The Value Of The Social Security Trust Fund

"What I enjoy most, is living like an aristocrat without the burden of having to be one…. I don't envy them. It's only the trappings of aristocracy that I find worthwhile - the fine furniture, the paintings, the sliver--the very things they have to sell when the money runs out. And it always does, and all they are left with is their lovely manners." - Jim Williams in Midnight In The Garden Of Good And Evil.

It is de rigueur conservative politics to call the Social Security Trust Fund a collection of worthless IOUs. This presents a serious problem for Americans worried about the subject because hyperbole will condition people to believe that the Social Security system can't get into worse shape, when in fact the situation can and will get much worse.

These are serious think tanks, journalists, and investment magazines.

• "As they are bonds not backed by any real assets, the government will have to either borrow or raise taxes to pay for them" ~ The Heritage Foundation
• "They do not consist of real economic assets that can be drawn down in the future to fund benefits." In other words, the Social Security trust fund contains - nothing." ~ Charles Krauthammer
• "Officially, the trust fund holds $2.6 trillion in special-issue Treasury bonds. In reality, it has no assets of any value", ~ Investors Business Daily

According to IBD, 28% of Americans have already become comfortable with the idea that Social Security contains nothing but worthless IOUs when in fact the assets are far from worthless. No hard assets? The government has significant hard assets in gold and oil. It is the largest land holder in the country. It has a pending revenue stream coming from 16 trillion dollars held in tax deferred accounts. The government today has the hardest asset in the country – the power to print money. This power is absolutely the hardest asset because it undermines every other asset in the country.

The problem isn’t that the securities held by the Social Security Trust Fund are worthless. The problem is that they are worth less every day, and will be worthless one day. Every day the government makes more promises, borrows more money and prints more money. The collective promises are growing much faster than our hard-assets. They are growing faster than our tax base. We are basically a family living on wealth which is running out. And if you don’t think it can get worse just wait until all we have left is our lovely manners.

USA Today's Dangerous Minds

http://www.usatoday.com/news/opinion/editorials/2011-06-16-Payroll-taxes-raid-Social-Security_n.htm

In an editoral, USAToday offers "For almost three decades, Social Security was the only major government benefit program that generated more money than it cost, thanks to hefty payroll tax revenue that exceeded benefit payments to seniors." It is dangerous thinking.

The only way you can say the Social Security has generated more money than it cost, is to ignore the real costs of the system. In 2010, Social Security generated a total of 677 billion and paid out 584 billion. But the 584 billion does not include the cost of future promises. In exchange for the 677 billion, we give pension promises to the working generation who pay Social Security. Social Security is only cashflow positive to the extent that we intend to renege on these commitments.

What USAToday says is based on "cash-accounting". Before you roll your eyes, here is a practical example of "cash-accounting": Wells is a beer drinking college student, who goes daily to the ATM to retreive his balance. He doesn't bother with the other checks that he has written or the impending tuition payment. Whatever the ATM says is how much beer he can buy. That is how cash-accounting works.

Now you may think that Wells is not a problem because he is not your son. But he is your problem if he is the chief accountant for the Social Security system. And there is no way to say he is not when you look at the way that the accounting is handled. When you hear that Social Security is 'making money' you need to think of Wells standing at the ATM shaking a receipt in your face and saying "come-on you cheap skate I'm buying".

The take home here is that cash accounting is illegal for all public companies. There is a reason. It is grossly misleading. Social Security does not generate more than it takes in. It has generated unfunded liabilities in the trillions of dollars.

Does Social Security Add To The Deficit

"Does. Does Not. " And the argument goes on forever.

The short answer is that Social Security in our view is a contributor to the deficit. The amount is less important because the short answer is no one knows the extent.

FICA taxes contribute to the deficit today, not just in the future. FICA taxes restrict the economic activity which generates income taxes that would pay down the deficit. They lower the incentive to work, and increase the incentive to evade or avoid the tax system all together. They make the cost of goods produced in the United States less competitive in the world markets, which costs us jobs.

The larger impact on the deficit comes as FICA diverts taxable income away from the general fund to the retirement system. FICA and Income taxes are connected because they compete for resources within the same tax base. They are like two straws drinking from the same soda. What one takes is not available for the other. This impact is enormous.

