Have we seriously forgotten 2008?
Today
the Federal Reserve has an economic policy that not only fosters
crisis, but introduces a Darwinian process that selects leaders who are
uniquely unfit to deal with it.
Let’s
step back to 2008, when the investment bank Bear Stearns failed with
leverage of 35 to 1, the danger of which should be obvious to anyone
who's taken fifth-grade math. Wall Street embraced these dangers to the
point where it nearly went extinct. Not only did our government miss the
risk, but the head of the Federal Reserve described derivatives, the
centerpiece of the crisis, as "a useful risk management tool"
held in the hands of the well-capitalized hands of sophisticated
investors. Six months later, virtually every government employee would
describe the financial crisis as a fast-moving event.
How does
this happen? Economic Darwinism. Whether it is getting elected or
getting promoted, Economic Darwinism selects people by success. The
Federal Reserve's 20-year policy of easy money created an environment
virtually assured to select bankers, bureaucrats, educators, and elected
officials who least understood the consequences of a credit crisis.
The
process of Economic Darwinism works within a corporation surprisingly
similar to how Darwinism operates in nature. The only difference between
evolution in nature and evolution in a corporation is the speed of the
transformations. Economic Darwinism moves much faster because humans can
learn traits, whereas a bird in the Galapagos requires generations to
grow a longer beak.
Natural
selection in organizations feeds on its reward system. If the system
rewards long hours, you will find people at the company who are willing
to sacrifice personal lifestyle for the good of the company. It isn’t
that they are more selfless, but anyone unwilling to work within the
system of rewards normally leaves or is pushed out.
When the
Federal Reserve forced interest rates lower, it altered the balance and
outcome of risk in favor of risk-takers. That step led to greater
earnings streams, or sales, or some measure of profitability. Stupid
transactions seemed wise, and foolish risks were rewarded. The most
important thing to understand about booms and Economic Darwinism is that
when it happens, the statistical likelihood of any system promoting
someone with a sensible risk perspective becomes lower and lower.
Capitalism acts as a steroid, drawing cash into a successful
companies. This process encourages other companies to emulate the
practices that made certain companies successful.
Thinking back to
2007, it should surprise no one that Darwinism had selected companies
like Bears Stearns for survival. The economy had made its corporate
culture wildly successful. It made billions packaging and selling loans.
When one bet was rewarded, the firm took on more risk in the next one.
This is how you expand from prime loans to alt-A to sub-prime. Bankers
call this universe expansion. The bankers didn't make the era. The era
made the bankers.
The boom times enabled animals called bankers
grow to massive size. Nature selected those who were the fittest for
that environment. When the environment changed, these animals were like
dinosaurs staring at the glaciers. The interest rate policy of the Federal Reserve today is designed to keep those dinosaurs warm and well fed.
The
people who run our country were largely selected by Economic Darwinism
from a pool of people who owe their success to cheap interest. It is no
surprise that these people see cheap interest as the only solution to
our economic woes. This policy is about rebuilding their past rather
than improving your future.
Tuesday, December 10, 2019
Friday, November 8, 2019
Confessions of a Social Security Mooch
There are many articles which say that Social Security is a bad
deal. I have written some of them myself. For younger workers, Social
Security is not terribly different from spending a quarter to buy a
dime. It is difficult to tell people with a straight face that is a
sensible transaction.
Yet, Social Security is a financial system which basically takes a dollar in and ships a dollar out. Contrary to popular mythology, it isn’t as though the money was siphoned away to pay-off wars and to provide comfortable housing for idle drug addicts. Someone has to make money if someone else is losing it.
In looking at what Social Security provides and what it costs, I confess I am a bit of a moocher. Statistically I am likely to make money on the system. I had a shorter working career, and married later in life. Understanding what makes the system work for me is likely a sound starting point for understanding why it does not work for the vast majority of Americans.
In terms of cost, my contributions measured in actual investments shows that Social Security will have cost me by the time I am 67 roughly $1 million (in 2014 dollars) in savings. My projected Social Security benefit is $1,250. That sounds like a losing proposition. Here is a specific example. In 1990, my contribution to Social Security was the maximum $5, 437.80. Invested in the Vanguard 500 Index fund, that sum would be worth more than $57,000 going into 2015. Given 13 more years of investment, that investment would grow to nearly $100,000 by 2028.
So what happened to the cash? The cash that I paid to Social Security went to existing beneficiaries, in part to my father. My father in turn gave me annual stipends which in some years offset the entire cost of FICA. He even called it my FICA rebate check. So the cash simply went in a circle from me to Social Security to my father and back to me.
While I am not 67, I already enjoy one of the lesser discussed retirement benefits – free life insurance. I qualified for Social Security many years ago, but only recently married and had children. The Survivor benefits from Social Security spare me the need to buy life insurance. That benefit saves me roughly $1,000 a year unless I take up cave-diving and drag racing in which case the savings are even more.
