Social Security Cliff in Sight

January 17th, 2013

by Mike Shedlock

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.


Retirees Will Outlive Trust Fund; Ramifications of Nonmarketable IOUs and Privatization

In response to my post Making Social Security Actuarially Sound in a Business-Friendly Manner I have been exchanging emails and phone conversations with Jed Graham at Investor's Business Daily.

Jed thinks benefit cuts will happen, and I agree. However, Social Security cuts are considered the "third rail" in politics.

If you are not familiar with the term, it means anyone espousing cuts cannot be elected.

Retirees Will Outlive Trust Fund

Graham's current position on the viability of Social Security can be found in his January 14 article New Social Security Retirees Will Outlive Trust Fund

For the first time since Social Security's cash crisis in 1983, the program can't afford to pay full benefits for its youngest crop of new retirees through life expectancy, government data show.

The hastening of the Social Security Trust Fund's demise to 2033 means that workers just becoming eligible for Social Security at age 62 face steep future benefit cuts if they live to the average life expectancy, now about 84.

Those abrupt benefit cuts of about 25% a year for today's 62 year olds and workers nearing the early retirement age would come at an especially bad time — late in life when savings have dwindled and health care bills are on the rise.

Old Contract Invalid

While the trust fund's nonmarketable Treasuries — really IOUs from one branch of government to another — have no value to offset the cost of benefits, they provide Social Security the legal authority to run cash deficits until they're spent.

Under current law, a worker who just turned 62 would face a 25% benefit cut once the trust is spent in early 2033.

Workers now 55 would, on average, lose two full years' worth of benefits, the equivalent of a 9.2% cut in lifetime benefits.

Cliff Now in Sight

Nonmarketable IOUs

Jed and I are 100% in agreement that the alleged " trust fund" is nothing more than "nonmarketable Treasuries — really IOUs from one branch of government to another " that have no real value.

As Jed states, those IOUs provide the Social Security administration the " legal authority to run cash deficits until they're spent. "

The key points are as follows: There is no lock box, there is no fund, there is a deficit, and IOUs in a pretend piggy bank are not the same as marketable bonds.

Amusingly, I got into an exchange with a reader just a few days ago over the IOU concept. Reader Elliot wrote "You don't seem to understand bonds. They're just an IOU. The Chinese give us $$, we give them an IOU, and then we spend the dollars."

Clearly, one major difference is the trust fund has nonmarketable IOUs, not marketable bonds.

I responded to Elliot that "You cannot owe yourself money and it's even more ridiculous to put an IOU in a piggy bank and pretend to collect interest on it."

Elliott was not convinced. The discussion with Elliott proves that some people will continue to believe whatever nonsense they want, no matter how carefully facts are presented otherwise.

One thing I did not realize before exchanging emails with Jed Graham was that the payroll tax cut did not actually contribute to the current Social Security deficit (SS was not charged for the reductions in payroll taxes). Rather, the cuts simply added to the general deficit, funded as temporary stimulus.

Thus, the current deficit is real, not imagined, no matter how one looks at it. The payroll tax cut did not temporarily overstate the problem.

Simply put, Social Security is already insolvent if one ignores imaginary interest deposited into an imaginary piggy bank. Only on a pretend basis, by counting interest owed to oneself in a piggy bank that does not even exist, is Social Security solvent.

Elliott's of the world aside, Jed points out the IOU pretense is universally understood by the CBO, by the administration, etc. Unfortunately, Congress ignores the problem for political reasons.

Clearly, something needs to be done to shore up the system. And since something has to give, by definition it will. I outlined six possibilities, none of which has universal appeal.

Six Possible Ways to Make Social Security Actuarially Sound

  1. Raise retirement age
  2. Raise or eliminate the cap on payroll taxes
  3. Cut benefits
  4. Collect Social Security on personal income
  5. Implement a Tiered Cap structure
  6. Means Testing

All of the above are likely as noted in Making Social Security Actuarially Sound in a Business-Friendly Manner

For more on Social Security trends please see …

Jed Graham Reflections

Jed invited me to post a few of his personal thoughts. Those thoughts are not necessarily reflective of the opinions of Investor's Business Daily, nor are they reflective of mine.

However, for the sake of further discussion …

Jed wrote the 2010 book A Well-Tailored Safety Net. He proposed a new approach to reform called " Old-Age Risk-Sharing".

Under Jed's approach, the maximum benefit cut would come in the first year of retirement; cuts would be progressively smaller for lower earners and the cuts would phase out over 20 years to preserve a robust safety net in very old age.

You can read about his views in his post What I Told Obama’s Fiscal Commission About Social Security.

Mish Reflections

In the above link, Jed writes … " If we want a Social Security system that maintains the promise of income security late in life, additional benefit cuts that apply in very old age should be off the table "

I have to ask: Is that want we want? My second question is: If so, how do we expect to pay for it?

It's far easier to come up with a want list, than a means to pay for it. People always want things, unless and until they have to accept tax hikes to pay for them.

