Monika Bütler at Vox EU writes, "Have social security reforms shifted too much risk to individuals? The financial crisis suggests they might have." Here's the basics, but read the whole piece, which is good. Pension system reforms have increased individual choice and individual risk. This column says that the current crisis proves that those reforms exposed individuals to too much risk. It argues for greater use of intergenerational transfers and says that it would be better if retirement plans were treated as insurance rather than pure investment decisions. Here's one problem I see with the argument, although there are others: on the one hand, folks argue that Social Security is so important because so many retirees are so dependent on it. On the other hand, they also argue that retirees are exposed to too much risk. Unless "too much" means "any" then I think this is overstated. We'd like workers and retirees to have a diversified portfolio of investments and income sources. Strengthening and, in some important cases, reforming individuals saving makes sense, as does strengthening and reforming government pension provision. But I don't see even our current situation as a "case closed" type argument regarding individual pension saving.
Tuesday, February 17, 2009
Vox EU: Have social security reforms shifted too much risk to individuals?
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Have social security reforms shifted too much risk to individuals? I can answer that one pretty quickly, no. The US savings rate during the 40’s was greater than 18%. The savings rate of the US during the 50’s dropped to 15%. During the 60’s the savings rate dropped to about 10%. During the 70’s the savings rate dropped even more to just over 5%.
Then entities began to question why is the US savings rate dropping? They came up with a simple answer, social security and Medicare taxes, wow, who would have thought that taking more out of paychecks would reduce savings rates? These same bright people than decided that Social Security and Medicare were not actual taxes, but deferred savings and added these taxes to the Savings rate to obtain an adjusted savings rate.
Then during the 70’s the unthinkable occurred again, social security began to run negative cash flows where the taxes paid by workers were not enough cover the benefits paid to beneficiaries. This continued until 1983 when the OASI trust fund was exhausted and SS-OASI borrowed $11 Billion from SS-DI and Medicare trust funds. Then we saw the largest tax increase ever in 1983.
Now the question is has social security reforms shifted too much risk to individuals? Again I say no. The problem is the Government has not balanced the budget since 1957. What do they expect happens when you run 52 yeas of deficits, never paying the interest and borrowing more? We end up with an economy built on debt which finally runs out of money.
Let us look at SS as an investment. We have workers contributing 10.6% of their wages up to the base limit to SS and what do they get? They get a promise, not a guarantee that SS-OASI will pay them some defined benefit in the future. However, the reality is this giant size pyramid scheme can pay only 73 to 7% of benefits under current law. Under current law (1984 legislation), across the board cuts take place when the SS-OASI trust fund falls below 20% of SS-OASI trust fund balance. This will occur in 2035. The first thing to go is COLA (cost of living allowance). This COLA reduction is equivalent to paying 60% of promised benefit with COLA or 373 to 7% of initial benefits without COLA. Based on this, the effective rate of return is between 0 and 1%. Based on the US Treasury Rate, one would have to loose 66% of their balance at retirement to reduce you to the level of Social Security’s failed program.
Number two, who in their right mind would contribute 10.6% of possible 15% of potential savings to one single investment? We need diversification, but with SS-OASI there is no diversity in our retirement.
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