While your parents and in-laws may not send you a rebate check, the liquidity provided by Social Security protects their asset base. If you inherit assets from someone who has been retired for any length of time, it is likely largely in part to Social Security which provided the predictable liquidity to protect their asset base.
Many on the internet believe (and spam) the idea that they would be millionaires if they had been allowed to save their future without the interference of government. It is possible. Of course, they fail to factor in the incremental support that they would need to provide for their parents, in-laws, and step in-laws. This is what Ronald Reagan meant when he said, ‘the nine most terrifying words in the English language are: I’m your mother-in-law, I need a place to stay.’
By the time I am 67, Social Security will certainly have returned all of the contributions that I made over my lifetime. If the system is still around at that time, I will draw the equivalent of roughly $1,250 a month. When I die, my wife who is younger than I am may well draw benefits until 2060 based on her life expectancy. I haven’t had a job in 15 years, and well may not again unless the issue of Social Security creates sufficient interest to support a writing position for me.
I am not the largest mooch by any means. There are workers, like Pete Stark, a man wealthy by Congressional standards, who more clearly demonstrate the real earning power of Social Security. He has 2 ex-wives, either of whom may be able to collect under his contributions. His current wife is eligible to collect as the mother of his 4 minor children, who are already collecting. She also may well collect benefits under his contributions past 2050.
The structure of Social Security is simple: dollar in and dollar out. It creates almost no economic wealth with which to pay positive returns. The only way to give me a bonus, and someone like Pete Stark, more than we contribute, is to pay others less. The others traditionally have been future workers.
The system desperately needs reform, unless you feel that the government should impoverish future workers for the benefit of me and the Pete Starks of the world. Americans are living longer. It makes sense to increase the retirement age – which we have already done. It makes sense to increase the number of quarters to qualify and the number of years to weight in the formula. And we need to revisit the idea of early retirement.
We need to look at reforming the freebies that Congress has embedded in the system over the years. In a world, where fewer couples are supported by a single income, spousal benefits do not make a lot of sense. The structure makes sense if the goal of the system to subsidize the trophy wives of the wealthy. We should separate survivor benefits into its own system, and require people pay for these benefits if they want them.
Yet, any reform is met with a scorch-earth resistance from the left, which pretends that Social Security is a safety-net for the poor. We are subjected to lectures about grandmothers being run-over by a bus, when the outcome of the resistance is that a future grandmother will be hit by a larger bus. It is hypocrisy at its worst.
Today the system is broken. Instead of talking about how to fix the brokenness, Congress is looking for a way to pay for it.
Yet, Social Security is a financial system which basically takes a dollar in and ships a dollar out. Contrary to popular mythology, it isn’t as though the money was siphoned away to pay-off wars and to provide comfortable housing for idle drug addicts. Someone has to make money if someone else is losing it.
In looking at what Social Security provides and what it costs, I confess I am a bit of a moocher. Statistically I am likely to make money on the system. I had a shorter working career, and married later in life. Understanding what makes the system work for me is likely a sound starting point for understanding why it does not work for the vast majority of Americans.
In terms of cost, my contributions measured in actual investments shows that Social Security will have cost me by the time I am 67 roughly $1 million (in 2014 dollars) in savings. My projected Social Security benefit is $1,250. That sounds like a losing proposition. Here is a specific example. In 1990, my contribution to Social Security was the maximum $5, 437.80. Invested in the Vanguard 500 Index fund, that sum would be worth more than $57,000 going into 2015. Given 13 more years of investment, that investment would grow to nearly $100,000 by 2028.
So what happened to the cash? The cash that I paid to Social Security went to existing beneficiaries, in part to my father. My father in turn gave me annual stipends which in some years offset the entire cost of FICA. He even called it my FICA rebate check. So the cash simply went in a circle from me to Social Security to my father and back to me.
While I am not 67, I already enjoy one of the lesser discussed retirement benefits – free life insurance. I qualified for Social Security many years ago, but only recently married and had children. The Survivor benefits from Social Security spare me the need to buy life insurance. That benefit saves me roughly $1,000 a year unless I take up cave-diving and drag racing in which case the savings are even more.
While your parents and in-laws may not send you a rebate check, the liquidity provided by Social Security protects their asset base. If you inherit assets from someone who has been retired for any length of time, it is likely largely in part to Social Security which provided the predictable liquidity to protect their asset base.
Many on the internet believe (and spam) the idea that they would be millionaires if they had been allowed to save their future without the interference of government. It is possible. Of course, they fail to factor in the incremental support that they would need to provide for their parents, in-laws, and step in-laws. This is what Ronald Reagan meant when he said, ‘the nine most terrifying words in the English language are: I’m your mother-in-law, I need a place to stay.’