Personal Belief

The income redistribution philosophy of tax hikes to support Social Security goes against my own Libertarian beliefs of minimalist government.

Cuts Coming, Regardless of Beliefs

However, and regardless of my viewpoint (or yours), cuts of some kind are without a doubt actuarially necessary as fewer workers support more and more retirees.

The only way cuts are remotely possible now would be to combine cuts with tax hikes. Politically speaking however, Democrats won't accept cuts, and Republicans won't accept tax hikes.

Yet, if cuts eventually come (and demographically speaking they must), then perhaps the phased-in approach suggested by Jed is a pragmatic starting point for discussion, whether or not one believes the stated goal of "guaranteed income security" is socialist silliness.

Once again, I am attempting to separate my own personal beliefs from something that may be more politically feasible.

Two Sure Things

  • The path we are on is not sustainable
  • Burying one's head in the sand because Social Security is the third rail only makes the problem worse

Safety Net Discussion

I have spent an amazing amount of time on this post already, probably 14 hours. I thought I finished yesterday but I didn't.

Yesterday evening I realized I did not fully address the concept of what constitutes a " safety net", and how much it would take for the average worker to accumulate one.

Jed has done quite a bit of research on the subject, so I decided to ask him.

Jed responded …

Since we are talking the bare bones safety net that people can’t do without, it makes sense to use the risk-free (some might argue with "risk free") long-term treasury rate (roughly 3.0%). An average earner (now about $45k a year) has to save 1% of wages (assuming Treasury returns and a lifetime annuity). New entrants facing an expected ballpark 25% benefit cut (as in the Romney plan), would need to save roughly 2.5% of annual wages.

The key words are "average earner". In a phone conversation with Jed, he acknowledged things are not so simple. Someone making minimum wage needs to save far more on a percentage basis. Those making $100,000 a year need to contribute far less on a percentage basis.

The problems do not stop there because we are not starting from scratch. What about the "average earner" who is now age 40?

Jed notes such a person may need to contribute 5% of his wages for a minimal return.

That still does not cover all the bases because it assumes everyone is funding their own plan.

Is self-funding the new idea? Or is the original intent of Social Security (minimum retirement income assistance regardless of how much one contributed) still intact?

Regardless of your answer, those making minimum wage will never be able to meet a reasonable "safety net" goal, on their own accord.

I do not champion the idea that Social Security is a "right". It isn't. Rather, I simply state the pure mathematics of the setup.

Funding Your Own Way

I have a close friend who objected to " Means Testing " which was point six of Six Possible Ways to Make Social Security Actuarially Sound, as listed above.

She proposed that what she puts into SS should be hers or her heirs, and no one else's.

Ideally, I agree.

However, if her money is hers (and your money is yours) let me ask a simple question: Does government belong in the "income guarantee" business at all (taking your money only to return some portion of it later)?

If so, why? If not, then let's stop Social Security altogether.

It's certainly a debate worth having, and the answer determines whether or not there should be any "safety nets".

Privatizing Social Security

In a follow-up phone call I discussed privatization of Social Security with Jed. He was once in favor of partial privatization, but that was when Social Security was running a surplus. He is not in favor of it now.

Let's discuss this from the point of view of my friend who states "What I put into SS should be mine, no one else's".

Privatization Ramifications

To create a real "lock box", not an imaginary lock box, with imaginary interest, we need to privatize Social Security, not send money to Washington to be confiscated for whims of the moment.

Assuming that is politically feasible, and ignoring all the people already fully committed to the current system (those retired), as well as those half-way in (those in their 40's), what are the ramifications of privatization?

Before answering, please note that Social Security revenues are in practice used for general expenditures. Simply put, if payroll taxes were diverted to funding private plans, the deficit would soar.

Such a step would require massive tax hikes or massive cuts across the board somewhere (I would vote for massive cuts across the board, especially cuts in military spending).

Then we would still need to do something about partial funding and those already retired. Finally we would need to discuss limitations on those who want to tap their SS funds before retirement.

For a discussion on tapping retirement money, please consider Over 25% of 401Ks Tapped to Pay Current Bills; Dead-Fish Housing Assets; Walking Away Yet Again.

Quickly you can see we are back to the basic question "Whose money is it anyway, and why should government dictate what I do with it?"

Frank Discussion of the Issues is Needed

Regardless of your point of view on what should or should not be done (Jed has his ideas, I have mine, my friend has hers, and you have yours), it's long overdue for a frank discussion of the issues.

Solutions can only happen following admission of the problems. The starting point for discussion is simple admission that Social Security and Medicare are both insolvent, that promises have been made that cannot possibly be kept.

Without a doubt the country needs a frank discussion of "safety nets" and how they should be funded, as well as frank discussions on Medicare and healthcare rationing.

Unfortunately, few if any politicians are willing to admit the truth or to have those discussions, for fear of losing votes.



Originally posted at Mish's Global Economic Trend Analysis

© Mike "Mish" Shedlock

Investment Advisor Representative
www.sitkapacific.com

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