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Friday, February 3, 2012

Truth about Social Security (Part II)

This completes my two-part look at Social Security in an FAQ format. Let's focus on the financial stability of the program.
  • Is Social Security a pay-as-you-go program? Yes and no. Keep reading.
  • What happens to the Social Security ("FICA") taxes that my employer and I pay? A percentage of the receipts from FICA are immediately paid out as benefits to existing retirees; that's the pay-as-you-go part. The remainder that's in excess of current payouts is placed into a Trust Fund in anticipation of future payouts. This Trust Fund has been accumulating assets for many years.
  • That sounds prudent. What's the problem? The size of the baby boomer generation, increased longevity, and reductions in the growth rate of the U.S. population have undercut the assumptions from 30 years ago. Soon it will be necessary to begin liquidating assets of the Trust Fund to augment pay-as-you-go FICA receipts. In other words, making good on promises to retirees will require depletion of the Trust Fund.
  • Has the recent recession worsened the problem? Yes. Unemployed people don't pay FICA taxes. Also, the FICA tax rate has been temporarily reduced to stimulate the economy.
  • What assets are in the Trust Fund? It invests in special debt obligations of the U.S. Treasury. Because our federal government almost always runs a huge deficit, the Treasury is almost always cash-hungry. It immediately spends the cash that it receives from the Trust Fund. In return, the Treasury provides the Trust Fund with ongoing interest payments and a commitment to repay the principal at a later date. Some critics call this an "IOU", but to me that's a pejorative term.
  • Does this mean that a portion of current FICA receipts is being used to pay expenses of the federal government not related to Social Security? Yes, if you look at it from the perspective of a unified federal budget and cash flow. No, if you look at it from the perspective of a Trust Fund and accrual accounting.
  • How will the Treasury repay the Trust Fund? Unless the federal government starts producing regular budget surpluses, the Treasury will have to repay the Trust Fund by refinancing the securities with new borrowings from another source. No one knows what interest rates will have to be paid on those refinancings, particularly if the government is still running budget deficits. Any delta in interest rates will have to recovered from taxpayers.
  • Of the total amount of U.S. government debt outstanding today, what percentage is this Trust Fund? About 15%.
  • Is that a worrisome amount? Probably not by itself, although it exacerbates the overall situation of government indebtedness.
  • Aside from the refinancing problem, how long will the Trust Fund last before it depletes entirely? 24 years. Starting in 2036, pay-as-you-go FICA will cover only about 75% of the benefits that have been projected to those who will be retired at that time.
  • In other words, if I expect to live to age 85 and I am currently under the age of 61, the Social Security Administration doesn't know how to pay all of the benefits that they are projecting for me? That's correct.
  • Would the Social Security Administration agree with this analysis? Yes, definitely. Read the first two pages of their most recent report. It's there in plain English.
  • Is that what people refer to when they mistakenly call Social Security a Ponzi scheme? Yes.
  • What might the government do? FICA tax rates could be raised again. The cap on annual FICA taxes for an individual could be raised. FICA taxes could be applied to unearned income. Qualifications could be raised, so that fewer people receive full payouts. The retirement age for full payout could be increased to a figure like 70. Payout formulas could be changed. Inflation, whether inadvertent or deliberate, could reduce the true value of future payments. All of the payouts from could be subjected to federal income tax. Future Congresses and Presidents have many options, but no option is painless.
  • How should I address the uncertainties when I update my financial retirement scenarios? I can't answer that question for everyone. Personally I use a working assumption that I will receive only 80% of what the Social Security Administration currently projects for me.
  • What would make that number 100% without inflicting tax increases or benefit reductions? Economic growth that would fill the Treasury's coffers and generate additional FICA receipts.
  • What would drive economic growth? That's an FAQ for another day.