By the time I am 67, Social Security will certainly have returned all of the contributions that I made over my lifetime. If the system is still around at that time, I will draw the equivalent of roughly $1,250 a month. When I die, my wife who is younger than I am may well draw benefits until 2060 based on her life expectancy. I haven’t had a job in 15 years, and well may not again unless the issue of Social Security creates sufficient interest to support a writing position for me.
I am not the largest mooch by any means. There are workers, like Pete Stark, a man wealthy by Congressional standards, who more clearly demonstrate the real earning power of Social Security. He has 2 ex-wives, either of whom may be able to collect under his contributions. His current wife is eligible to collect as the mother of his 4 minor children, who are already collecting. She also may well collect benefits under his contributions past 2050.
The structure of Social Security is simple: dollar in and dollar out. It creates almost no economic wealth with which to pay positive returns. The only way to give me a bonus, and someone like Pete Stark, more than we contribute, is to pay others less. The others traditionally have been future workers.
The system desperately needs reform, unless you feel that the government should impoverish future workers for the benefit of me and the Pete Starks of the world. Americans are living longer. It makes sense to increase the retirement age – which we have already done. It makes sense to increase the number of quarters to qualify and the number of years to weight in the formula. And we need to revisit the idea of early retirement.
We need to look at reforming the freebies that Congress has embedded in the system over the years. In a world, where fewer couples are supported by a single income, spousal benefits do not make a lot of sense. The structure makes sense if the goal of the system to subsidize the trophy wives of the wealthy. We should separate survivor benefits into its own system, and require people pay for these benefits if they want them.
Yet, any reform is met with a scorch-earth resistance from the left, which pretends that Social Security is a safety-net for the poor. We are subjected to lectures about grandmothers being run-over by a bus, when the outcome of the resistance is that a future grandmother will be hit by a larger bus. It is hypocrisy at its worst.
Today the system is broken. Instead of talking about how to fix the brokenness, Congress is looking for a way to pay for it.
Monday, October 14, 2019
How Would You Change Social Security?
Generally, I believe that labeling Social Security as a "Ponzi Scheme" is a little more than name calling. It is an emotional trigger, that people use to vent frustration with the system. I am curious about the thoughts of these people. How would you change the system from what we have today?
Thursday, October 3, 2019
Social Security and the Myth About the 3rd-Rail
Every year, the Trustees of the Social Security Trust Funds urge
Congress to take action on the gaps developing in the beloved program’s
finances. Just as frequently, our law makers do nothing.
Typically, pundits explain the gap between reason and action as the rational response of a political class to the career-killing consequences of talking about Social Security or Medicare. At this point, the narrative is so pervasive that everyone pretty much blindly accepts that the fabled “third rail” is as electrified as ever.
Specifically, the program faced a short and shallow period of insolvency. The remedy for those gaps was little more than gradual changes that mainly affected those 17 and younger. In that situation, major reform is impossible, and politicians would have died politically for suggesting it.
In this scenario, it is much more difficult to understand why older voters would stymie any reform effort. Maybe they do not fully comprehend the size of the approaching crisis. Maybe they believe that they will be exempted from change if they can prolong it. The one thing that makes no sense is the idea that older voters would intentionally insure that trillions of dollar of misery falls on themselves as individuals.
This scenario makes benefit cuts today nearly impossible because any
reduction on someone in this group is layered on top of the 1983
reductions that are only now being phased in. On the other hand, if we
do not revisit this same audience for savings, reform by reduction will
be completely ineffective.
The agreement in 1983 took most of the low hanging fruit. It expanded the coverage of Social Security to government workers, increasing the coverage to 94% of the workforce. Also it added the taxation of benefits, which now recovers as much as 33 percent of the benefits paid to the wealthy. There is no low hanging fruit – there isn’t even a tree left.
Less understandable is the public’s tolerance of a cliché 30 years
out of date holding reform of the nation’s largest program hostage.
Typically, pundits explain the gap between reason and action as the rational response of a political class to the career-killing consequences of talking about Social Security or Medicare. At this point, the narrative is so pervasive that everyone pretty much blindly accepts that the fabled “third rail” is as electrified as ever.
A Clichéd And Broken Story
The metaphor implies that issue of Social Security is electrified – touch it and you faced certain death politically. It dates back to the 1980s when the finances of Social Security were very different. The problem was small, and options were plentiful.Specifically, the program faced a short and shallow period of insolvency. The remedy for those gaps was little more than gradual changes that mainly affected those 17 and younger. In that situation, major reform is impossible, and politicians would have died politically for suggesting it.
Times have changed
Today, on the other hand, the current numbers point to a deep insolvency that grows forever, affecting people who are now in their 70s. Specifically, the Social Security Administration believes that about half of those turning 71 today will be turning 87 as the system reduces benefits. In this case, the strategy of stagnation exposes these Americans to the worst of the crisis.In this scenario, it is much more difficult to understand why older voters would stymie any reform effort. Maybe they do not fully comprehend the size of the approaching crisis. Maybe they believe that they will be exempted from change if they can prolong it. The one thing that makes no sense is the idea that older voters would intentionally insure that trillions of dollar of misery falls on themselves as individuals.