There are people who will disagree with our position. These people will argue that FICA isn't a tax at all. It is an economic investment which will pay-off at retirement. Further they suggest that it is an investment which lowers the overall borrowing costs of the government. Our surveys find very little public support for this theory. ABC News/Washington Post polls showed that 81% of Americans believe that Social Security is heading for a crisis without changes. So if it is an investment, most people think it is a pretty bad one.

No one can tell you how much Social Security contributes to the deficit. The more it is a tax, the more it contributes to the deficit. The more it is an investment, the less it contributes.

FICA Is A Tax

The flaw in most commentary about Social Security is that it assumes that FICA taxes and Income taxes are unrelated. They are related because FICA taxes and Income taxes compete for resouces within the same tax base. You might view them like two straws drinking from the same soda. What one takes, the other cannot. Every dollar that is collected by FICA is a dollar that could have been raised to pay down the deficit. In the extreme view, we are allocating our tax base to our own retirement system and putting the rest of the government on our kids credit card.

The more people view that it is a tax, the more it adds to the deficit. As a tax, it directly contributes to the underground economy - now estimated to be about 2 trillion dollars. As a tax, it creates a significant pushback on general taxes. It is not possible to miss the correlation between rising FICA taxes and increasing pushback on income taxes. Today 47% of American households had no income tax obligation, and yet more than half of them had a FICA contribution.

FICA Is An Investment

The other extreme view is that FICA isn't a tax at all. It is an insurance premium which people treat like an investment. Many years ago people though of it as an investment at least to some extent. The terms were so generous that my father worked two summers away from home just to qualify. His salary barely covered his gas and lodgings, but it added the two quarters necessary for him to qualify for Social Security. He not only thought of it as an investment but a good one. In the extreme view, it is just a forced investment which induces a reduction in personal savings.

Does Social Security Add To The Deficit?

Anyone telling you that Social Security does not contribute to the deficit believes that FICA is an investment. They believe that every man, woman, and yes child(contributing) to the system believes that it is an investment. We will tell you that people have different views of what FICA is or isn't. To the extent that FICA is considered a tax, it adds to the deficit in a significant way.

Hauser's Law

The proposition was first put forward in 1993 by William Kurt Hauser, who wrote, "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP." That means that as FICA taxes go up, some other tax revenue must go down.

Why People Hate Discussions Of Social Security

One reason that people avoid the discussion of Social Security is that Yes is not necessarily the opposite of No. This is the result of politics in which the answer is less important than the framing of the question. Case in point.

This is : Yes, Social Security adds to the budget deficit

"These deficits, which began in 2009, could add trillions to the federal debt held by the public and hundreds of billions in annual interest costs. "

This is : No, Social Security does not add to the budget deficit

"In fact, Social Security’s Old Age and Survivors Insurance Trust Fund and its Disability Insurance Trust Fund are prohibited from paying benefits unless those funds have sufficient income and assets to cover the cost, and they have no borrowing authority to acquire the requisite income and assets. Consequently, Social Security is prohibited by law from deficit-spending and thus contributing to the federal deficit"

Both are true statements, but they don't actually refer to the same thing. The difference is "Held By The Public". The Social Security Trust Fund is not the public. It is an intergovernmental agency. So as we liquidate the Trust Fund, we will have to borrow from "the public", and we will see higher interest costs as a result.

Why does the public get a better deal than Social Security? Because "the public" has options to invest its money at the best rate. Social Security doesn't - and no one is talking about fixing that. (other than us)...

source :
http://jec.senate.gov/republicans/public/?a=Files.Serve&File_id=0edfdbbe-6f48-4007-a429-6ef64fda10cb

What Washington Is Missing

The biggest challenge for Social Security is the stubbornness of Washington where our leaders are focused on yesterday's news, and promote ideas which are yesterday's answers. The experts believe that the problem is demographic in nature, ie too many retirees for each worker. While demographics may be a problem, it isn't the imminent problem.

The pressing problem is stagnant wages. Social Security depends upon wages from the private sector to pay benefits. While public sector jobs may contribute to the system, these jobs are funded again by private sector wages in the form of income taxes. Over the past 10 years, the problem of demographics has been replaced by a much larger problem of economics: jobs, wages, and productivity.

