Gaming Social Security

Few, if any, articles on Social Security discuss “Adverse Selection”, and the associated havoc that it can play on projections for the system’s future.  Another name for “Adverse Selection” is gaming the system.  Whatever you call it, the concept is basically the economic equivalent of gravity.

The concept refers to the economic force in which freedom and choice combine to create the least profitable response to a business’s offerings.  In terms of Social Security, the least profitable mix of customer means that some taxpayers are trying to contribute the least while at the same time some beneficiaries are trying to maximize what they collect.  While we may like the system as a whole, our individual interests are doing everything that they can to drive the system to insolvency.

Adverse selection has been around since the inception of Social Security.  What is not getting enough coverage is that these forces are getting stronger over time as beneficiaries have more resources with which to make claiming strategies more effective.

The Trustees Reports are based on historic norms that cannot reflect this evolution.  Historically, there was little way for someone to completely maximize their benefit levels from Social Security.  There are more than 2,000 rules which can determine benefit levels.  That is a lot of rules to maximize.

Retirees are not on our own anymore. The internet is greatly improving the odds in favor of retirees. Today retirees have a cottage industry of financial advisors that do nothing other than help retirees maximize their benefits.  These people know how to twist the thousands of rules in the system in favor of their clients.

Retirees are using these resources.  “Get What’s Yours”, a how-to book on maximizing your Social Security payout, reached #3 on Amazon’s best seller list last month. This isn’t “50 Shades of Grey”, but it is an example of people learning to game the system.

One example of this trend is the “File and Suspend” tactic enjoyed by married couples.  The Center for Retirement Research at Boston College says, “This strategy is equivalent to a “no interest” loan from Social Security and could potentially cost the program as much as $11 billion a year.”  This isn’t what people paid for.  It is a loophole that was created in 2000.

This is a trend that Social Security Administration should follow.  When the Trustees project the solvency of the Trust Fund, they use assumptions that are based on historic standards.  These historic measures will be progressively out-of-sync with actual benefit draws as retirees get better at gaming the system.

Here are the facts.  In 1984, Social Security was projected to be solvent for roughly 80 years, more than 2060.  Since that time, roughly 30 years of solvency have simply evaporated.  The projected exhaustion point of the Trust Fund is now to 2033.  The Congressional Budget Office even predicts 2030.

There are a couple of things that are clear. Retirees are trying to improve their return on their past Social Security contributions.  Any success that they have will come at the expense of the system’s solvency.

Originally published at :  http://www.fedsmith.com/2015/03/25/gaming-social-security/#sthash.fEL9Vzlr.dpuf

There Is No Raid On Social Security - We Just Keep The Books That Way

Accounting is dull by nature, and the only thing that makes the craft less appealing is when it deals with the finances of government.  I will do my best to make it interesting because the way our country accounts for its finances demonstrates a breath-taking indifference to reality.

On Monday, the Congressional Budget Office released its “Updated Budget Projections: 2015 to 2025”.  While the report drew extensive media coverage, what isn’t covered is the disconnect between how money actually moves and how the numbers are calculated.  The headline number is just a number.

A budget should tell us about the balance of revenue and expense within our government.  The budget reported by CBO portrays liabilities as assets, loans as income, and debt as nothing.  This picture tells us nothing about the actual finances of the government.  It is more of a Jackson Pollack which is roughly the equivalent of a financial Rorschach test. 

The biggest problem is of course the inclusion the revenue and expense of Social Security. It isn’t just the size of the program.  The way that figures are included in the budget defies common sense, any level of accounting standards, and even current law. 

In the headline number[i], CBO’s accounting practice treats Social Security as a profit and loss center for the government.  Payroll taxes are booked as revenue indistinguishable from income taxes.  If we collect more in payroll taxes than we spend, it is a profit to be used to offset spending elsewhere in the budget. 

This depiction of course is inconsistent with current law.  As the Trustees note, “The Social Security Act prohibits expenditures from the OASI and DI Trust Funds for any purpose not related to the payment of benefits or administrative costs for the OASDI program.“  Social Security taxes are not general tax revenue.

CBO not only books Social Security contributions as general revenue, it does not book the offsetting cost of future benefits associated with collecting payroll taxes.  When the government collects a dollar of payroll taxes, it makes a commitment to pay roughly a dollar of benefits in the future.  That isn’t tax revenue.  That transaction is what normal people call a loan.

The budget of the federal government is like you borrowing $100,000 from a bank and declaring that loan as income on your 1040. You wouldn’t do include this income on your personal return because overstating your income would cost you more in taxes.  The government on the other hand has no disincentive to overstate its revenue.  In fact, inflated revenue can be a trumpeted success.

How much?  CBO says that the government collected roughly $3 trillion in 2014.  It says separately that the Social Security contributed $877 billion to total revenue.  How much expense does CBO set-aside within the budget for the repayment of the loan?  Zero.  Nearly 1/3^rd of the revenue booked by the government’s chief accountant is really a loan which is kept entirely off-balance sheet.