1983 Was Easy
In 1983, the solution was as simple as Congress agreeing with itself that people who were 17 and younger at the time would pay vastly higher taxes, and absorb the benefit cuts that voters would not even consider. Lawmakers didn’t have to face any angry voters.2018 Is Hard
Unfortunately, the strategy of the past complicates our situation today. The 17 year old is now 52. The 1983 reform reduced benefits of this worker by nearly 25 percent. He has paid record payroll taxes for his working career, and now expects to retire in 2033, which is the year before the program augurs another 20 percent plus reduction of benefits.The agreement in 1983 took most of the low hanging fruit. It expanded the coverage of Social Security to government workers, increasing the coverage to 94% of the workforce. Also it added the taxation of benefits, which now recovers as much as 33 percent of the benefits paid to the wealthy. There is no low hanging fruit – there isn’t even a tree left.
Explaining the Narrative
From the politician’s point of view, the 3rd rail narrative is a blessing. It provides a reasonable shelter from criticism for the lack of progress on stabilizing the nation’s largest and arguably most important program. They reason that stagnation isn’t their fault. The problem is the nameless voter who will punish any lawmaker responsible enough talk about change.Thursday, August 29, 2019
Social Security : Delayed Claiming Needs Reform
This
piece originally ran on TheHill.Com
The debate about Social Security
focuses too much on fix and too little on better. At some level, the debate
about Social Security should consider how we can make the system run safer or
serve the country better.
The government must run Social
Security. Social insurance is by its nature antitheoretical with
capitalism because pricing is dictated by the buyer’s earnings rather than
production costs.
The program has however overtime
assumed tasks that go beyond social insurance. One example of that expansion is
the rule which enables a retiree to increase monthly benefits by delaying retirement
claiming (DRC). This function essentially translates current benefits into
an inflation adjusted annuity. It serves an individual’s want, not a
societal need, in which the retiree transforms his benefit into the way that he
wants to collect his benefit. There is nothing social about it.
When DRC was created in 1972, the
annuity market may have forced the government to assume a monopoly role. The
past is the past. Today, the government’s role is completely unnecessary. There
is a robust annuity market today that could support retirees with an expanded
range of choices.
The problem for Americans with this
rule is risk. Annuities in the private sector are priced daily – every
day. The government does not re-price the annuity daily, weekly, monthly,
or even yearly. The last time that the government changed the pricing for
the annuities issued by Social Security was in
1983. Pricing is a tri-decennial event.
A lot has happened over the last 32
years. Interest rates have dropped from 13.75 percent to slightly more
than 2.125 percent. Our life expectancies have risen nearly two years
since that time. Pricing seems unconnected to the cost and benefit of what the
government is selling.
It isn’t a problem that the
government provides incentives or disincentives for work behavior. Social
Security in 1990 paid people to collect benefits early, and today it pays them
to defer their retirement.
The problem is that we do not seem to follow what
incentives are hidden in the system.
Pricing is a legislative process
which is neither perfect nor responsive. In 1972, for example, Congress introduced a flawed benefit adjustment method which triggered benefit
increases large enough to push the system into crisis by 1983. It took
Congress five years to address that flaw.
DRC introduces open-ended risk to
the system because we don’t know how long these annuities will last. For
prospective, the VA is still paying today on pensions from the Civil War.
So any mistake may be around for a very long time.
All of the risk for the system
benefits the few. Who are the few? Today about 10 percent of claims occur
after normal retirement age. The one thing that we know about these
retirees is that they can afford to defer their benefits.
At some point, the debate about Social Security reform must grow beyond simply cutting benefits and raising taxes. These solutions do not fix Social Security. They are the way that we pay for its brokenness.
Wednesday, July 31, 2019
Social Security: Investing the surplus in marketable securities
Originally published in TheHill.Com.
It is human nature to look for the easy solution. My kids do it. Our politicians do it.
It is one thing when my kids believe the tooth fairy will fix their cavities. It is another thing when politicians try to convince the public at large that there is no shortage of ways to reduce the growing gap between the projected revenue and expense of Social Security.
There is no free lunch anywhere in the system. If, for example, you remove the maximum taxable wage cap, the system will generate more revenue. At the same time, the change will make it harder to raise revenue for other governmental needs, such as paying down our debt. Increasing payroll taxes is a political statement that Social Security is relatively more important than other governmental priorities.
The Center for Retirement Research at Boston College released a study that suggests it has identified the free lunch solution for Social Security. They believe that we can solve the financial gaps by investing some of the existing surplus in marketable securities.