The following article is important to read. Here is its connection to Social Security. There are fewer jobs to pay into Social Security. The job mix is shifting to lower paying work. Finally, much of the wage growth is in benefits which are not subject to FICA tax. In conclusion : you can't increase wage growth with higher taxes.

http://www.investors.com/NewsAndAnalysis/Article/573982/201106020800/10-Year-Real-Wage-Growth-Worse-Than-During-Depression.aspx is a worthwhile article to see what is happening our labor markets.

Here are some highlights:

• There has been a net loss of 2.7 million private nonfarm jobs since March 2001. (Government payrolls rose by 1.2 million over that span.)




• The problem is worse than lost jobs, as job losses have been concentrated in higher-paying goods-producing sector, including construction and manufacturing, which has shed 26% of its workers. Job growth has been in typically lower-paying service industries have kept growing their payrolls: social assistance (41%), nursing homes (21%), leisure and hospitality (10%).




• Globalization of production has fed a "the substitution of capital for labor" amid a push for productivity and competitiveness.




• The increase in nonwage compensation — fueled by the growth of tax-free health care spending — which has eroded real wage gains.
  

Higher Taxes And Lower Benefits Will Only Make Social Security Worse

Last summer, Congressional Budget Office scored 30 potential solutions for Social Security for the effectiveness of each in dealing with the financial imbalances in the system. Every solution was either a tax increase or a benefit cut. More recently, the President’s Financial Commission on Fiscal Responsibility outlined yet more solutions which consisted of benefit cuts and tax increases. It is a frightening statement on how little our leaders understand the problem.

The solvency of the Trust Fund is not the primary problem in Social Security. The question of solvency is the unavoidable outcome of a deeper problem within the system, return on contribution(“ROC”). It is terrible, particularly for younger workers. If so raising taxes and cutting benefits will only make the core problem worse and the whole system less stable because while these solutions will make the Trust Fund last longer, it also discourages people from participating.

Social Security is unfortunately a pay-as-you-go system for which the Trust Fund provides very little economic support. According to the Social Security Administration, the OASI Trust earned only 118 billion dollars in 2009 while distributing 564 billion dollars in payments . Moreover, the role of the Trust Fund in providing for Social Security benefits is likely to drop going forward . So the solutions in Washington largely provide 15% of the solution and put the rest of the system at risk.

The problem is return on contribution. When the ROC drops, so does the willingness of people and business to participate. They either evade or avoid the system. In a recent study, it was estimated that two trillion dollars of the economy is underground hiding from the tax man . The hidden economy costs Social Security as much as 250 billion dollars last year. The larger problem is that the ROC encourages business to allocate labor earnings away from wages into benefits which are not subject to FICA tax. Data from the Labor Department shows that wages are only 70% of employee compensation. The remaining wages are paid in benefits which are not subject to FICA taxes.

How bad are the returns in Social Security today? Last summer, the government provided a periodic moneys-worth study of the Social Security system, which compares a dollar of contribution with the present value of future benefits. A moneys-worth ratio of 1 means that you are getting back exactly what you put into the system. In the report, the government predicts that some workers will get back as little as .50 cents on the dollar . The report paints, however, a rosy picture of the real returns from the system by using assumptions which artificially inflate the ROC. The report assumes that all workers given a choice would invest the money as poorly as the Trust Fund does. Social Security for younger workers isn’t terribly different than spending quarters to buy dimes.

Washington’s solution to this problem is to get younger workers to spend quarters to buy nickels.

The Crisis Is Social Security Is Bigger And Closer Than You Think

The Social Security Administration shortened its timeline for the depletion of the Social Security Trust Fund. Now the Social Security Administration projects that the Trust Fund will be exhausted in 2036. This change in timeline means that if you are 43, you are scheduled to retire the year that the Trust Fund hits zero.

This story shouldn’t be ignored by anyone of any age because Washington’s record in financial forecasting is astoundingly bad. The government was wrong about Freddie and Fannie. The government was wrong about the housing bubble. The government was wrong about derivative exposure of the banks. The government wasn’t just wrong it was wrong on scales never seen in human history. Can you afford for them to be wrong again?

