Tuesday, February 01, 2005

Guest Writer on SS "Crisis"

The following analysis is not my work. It was sent by an anonymous local lawyer who has always prided himself on being independent, and his approach to most issues is to apply logic and facts. In this instance, he has done an exemplary job of addressing the Bush Administration's Social Security "Crisis":
In my initial foray into this issue, I expressed a desire that we look at the facts. Obviously, that is not going to be the case. Since my earlier post I've seen speeches by President Bush, Vice President Cheney, Senator Kennedy and others as well as numerous panels, columns, etc. all of which make it clear that facts will have precious little to do with this discussion.

In the process I have been convinced that I made a significant error in my initial post. That error has to do with the Social Security Trust Fund. In my earlier post I misunderstood the nature of the Trust Fund. I had bought into the propaganda that it consisted of "worthless IOU's". Turns out if the Trust Fund is holding "worthless IOU's", then so are almost all of our government's lenders. The assets of the Trust Fund are US Treasury Bonds, the most secure investment in the world for some time now. These are the same instruments that are held by foreign reserve banks and foreign governments. In this time when we need to continue to borrow from foreign investors to cover our growing federal budget deficit, it seems rather stupid for us to be telling lenders that their loans to the government are worthless. A default on any of these bonds, including those held by the SS Trust Fund would make ours a
third world economy.

The consensus seems to be that until 2018, SS taxes will continue to generate a surplus of revenues over benefit payments. For all the concern about there being two workers for every retiree at some point in the future, the fact is we are presently generating a surplus of SS revenues over benefits with three workers for every retiree. While it may seem logical to be concerned about the worker/retiree ratio, one really needs to do the math and not look just at the ratio. The ratio affects the math, but not nearly to the extent one might assume without looking at the actual numbers. When SS was "saved" in 1983, the two to one ratio was anticipated and was dealt with in the creation of the trust fund.

If it is correct that in 2018 benefits will begin to exceed SS revenues and start drawing on the Trust Fund, that is not a crisis. It is in fact what was contemplated when we "saved" SS in 1983. It was part of the plan that was sold to the public at that time. If the Greenspan committee's 1983 projects had been accurate, we would perhaps not be having the present discussion. Those projections proved to be a little off. The primary wrong assumption was the rate of wage increases. If actual wage increases had matched the assumptions, SS would have been funded to the infinite horizon, in perpetuity, forever. The worker/retiree ratio was not a problem.

We now have revised projections. Nevertheless the original plan is working pretty well. It always included using the Trust Fund, US Treasury Bonds, to cash flow the benefits. This method of saving SS was the reason the 1983 SS "Reform" and corresponding SS tax increase was approved on a bipartisan basis. Some would argue that the real reason for the SS tax increase was to provide the government with a source of revenue to offset the tax breaks given to the wealthy. The SS tax increase, on the low and middle income Americans, resulted in an immediate SS surplus. A fund was created from which the government could borrow funds needed in the face of a growing deficit created by the tax cuts for the "wealthy." Reagan wanted to privatize SS but had to go for the borrowed funds in view of the defect.

If using the Trust Fund was such a good idea in 1983, why is it such a bad deal now? Is it because the government has already spent the surplus collected to date, and now they don't want to pay it back? Of course they are continuing to get the SS surplus for some time yet, at least until 2018. They got and continue to get cold, hard taxpayer cash that they are borrowing, so why shouldn't they pay it back? They have to pay back all the other lenders. If they don't, SS will be the least of our problems.

It is not a fact; it is a projection, that in 2042, according to SS Trust Fund, or 2052 according to the Congressional Budget Office, we will have exhausted the Trust Fund. Both projections are fairly conservative, especially the Trust Fund's. If either model were applied using the Administration's economic assumptions, the above dates would be extended, perhaps indefinitely. A key element of the assumptions is life expectancy. We already know that life expectancy is not increasing at the rate assumed in the projections. As a result all of the projected dates would be extended using real life expectancy experience. As medical costs continue their double-digit inflation rate, it is likely that the original projections of life expectancy will prove to be even higher than reality.

The Administration says that in forty years SS will be "flat broke." I guess it has a different meaning than I would normally use. If we do nothing, in forty years SS will still be able to pay 70% to 75% of presently committed benefits. I wouldn't say that was "flat broke." In fact it is better than retirees will receive under the Administration's privatization proposal, as will be shown below.

The Administration also says the system will be "bankrupt" in 40 years. To the extent that commitments exceeding tax revenues constitutes bankruptcy, then perhaps that is a correct statement. That hardly seems to qualify as a "crisis." If a potential bankruptcy of a portion of the government forty years from now is a "crisis", then I fail to understand why the Administration isn't more concerned about an even bigger crisis that exists today. Today the entire government is bankrupt using the definition Bush applied to SS. Today our expenses exceed tax revenues resulting in a huge and growing deficit that is partly financed by borrowing the SS surplus and selling "worthless IOU's" to foreign governments and others.

I have no objection to addressing a possible, perhaps likely, shortfall in SS forty or fifty years from now. However, regardless of what we might do today, or if we do nothing, We will be addressing SS issues again much sooner than forty or fifty years. It is less than twenty years since we last saved SS. At present the x-trillion dollar shortfall predicted is primarily between 75 years from now and infinity. I confess not to be too worried about specific projections for that period of time. It is fairly certain that such projections will change long before we get there. I'm not even sure that as we approach infinity that a trillion dollars will even buy a cup of coffee. The x-trillion dollar shortfall that far out is mostly a scare tactic with little impact on the reality with which we will then be dealing.