The research reached an astounding conclusion:
The concept holds the appeal of the easy solution. If we were just smarter about the way we handle the existing resources of the system, all of the difficulties in the program would melt away.
Is it possible? Maybe. The Social Security Administration (“SSA”) doesn’t belief so. Its research suggests that investing 40 percent of the surplus in marketable securities will increase the exhaustion point by a total of 1 year, rather than 75. So success isn’t a sure thing.
The success, or failure, of this concept largely rests upon the investment returns generated by the Trust Fund. Typically, the baseline for most of this type of research is based on historic market returns.
This theoretical assumption isn’t a realistic expectation. Social Security’s revenue is correlated to wages which is correlated to the stock markets. The connection means that Social Security will statistically overbuy market tops and under-invest in market bottoms. It is a statistical anti-dollar cost averaging concept.
Secondly, the index return does not incorporate the cost to buy and sell the security. This problem is largely overlooked today because capital inflows of the typical index fund are sufficient to meet redemptions.
That will not be the case with Social Security. The investment redemptions of Social Security will be priced at the bid. The size of these redemptions may well move the market down as the government sells its positions. A theoretical return of the index never prices in the spread.
The paper from CRR looks at the returns of the Wilshire 5000, an index that includes highly illiquid stocks. One example is Acme Corporation, ACU, a $20 stock which trades with a spread of $0.50 on an average daily volume of 2000 shares. In other words, the loss starts at 2.5 percent and rises as the price of the stock falls.
This solution does not fix Social Security. It redistributes the allocation of associated risk. Investing the surplus in marketable security lowers the risk of insolvency by investing in assets with higher returns that introduce credit risk that isn’t present today’s portfolio.
This concept introduces the possibility that Social Security will be adversely affected by a credit market disruption. That risk will be borne progressively by future workers. The possibility that a credit event will occur over the next 10 years is less than over the next 50 years. In this respect, the policy option is no different from the standard line that we will tax future workers more.
Redistributing risk might be a good idea. It isn’t a good idea to base that decision on market returns that Social Security will never achieve.
It is human nature to look for the easy solution. My kids do it. Our politicians do it.
It is one thing when my kids believe the tooth fairy will fix their cavities. It is another thing when politicians try to convince the public at large that there is no shortage of ways to reduce the growing gap between the projected revenue and expense of Social Security.
There is no free lunch anywhere in the system. If, for example, you remove the maximum taxable wage cap, the system will generate more revenue. At the same time, the change will make it harder to raise revenue for other governmental needs, such as paying down our debt. Increasing payroll taxes is a political statement that Social Security is relatively more important than other governmental priorities.
The Center for Retirement Research at Boston College released a study that suggests it has identified the free lunch solution for Social Security. They believe that we can solve the financial gaps by investing some of the existing surplus in marketable securities.
The research reached an astounding conclusion:
At the 50th percentile of outcomes, equity investing has the potential to maintain a healthy Trust Fund ratio through the 75- year period.
The concept holds the appeal of the easy solution. If we were just smarter about the way we handle the existing resources of the system, all of the difficulties in the program would melt away.
Is it possible? Maybe. The Social Security Administration (“SSA”) doesn’t belief so. Its research suggests that investing 40 percent of the surplus in marketable securities will increase the exhaustion point by a total of 1 year, rather than 75. So success isn’t a sure thing.
The success, or failure, of this concept largely rests upon the investment returns generated by the Trust Fund. Typically, the baseline for most of this type of research is based on historic market returns.
This theoretical assumption isn’t a realistic expectation. Social Security’s revenue is correlated to wages which is correlated to the stock markets. The connection means that Social Security will statistically overbuy market tops and under-invest in market bottoms. It is a statistical anti-dollar cost averaging concept.
Secondly, the index return does not incorporate the cost to buy and sell the security. This problem is largely overlooked today because capital inflows of the typical index fund are sufficient to meet redemptions.
That will not be the case with Social Security. The investment redemptions of Social Security will be priced at the bid. The size of these redemptions may well move the market down as the government sells its positions. A theoretical return of the index never prices in the spread.
The paper from CRR looks at the returns of the Wilshire 5000, an index that includes highly illiquid stocks. One example is Acme Corporation, ACU, a $20 stock which trades with a spread of $0.50 on an average daily volume of 2000 shares. In other words, the loss starts at 2.5 percent and rises as the price of the stock falls.
This solution does not fix Social Security. It redistributes the allocation of associated risk. Investing the surplus in marketable security lowers the risk of insolvency by investing in assets with higher returns that introduce credit risk that isn’t present today’s portfolio.
This concept introduces the possibility that Social Security will be adversely affected by a credit market disruption. That risk will be borne progressively by future workers. The possibility that a credit event will occur over the next 10 years is less than over the next 50 years. In this respect, the policy option is no different from the standard line that we will tax future workers more.
Redistributing risk might be a good idea. It isn’t a good idea to base that decision on market returns that Social Security will never achieve.