There are two huge differences between failing to see the dangers of the banking crisis and failing to foresee the collapse of Social Security. First, the government served as a backstop in the banking crisis. There isn’t anything to backstop a crisis in Social Security. Second, if the government had allowed banks to fail during the banking crisis, the bankers would have adapted, and become something new. Social Security primarily serves the elderly and disabled. This audience consists of people who are not equally suited to adapt to change. If a crisis erupts in Social Security, the consequences will be severe, and will have human consequences not seen in this country since the 1930s.

The problem is much bigger and closer than Washington understands. The projections of how long the Trust Fund will last are based on a number of economic assumptions. If one assumption is wrong, then the projection will be wrong. For example, if real interest rates are 2.9%, the Trustees project that the fund will last until 2036. If real interest rates fall to 2.1%, the Trustees project that the fund will last until 2034. The fact is that the real interest rate is closer 1.5%, and will be for some time as the Trust Fund replaces maturing high-yield debt with debt based on today’s interest rate structure. So prepare for next year’s exhaustion point to be less than 2036.

The problem is much bigger as well. Washington is looking at the wrong metric as usual. Washington and the talking heads in the mainstream media believe that the key figure is the support ratio, the number of workers to retirees. It is dangerous to think of this relationship as a useful number because workers do more than support retirees. Workers also support the interest cost of the government. A better picture of the problem is looking at debt burden + retiree cost / worker. The situation is much worse in that light.

People have talked about the crisis in Social Security for so long that most people are immune to the idea that there will be a crisis. I want to change the discussion from whether a crisis will occur to how it will take shape when it occurs. The crisis will form out of the deficit, and the interest burden to support it. Interest cost currently consumes 30% of our tax base, and that percentage is growing. Interest is not negotiable, and it will over time set-off a national debate about how taxes are raised and how money is spent. The Teaparty is just the beginning of that discussion.

Many people look at Social Security as independent of the deficit because it is funded by payroll taxes not income taxes. The problem is that both taxes draw on the same tax base, so they are somewhat mutually exclusive. They are like two straws drinking from the same soda. Any dollar raised in payroll taxes is a dollar that cannot be raised in the form of income taxes. In this sense, Social Security will become a major target when interest cost force a discussion about how the taxes will be spent. To pay down the deficit, the working generation need only vote to increase income taxes and decrease payroll taxes. When that happens, Social Security will simply be re-written on very different terms.

It will have to be re-written because Social Security will have to depend upon the Trust Fund once the payroll taxes are cut. While 2.5 trillion may sound like a lot of money, it is basically economic parsley when compared to outgo of the system. Without payroll taxes, the Trust Fund would last less than 4 years. When the crisis forms, the economic support for the retired really will come down to how much payroll taxes the working generation is willing to pay.

The support for Social Security within the working generation may be very modest. It is virtually impossible to believe that the working generation will not resent the obligation to take care of both the deficit and the retirees who largely created it as younger voters. For years, baby boomers have talked about the burden that they are putting on their children. The fact is that it is a burden that their children can largely shake-off simply by diverting payroll taxes to pay down the deficit. It is naive to believe that politicians will not serve that audience.

You will start seeing this politician much sooner than you think. According to the US Census bureau, 2010 was the first year that a majority of voting aged Americans can expect to less than what was promised. 2012 will be the first year where a majority of registered voters can expect to get less than what was promised. That trend continues until a majority of registered and active voters can expect to get less than what was promised. To believe that Social Security will survive in its current state, one has to believe in a majority of people will vote against their own self interest.

Politicians will emerge to play on this block. They will say: Interest is the cost of government that the retired generation wanted but was unwilling to pay for. They will say: the retirees padded their retirement accounts (ie Social Security) while putting the rest of the government on your credit card. They will say those retirees had pensions that you don’t. They had healthcare costs that weren’t burdensome. They had 4 years of college for what you pay per class. And they will get elected on that message.

Of course, I could be wrong, and Washington might be right. Maybe deficits don’t matter. Maybe foreigners will continue to lend us dollars knowing that they will be repaid in pennies. It all comes back to the real question : can you afford for Washington to be wrong again?

Social Security Number Watch

Be very careful when you are looking at numbers about Social Security.

