This is a form of socialism, which people tend to dislike in the US.)

Q: Investing in a higher paying investment sounds like the best plan. No belt tightening for anyone. Why are people against it?
A: Most of Social Security benefit funds that people have earned do not exist. Only 2 years of outgoing money actually exists. You can't invest money that doesn't exist. We can invest the existing reserves better, but there are the following problems:
1. Where do we invest it? The Social Security Reserves are so huge that it rivals the full value of all outstanding stock.
2. We could re-invest part of it, but who decides where it gets invested? Any company that benefits from the influx of funds this huge has a big advantage over other companies. Therefore the people who decide where to invest it will get bribed, regardless of laws stopping it. No one in history has ever made a system bribe-proof. The larger the funds to be gained, the more likely bribing will happen. Therefore re-investing is creating monopolies and making people rich unjustly. Those unjust funds would be coming from tax payers which would make the system cost far more. Basically this is a recipe for institutionalizing corruption.
3. The number of investment choices would have to be limited and managed. Too many choices would be too confusing to the public. We would have to set up funds that people could choose from like money market funds. If the public could choose by company, then some companies would get more funds than they would know what to do with. It might also create monopolies and some people might invest unwisely. (This is a manageable problem)
4. To redesign this system would cost anywhere between $500 Billion and $2 Trillion initially. A whole new accounting system would have to be put in place to keep track of how people would choose to allocate funds. This cost is far more than it would cost for easier fixes. There would also be extra costs in keeping the funds actively managed. The later costs would be small compared to extra investment assets available, but it would take many decades to make up for the initial costs alone.

How do the initial costs get paid? There isn't nearly enough discretionary funds coming in from all US federal taxes to pay for this in one year. The only fund large enough to pay for this initially is SS reserves itself. So basically the idea is to drain half the funds from a cash starved system and hope there are no miscalculations in the payoffs. However with such a brand new system, there are always miscalculations.
5. Higher paying investments means more risk. Even small risks eventually happen and such risks need to get out of control only once for there to be such a disaster. The current investments have no risk other than the US government going bankrupt, which would make US currency worthless anyway.

Q: So what is the best solution?
A: The easiest and best thing to do a combination of fixes. Simply raise the retirement age a little and raise contribution levels a little. A raise of 0.75% of contribution levels and an eventual raise of 1 year in the normal retirement age to 68 will fix SS for at least the next 75 years. Benefits wouldn't have to be cut if we do this, there's no risk involved and there's no initial cost.

Another solution is to also raise the cap on SS tax. There is no SS tax on individual income above $90,000. So we can raise this cap to about $150,000, raise contribution levels to 0.50%, and raise the normal retirement age one year to 68. This raise in the cap makes it an inequitable insurance to people making more than $90,000 per year, but SS was designed to be inequitable to those making more. It's why it's called "Social" Security or a social insurance (or a socialist insurance, but we in America don't like to use the word "socialist". It's too akin to what we think of as "communism")

Q: So why do so many people want to re-invest into funds if it causes so many problems?
A: Some people don't know any better. Some people know better, but will make such a huge amount of money at tax payers' expense off this proposition that it's irresistible.

In retrospect the problems of SS can be easily fixed. It is not a powderkeg waiting to explode. At worst it'll make a mild popping sound, as long as we don't do something really stupid

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