Tuesday, July 23, 2019
Social Security deal of 1983 was a punt
The Holy Grail of politics is a ‘grand bargain’ on Social Security in
which both parties agree to a mix of benefit cuts and revenue increases
that will stabilize the system for the foreseeable future.
Pundits and politicians point to the negotiations which saved Social Security in 1983 as a model of success to imitate. Obama even invoked the memory of 1983 Reform during the 2012 Presidential Debates.
“Social Security is going to have to be tweaked the way it was by Ronald Reagan and Speaker -- Democratic Speaker Tip O'Neill.”
The story goes that elected leaders put principle over ideology. Bipartisan compromise produced the additional revenue and benefit reductions necessary for the system to not only to survive, but build a $2.7 trillion surplus in the process. It is a wonderful story.
The problem, of course, with this narrative is reality. The 1983 reform of Social Security largely shifted the burden of Social Security from one generation to the next with the consequences falling heavily on late-boomers and those that followed. The Republicans and Democrats came together in a bipartisan effort to kick-the-can.
This legislation wasn’t a hard-choice politically because the consequences were phased-in such that the group most affected were non-voters. The largest tax increases and the maximum benefit cuts targeted people who were 11 and younger at the time. The political calculus behind the bipartisan compromise is simple: 11 year-olds can’t vote.
The reform contained many changes, but three of these changes accounted for roughly 75 percent of the solution. All of the money-makers disproportionally targeted future generations.
The most favorable change for Social Security was the taxation of benefits. This revision helped the system because the tax revenue collected by the IRS on Social Security benefits was returned to Social Security. The law approximated a means-tested claw-back of benefits by the system from people with “other substantial income”.
This aspect of the reform increasingly affects retirees over successive generations because the trigger thresholds are not indexed to inflation. The Greenspan Commission originally estimated that these rules would affect “10 percent of OASDI beneficiaries”. 30 years later, the Social Security Administration estimates that nearly 40% of beneficiaries pay taxes on their benefits. Separately, actual IRS data shows that 70 percent of tax returns filed in 2012 that include Social Security benefits generate revenue under this provision.
The next largest change increased gradually the normal retirement age for people born after 1937. The people who felt the full impact of these adjustments were 23 and younger at the time.
The final large impact change was the expansion of Social Security’s coverage to new participants. The law required at all “new” federal employees to participate in Social Security. Again, older workers were largely insulated from the change.
While these changes may seem modest, they weren’t. Data from the Urban Institute shows that the average retiree couple in 1985 enjoyed $3 of expected benefits for every $1 that they contributed. Today, the average retiree expects to lose money on Social Security. So, benefit reductions were more of an option in 1983 because benefits were relatively generous compared to past contributions.
Separately, Congress was able to create benefit cuts in 1983 that cannot be replicated. In 1983, the system had no means test. The one that was added in 1983 targeted retirees with an income ($25,000) that approximated the median income of a 4 person family. Today, these rules hit retirees who earn only slightly more than the poverty-line.
Congress’ options have narrowed considerably as the problems in Social Security have worsened. As Charles Blauhous points out, “In the early 1980s they merely had to get through a relatively small near-term solvency crisis before entering decades of previously-projected surpluses as the baby boomers moved through the workforce.” (emphasis added) Social Security does not project any surpluses for an indefinite period of time.
Someone turning 66 today expects live long enough to experience substantial benefit reductions. It is simply delusional to believe that we can protect people who are 46 and older again. We have to make changes just so that existing retirees can collect their promised benefits – and that assumes favorable economic conditions. It is no longer economically possible to kick the can.
The story of the 1983 agreement on Social Security is one of Irish drinking buddies who found enough common ground in the good of the country to overcome their ideological differences. The hard reality is that the president and Congress reached a bipartisan agreement that voters would take more from Social Security than it would give to their children.
Pundits and politicians point to the negotiations which saved Social Security in 1983 as a model of success to imitate. Obama even invoked the memory of 1983 Reform during the 2012 Presidential Debates.
“Social Security is going to have to be tweaked the way it was by Ronald Reagan and Speaker -- Democratic Speaker Tip O'Neill.”
The story goes that elected leaders put principle over ideology. Bipartisan compromise produced the additional revenue and benefit reductions necessary for the system to not only to survive, but build a $2.7 trillion surplus in the process. It is a wonderful story.
The problem, of course, with this narrative is reality. The 1983 reform of Social Security largely shifted the burden of Social Security from one generation to the next with the consequences falling heavily on late-boomers and those that followed. The Republicans and Democrats came together in a bipartisan effort to kick-the-can.
This legislation wasn’t a hard-choice politically because the consequences were phased-in such that the group most affected were non-voters. The largest tax increases and the maximum benefit cuts targeted people who were 11 and younger at the time. The political calculus behind the bipartisan compromise is simple: 11 year-olds can’t vote.
