Sunday, September 27, 2009

The best way to pay for Social Security?

It's good to be optimistic about our ability to solve big problems -- goodness knows the power of positive thinking is about the only power we're showing these days. And financial analyst
Eric Schurenberg, writing at, is pretty confident.

Schurenberg's source material is updated estimates from Social Security's actuaries of the financial effects of various reform provisions, summarized in a new paper from the Employee Benefit Research Institute.

Schurenberg says "The new EBRI research shows that it won't really cause a huge amount of pain. We just have to get to it." For instance,

"One way to fully fund Social Security is to apply payroll tax to all wages. At the moment, taxes cease after your income hits $106,800. That covers the 2% gap with 0.19% of national payroll left over to have a party to celebrate." The problem is with that of this option imposes an additional 12.4% fewer tax on all earnings, with no additional benefits paid in return. This would push top marginal tax rates well past 50%. Usually, tax exiles flee to places like the Cayman Islands or Monte Carlo; in this world, people could flee to Sweden to find lower taxes.

But Schurenberg is also big on cutting benefits: "My favorite tactic is to tinker with the complicated formula Social Security uses to calculate benefits in such a way that future benefits rise at the rate of inflation rather than the rate of wage growth, as it does now. The adjustment is invisible because it still creates benefits that are nominally higher year after year, and the pain is gradual because it phases in slowly. And it's more than good enough: it adds up over time to 2.3% of the national payroll."

The problem here is that price indexing, while keeping real benefits constant, implies lower benefits relative to pre-retirement earnings – that is, a lower "replacement rate" – and relative to taxes paid. This doesn't mean that more seniors will be thrown into poverty, but they'll also surely notice what's going on and many won't be happy.

The key conclusion is that while fixing Social Security is easy on paper, the size of the shortfall means there will be significant pain no matter which route we choose.


1 comment:

WilliamLarsen said...

Tinkering with the complicated SS-OASI formula by reducing the nominal ever increasing benefit. COLA increases the benefit based only on that basket of goods available when the worker retires. In simple terms, if you retired in 1990, the basket of goods that are added in 1991 and later are not your basket that is being adjusted for inflation.

What the SS-OASI benefit formula does is to start each retiring Cohort with the same value of benefit for the wages that were taxed.

If this is not done, then a person who retires in 2020 will be getting a benefit in dollar terms equal to that of 2010. The increased taxes paid due to economic growth will not be included in the calculation.

The formula is not complicated at all. It indexed past wages each year by the change in the US Average Wage when you turn 60 and each previous year's US Average Wage. How complicated can this be, it is simple math.

What this person is attempting to do is persuade us that the formula is too complicated and that they deserve benefits far greater than what those in 1980 got while those who come after are not given the same opportunity.

However, by far the greatest injustice is that those in year 76 would now face the same fate we are facing now, Social Security solvency over from year 76 to 150.

He is oblivious to the fact that over 75 years, those born in 2017 turn 67 (full retirement age) in the 75th year of the analysis. What happens to them in year 76, lower benefits unless some future generation finds another stop-gap, bandaid save. In the simplistic of terms this person proposes including in the 75 year solvency period 75 cohorts of taxes that benefit less than 54 cohorts.

Question - What is a pyramid Scheme?

The definition I have heard and use goes something like this:

A person, whom I will call the seller, asks another person, whom I call the investor, to invest in a scheme. The seller of the scheme asks for a lump sum or a periodic payment into an investment proposal from the investor. In return the seller promises a return to the investor. Normally the return is far greater than can be obtained by the seller. It is not based on any actuarial basis and the risks have not been fully disclosed nor identified.

The seller normally provides a statement showing how well the fund is doing. This statement shows the buyers investment is paying off as stated. This can be in dark contrast to a reality. The seller will show new prospective investors the statement as proof the investment is sound.

What normally happens is the first investors are being paid their promised returns from two sources. One source is real returns and the other is from the contributions of later investors. The seller was unable to earn the stated return on the original investors money. The seller is forced to use some of the money received, for investment, from new investors, and show it as a return on the original investors money. It is a game of moving money around to show investors good returns, keep them happy and unaware there is a problem.

When the seller can no longer enroll new investors, they have a problem. They can not indefinitely continue to pay unreasonable returns. Without new investors, the sellers cash flow is insufficient to pay promised returns to all the investors. When this happens, the investors tend to become angry with the seller. Those who were the last ones enrolled normally loose the most.

You can define pyramid scheme in two words "Social Security."