The budgeting process slowly brings these off-balance sheet loans onto the books over time. Instead of booking the actual cost of collecting payroll taxes, the CBO expenses the cost only when benefits are actually paid. This approach enables CBO turns a system which created $1.8 trillion in liabilities over 2014 into a $30 billion profit. 

To give you some idea of how long these loans can stay off-balance sheet, the Veterans Administration is still paying pension benefits from the Civil War!  To give you some idea of the magnitude, Social Security’s unfunded obligations grew by $900 billion simply because we moved the clock forward by a year.  That is effectively the interest due on the off-balance sheet loans.

Let’s take two transactions out of the headline number.  If we booked the revenue from Social Security as a loan instead of general tax revenue, the government would have collected only 2.27 trillion in revenue instead of roughly $3 trillion.  If we book the cost of interest on the off-balance sheet loans, the outlays increase to nearly $4.5 trillion.  So the reported deficit of $486 billion would balloon to more than $2 trillion under even lax accounting standards.  

The headline number of the budget says that the budget deficit was $486 billion in 2014.  That figure only has meaning provided that the government in 2014 did not have any intent to pay a penny of Social Security benefits in the future due on all of the payroll taxes that it has collected over the last 80 years.  That is what the number we all quote actually means.

There is no raid on Social Security in reality.  We just run our books as though there were.

 

 

 

 

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[i] Supporters for CBO’s figures will tell you that the reports break-out the information related to Social Security. That material is much like this footnote, a disclosure that few read and no one reports.  No one ever asks the question if Social Security belongs in the budget, nor why the reporting is inconsistent with current law.

 

Social Security : Congress's Re-election Campaign Fund

Originally FDR designed Social Security so that no damn politician could ever scrap his program. 

FDR foresaw the most basic problem with Social Security.  Congress would use benefit levels in Social Security to curry favor with voters today at the expense of workers in the future. He was right.  Congress rewards it’s constituents with cash that seemingly falls like manna from heaven.

While it is not the most egregious example, the “Notch Babies” provides transparent insight into the financial imbalances in the system.  What is a Notch-Baby?  The Social Security Administration defines this group as those people born between 1917 and 1921 who believe that they received less than their fair share of Social Security benefits. American Association of Retired People (AARP) accepts this definition.

Voting-Buying is a non-partisan issue in 2015.  U.S. Rep. Grace Meng (D-Queens) introduced the “Notch Fairness Act” (H.R. 314) in the House.  In the Senate, Sen. David Vitter (R-LA) introduced the same legislation (S.99).  If enacted, the proposal would increase benefits of select retirees who would be given a choice between a lump-sum pay-out and an increase in their benefit checks.

This legislation does not fix injustices of the past, nor correct the benefit levels of anyone. As written, the legislation would invade the Trust Fund for the purpose of enriching current voters with money reserved for future retirees.  The legislation in fact widens the definition of Notch-Baby to 1917 to 1926 to capture an extra 5 years of voters.  The proposal contains no source of additional funding to pay for the largesse.  It is just manna from the Social Security Trust Fund.

Who will pay for this generosity? Future retirees. The Trustees Report says that the system created $900 billion in unfunded liabilities solely because we moved the clock forward by one year.  That figure is more than the system collected in all forms of revenue during that time.  In English, this means that every dollar of benefit paid in 2013 comes at the projected expense of a future retiree.

The notch was created by separate pieces of legislation. In 1972 Congress passed a law which automatically adjusted benefits for a cost-of-living adjustment. That law contained a flaw in the calculation which acted something like the mythical Monopoly card “Government Calculation Error in Your Favor, Advance to Go and collect $50,000.”  The costs quickly spiraled out of control.

Congress fixed the flaw in 1977 for those born 1917 and later. These changes significantly lowered benefit level. The legislation protected retirees born between 1910 and 1916, thus creating the illusion of unfairness. The notch-babies do not want their fair share of Social Security benefits.  They are angry that they were excluded from falling manna.

The Notch-Babies have never been harmed as a group in anyway.  They collected benefit levels that were roughly what they were supposed to collect from Social Security.  This group received some of the highest replacement rates in the history of the system.  The Urban Institute reports that an average couple born in 1920 expected to collect nearly $2 for every $1 contributed on an investment adjusted basis.  In short, they have received nearly the best deal of anyone.

In 1992, Congress formed the “The Commission on the Social Security “Notch” Issue”.  It concluded :

To the extent that disparities in benefit levels do exist, they exist not because those born in the “Notch” years received less than their due; they exist because those born before the “Notch” years (who were “grandfathered” under the old law’s more generous computational method) continue to receive substantially inflated benefits. This disparity has created an understandable perception of unfairness.

Congress sees the resources of Social Security as a campaign re-election fund, something with which to reward constituents.  Here Rep. Meng has widened the number of people to include 5 years of people who weren’t even in the notch.  At the same time, the system cannot reasonably assure those who are 67 that they will receive their full scheduled benefits.

This legislation is an example of Congress trading the short-term interest of politicians at the expense of the long-term needs of the elderly.