The reform contained many changes, but three of these changes accounted for roughly 75 percent of the solution. All of the money-makers disproportionally targeted future generations.
The most favorable change for Social Security was the taxation of benefits. This revision helped the system because the tax revenue collected by the IRS on Social Security benefits was returned to Social Security. The law approximated a means-tested claw-back of benefits by the system from people with “other substantial income”.
This aspect of the reform increasingly affects retirees over successive generations because the trigger thresholds are not indexed to inflation. The Greenspan Commission originally estimated that these rules would affect “10 percent of OASDI beneficiaries”. 30 years later, the Social Security Administration estimates that nearly 40% of beneficiaries pay taxes on their benefits. Separately, actual IRS data shows that 70 percent of tax returns filed in 2012 that include Social Security benefits generate revenue under this provision.
The next largest change increased gradually the normal retirement age for people born after 1937. The people who felt the full impact of these adjustments were 23 and younger at the time.
The final large impact change was the expansion of Social Security’s coverage to new participants. The law required at all “new” federal employees to participate in Social Security. Again, older workers were largely insulated from the change.
While these changes may seem modest, they weren’t. Data from the Urban Institute shows that the average retiree couple in 1985 enjoyed $3 of expected benefits for every $1 that they contributed. Today, the average retiree expects to lose money on Social Security. So, benefit reductions were more of an option in 1983 because benefits were relatively generous compared to past contributions.
Separately, Congress was able to create benefit cuts in 1983 that cannot be replicated. In 1983, the system had no means test. The one that was added in 1983 targeted retirees with an income ($25,000) that approximated the median income of a 4 person family. Today, these rules hit retirees who earn only slightly more than the poverty-line.
Congress’ options have narrowed considerably as the problems in Social Security have worsened. As Charles Blauhous points out, “In the early 1980s they merely had to get through a relatively small near-term solvency crisis before entering decades of previously-projected surpluses as the baby boomers moved through the workforce.” (emphasis added) Social Security does not project any surpluses for an indefinite period of time.
Someone turning 66 today expects live long enough to experience substantial benefit reductions. It is simply delusional to believe that we can protect people who are 46 and older again. We have to make changes just so that existing retirees can collect their promised benefits – and that assumes favorable economic conditions. It is no longer economically possible to kick the can.
The story of the 1983 agreement on Social Security is one of Irish drinking buddies who found enough common ground in the good of the country to overcome their ideological differences. The hard reality is that the president and Congress reached a bipartisan agreement that voters would take more from Social Security than it would give to their children.
Saturday, July 6, 2019
Social Security Crash Explained In 4 Simple Steps
When Social Security was created in 1935, the system was designed to be funded by workers
not financed by their children. It wasn't a generational-transfer or a
Ponzi scheme. Since that time, the system's finances have deteriorated
virtually every year to the point where the financing gap is nearly the size of our entire GDP.
So what the hell happened? How to destroy the future in four easy steps:
1. Give To Voters
The original law included automatic tax increases which would have increased the cost of Social Security to 6% of wages from its 2% base. Over the 1940s, Congress waived every increase, one of which required a Congressional override of FDR's veto. Funding for Social Security did not reach the originally envisioned 6% until the 1960s. Self-employed workers would not pay 6% until the 1970s.
These tax cuts transformed Social Security from a system paid by workers to a system financed by children.
2. Take From Non-Voters
Once voters did not have to pay for benefits, Congress raised benefits — every election year in the 1950s. Social Security Act Amendments of 1950, 1952, 1954, 1956, 1958 all increased benefits. These increased the value of existing benefits, created new benefits, or expanded coverage to more Americans. The 1950 Amendment raised benefits by 77%, 1952 (12.5%), 1954 (13%), 1956(added disability), 1958 (7%).
A couple retiring in 1960 expected to collect $8 of benefits for every $1 of contribution. Basically, Congress in the 1950s was selling dollars of benefits to voters for little more than a dime. The difference between the cost and the benefit was largely passed on to future generations who had no vote in 1950.
3. Allow The Federal Reserve to Lower Interest Rates At A Cost Of $1.2 trillion of Projected Interest Income (in 2012 alone)
In 2011, projected interest income over the life of the Trust Fund was 3.6 trillion. In 2012, projected interest income over the life of the Trust Fund was 2.4 trillion.
Thanks, Ben Bernanke.
4. Ignore The Problem
Social Security almost reached insolvency in 1983. At that time, Social Security had more than 40 years of promises embedded in a system that did not have a penny to pay them. The solution to these problems in 1983? Repeat step 1. Repeat step 2. Prepare for step 3. The solution to these problems in 2013? Repeat step 1. Repeat step 2.
Today, Social Security is not much different than spending quarters to buy dimes, provided that Congress is able to get our kids to spend quarters to buy nickels.