It would be wonderful if the attention being paid to retirement security were broadened to include the real areas of concern. Retirement is often viewed as three-legged stool. The three legs being SS, retirement plans, and personal savings. SS is by far the strongest and most secure of the three.

The retirement plan leg includes pension plans as well as 401K's, IRA's and similar investment plans. Actual pensions are a declining factor and have been largely replaced by 401K's. In addition the Pension Guaranty Fund is broke, if we are worrying about bankrupt government entities. Only 20% of workers have access to 401K's, and a majority of those have relatively little invested in their 401K's. IRA's have been viewed primarily as a way to achieve immediate (and with Roth's
subsequent) income tax relief. Few seem to truly use them to plan retirement. The average 55 to 59 yearold only has about $40,000 in their IRA's, etc. Clearly most of their retirement income will be from SS. The retirement plan leg is a very weak leg of the retirement stool.

These are privatized accounts. That is no guarantee of success. Enron. WorldCom. One WorldCom employee of over twenty years at one time had an account valued at over $1,000,000 and ultimately had the account cashed out with a $500 check. Many private pensions did no better. Employers in many cases raided the pension funds and ultimately left them severely underfunded. The reason the Pension Guaranty Fund is broke.

Major Wall Street industries (insurance, brokers, mutual funds), have all come under attack for corruption. These are the same industries that would be the caretakers of the SS private accounts. Not very comforting. Not withstanding the corruption, most of us need to be investing more in our retirement accounts, though perhaps with greater attention to those investments.

But, it gets worse. The third leg is personal savings. The US savings rate is one of the lowest of industrialized nations. Our current average rate is 0.002%. Yes the decimal is in the right place. That means an average family with an income of $40,000 saves $80.00 per year. That's not going to make for much of a retirement.

I don't have the stats in front of me but something like 70% of retirees depend on SS for about 70% of their income. I don't believe it was ever intended, not should it be intended now, that SS would be the primary vehicle of retirement.

We should definitely be paying attention to the retirement situation, but SS is not the issue of concern in the overall picture. It would be wonderful if we considered the other larger and more difficult problems facing retirees, but I doubt either party will do so. "Fixing" SS is relatively easy and there are numerous and relatively painless ways to do so. For those favoring a tax increase, there are still a number of possibilities. One would not even be a tax on income, but a tax on
estates over $7,000,000. Simply increasing the SS tax would only involve an increase of less than 1% on employees and less than 1% on employers. While there is opposition to any tax increase it is clear that such an SS tax increase would not impose the burden implied by those harping about the two workers to one retiree ratio. The reality is in the $ not the ratio.

In spite of some of the bad experience with savings, pensions and 401K's, I believe in private accounts. We need more of them. We just don't need them as part of the SS system. Those who want the higher returns that are supposed to follow higher risk should make such investments. Actually we should all do so, but not with SS taxes. Investment risk is not supposed to be part of the SS system.

The Administration's fabricated crisis, naturally has a fabricated solution. The Administration's is to privatize at least a portion of our SS taxes. At least initially participation is supposed to be voluntary. While we don't have much in the way of detail on the Admin's proposal, there has been mention of 25% of SS tax being allowed into private accounts.

There are those who think they can invest their money better than SS. That's an apples and hocky pucks comparison. SS is not an investment. It is a tax combined with certain commitments from SS. Dollars paid in SS tax go primarily to SS beneficiaries that include more than retirees. The government borrows the surplus. That is required. There is no option of investing the money otherwise.

Nevertheless, proponantes of privatization attempt to compare "returns" on SS with other return options. In Cheney's speech on SS he compared some returns, including average stock market returns, with the 2% return on the SS Trust Fund's US Treasury Bonds. There are major problems with those comparisons.

First the 2% return on the Bonds has nothing to do with the SS benefits a retiree receives. If you want to call the benefit payments "returns", the typical "return" is substantially better than 2%. A retiree's "return" depends on a number of factors and is not the same for all retirees. One needs to do some calculations that start with a visit to the SSA.gov website.

The second problem is that the touted returns for private accounts are exaggerated. Some like to say the average stock market return is 9% when it is really about 6% since 1871. These are gross returns, before admin fees, commissions and other costs, and the SS "return" is net. The Congressional Budget Office projects a return of 4.9% after inflation and expenses. The Market has done worse than 3% in nine different 20-year periods.

A third problem is applying Market return rates to the entire private account. In almost all cases the account will include only a portion invested in the market with other portions invested in more conservative investments.

No doubt some investors would do better in a private account than they will under SS, but not the average investor.

There generally seems to be an assumption in this country that if a foreign industrialized nation is doing something differently than us, our way is superior. Strangely, when it comes to privatizing retirement accounts, we seem to want to adopt a foreign system, even when it has failed.

Britain has 20 years experience with privatization. Britain's problems include lower than anticipated returns, higher than anticipated administrative expenses (20% to 30%) and major fraud by investment advisers. In a fraud by insurance companies where they had sold misrepresented policies the government was forced to pay out $20 billion.

The Bush proposal is modeled after the system attempted by Argentina. It also has failed in large part. Almost half of the covered workers in Argentina now decline to participate in the voluntary private accounts.

In view of the fiscal reality, it should be clear that privatizing SS should not be the Administration's number one priority. Whatever potential future problem may face SS, there is no present crisis. Some supporters of privatization have admitted that their true objective is to eliminate all "entitlements" beginning with SS. Such an objective is purely ideological and the topic may be appropriate for debate, but it should be an honest debate that does not try to create a phony crisis as its basis. Unfortunately, millions of our tax dollars will be spent in a propaganda effort to persuade the public that a crisis exists.