Numbers about Social Security do not lie, but they can mislead not only the public but policy makers as well. The numbers watched by the experts in Washington suggest that Social Security is slowly moving to crisis. The numbers have lulled even the harshest critics of the system into believing that the system is many years from crisis. The problem is in the numbers : we are looking at the wrong numbers.

This article isn’t for policy wonks. It is intended for average Americans who get pounded with useless statistics about the system. This is a typical quote that a reader will see when researching Social Security : “When Social Security started, there were 16 or 17 workers for every retiree. When the baby boom finally finishes retiring, there will be 2 workers for every retiree.”

It sounds scary, but it is completely uninformative. The statistic in this case is the Support Ratio[1]. It doesn’t accurately track what it is suppose to track, and authors subsequently quote bad data out of context. In the process, the statistic goes from simply bad economic theory to dangerous public policy.

First, the number of workers includes government workers who have been purchased with debt, or future tax revenues. This debt inflates the number of workers today by pulling future jobs into the today's numbers. If as CBO has warned, the government is unable to place debt at reasonable prices, these jobs will disappear. Worse, if the productivity of the public-sector jobs doesn't create sufficient wealth to pay off this debt, the debt becomes a drag on future jobs.

Second, the number does not factor in the impact of the Trust Fund[2]. The Trust was designed to hold excess cash in the system, so that the Trust Fund could serve as an addition worker as the Baby Boomers started to retire. Hence some of the workers from the 1990s were really working to support 2010 beneficiaries – the first year that outgo of the system exceeded payroll tax contributions. In 2009, the Trust Fund generated about 110 billion dollars of interest income. That is about 16% of the total income of the system. So the workers per retiree should have been roughly .5 workers higher.

Even if one had an accurate Support Ratio, the number isn't very informative because it does not factor in productivity. As productivity increases, it takes fewer workers to support a retiree. When Social Security started, we had something like 25% of our workforce in argricultural production. Today it is something like 3%. Telling someone that there are too few workers without knowing what their productivity is, is just like telling someone that they are over-eating without considering their exercise regime. That is where the data goes from wrong to pointless.

Experts use this statistic far out of context, as you can see in the example above. In the context above, the author assumes that workers are the same today as in 1955. The assumption is horribly wrong. Today’s worker contributes at a higher rate and against a larger cap. In 1955, the maximum contribution was an inflation adjusted $168. Today it is more than $13,000. In other words there are workers in 2011 who effectively are the same as 77 workers from 1955.

Like the workers who are counted like beans, the beneficiaries are not the same today as they were in 1955. According to JustFacts.Com, “Benefits have not remained constant. If they had, SS would now be collecting roughly three times more in taxes than it is paying in benefits.” I haven’t seen their data, but it is not unreasonable. Beneficiaries are living longer and may well be retiring earlier. Comparing the number of beneficiaries over time when pay-outs are changing is simply pointless.

A reader might arrive at this point in the article feeling relieved that the Support Ratio suggests that the problem is smaller than the raw data suggests. And that belief would be correct if workers did nothing but support retirees. The fact is that they do substantially more than support retirees. Workers through wage taxes also support the budget deficit. The budget deficit is growing and so is the interest cost to support it. Today’s worker carries about $75,000 in look through debt from the government. Assuming that workers today are in the same position to provide financial support for retirees as they were 40 years ago, or even 5 years ago, is where authors cross the line from bad economics into dangerous public policy.

In summary, there very well may be a shortage of workers to provide benefits for all of the Baby Boomers. My guess is that there is a dramatic shortage but I don't have any data to support that belief. The actual data that you need to see is compensation slack - which would measure the ability of workers to support a retiree. If you had that data, I suspect that the slack has dropped radically and you would see that the crisis is now, not some stardate in the distant future.

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[1] The SUPPORT RATIO, which measures the number of beneficiaries to number of retirees. Data Source Social Security Administration

http://www.ssa.gov/OACT/TR/2010/lr4b2.html

[2] There are some who question the existence of the Trust Fund. Here is why I discount their view. The government holds a number of hard assets such as oil, land, and gold. Beyond that, the government has future revenue streams based on 16.6 trillion dollars in retirement assets which are tax deferred. Beyond that, the government has the ultimate power of taxation, printing money. As long as the citizens grant the power to print money to the government, US Treasury debt will represent the safest investment in the country.