So what the hell happened? How to destroy the future in four easy steps:
1. Give To Voters
The original law included automatic tax increases which would have increased the cost of Social Security to 6% of wages from its 2% base. Over the 1940s, Congress waived every increase, one of which required a Congressional override of FDR's veto. Funding for Social Security did not reach the originally envisioned 6% until the 1960s. Self-employed workers would not pay 6% until the 1970s.
These tax cuts transformed Social Security from a system paid by workers to a system financed by children.
2. Take From Non-Voters
Once voters did not have to pay for benefits, Congress raised benefits — every election year in the 1950s. Social Security Act Amendments of 1950, 1952, 1954, 1956, 1958 all increased benefits. These increased the value of existing benefits, created new benefits, or expanded coverage to more Americans. The 1950 Amendment raised benefits by 77%, 1952 (12.5%), 1954 (13%), 1956(added disability), 1958 (7%).
A couple retiring in 1960 expected to collect $8 of benefits for every $1 of contribution. Basically, Congress in the 1950s was selling dollars of benefits to voters for little more than a dime. The difference between the cost and the benefit was largely passed on to future generations who had no vote in 1950.
3. Allow The Federal Reserve to Lower Interest Rates At A Cost Of $1.2 trillion of Projected Interest Income (in 2012 alone)
In 2011, projected interest income over the life of the Trust Fund was 3.6 trillion. In 2012, projected interest income over the life of the Trust Fund was 2.4 trillion.
Thanks, Ben Bernanke.
4. Ignore The Problem
Social Security almost reached insolvency in 1983. At that time, Social Security had more than 40 years of promises embedded in a system that did not have a penny to pay them. The solution to these problems in 1983? Repeat step 1. Repeat step 2. Prepare for step 3. The solution to these problems in 2013? Repeat step 1. Repeat step 2.
Today, Social Security is not much different than spending quarters to buy dimes, provided that Congress is able to get our kids to spend quarters to buy nickels.
Thursday, June 27, 2019
Social Security: Investing the surplus in marketable securities
It is human nature to look for the easy solution. My kids do it. Our politicians do it.
It is one thing when my kids believe the tooth fairy will fix their cavities. It is another thing when politicians try to convince the public at large that there is no shortage of ways to reduce the growing gap between the projected revenue and expense of Social Security.
There is no free lunch anywhere in the system. If, for example, you remove the maximum taxable wage cap, the system will generate more revenue. At the same time, the change will make it harder to raise revenue for other governmental needs, such as paying down our debt. Increasing payroll taxes is a political statement that Social Security is relatively more important than other governmental priorities.
The Center for Retirement Research at Boston College released a study that suggests it has identified the free lunch solution for Social Security. They believe that we can solve the financial gaps by investing some of the existing surplus in marketable securities.
The research reached an astounding conclusion:
The concept holds the appeal of the easy solution. If we were just smarter about the way we handle the existing resources of the system, all of the difficulties in the program would melt away.
Is it possible? Maybe. The Social Security Administration (“SSA”) doesn’t belief so. Its research suggests that investing 40 percent of the surplus in marketable securities will increase the exhaustion point by a total of 1 year, rather than 75. So success isn’t a sure thing.
The success, or failure, of this concept largely rests upon the investment returns generated by the Trust Fund. Typically, the baseline for most of this type of research is based on historic market returns.
This theoretical assumption isn’t a realistic expectation. Social Security’s revenue is correlated to wages which is correlated to the stock markets. The connection means that Social Security will statistically overbuy market tops and under-invest in market bottoms. It is a statistical anti-dollar cost averaging concept.
Secondly, the index return does not incorporate the cost to buy and sell the security. This problem is largely overlooked today because capital inflows of the typical index fund are sufficient to meet redemptions.
That will not be the case with Social Security. The investment redemptions of Social Security will be priced at the bid. The size of these redemptions may well move the market down as the government sells its positions. A theoretical return of the index never prices in the spread.
The paper from CRR looks at the returns of the Wilshire 5000, an index that includes highly illiquid stocks. One example is Acme Corporation, ACU, a $20 stock which trades with a spread of $0.50 on an average daily volume of 2000 shares. In other words, the loss starts at 2.5 percent and rises as the price of the stock falls.
This solution does not fix Social Security. It redistributes the allocation of associated risk. Investing the surplus in marketable security lowers the risk of insolvency by investing in assets with higher returns that introduce credit risk that isn’t present today’s portfolio.
This concept introduces the possibility that Social Security will be adversely affected by a credit market disruption. That risk will be borne progressively by future workers. The possibility that a credit event will occur over the next 10 years is less than over the next 50 years. In this respect, the policy option is no different from the standard line that we will tax future workers more.
Redistributing risk might be a good idea. It isn’t a good idea to base that decision on market returns that Social Security will never achieve.
It is one thing when my kids believe the tooth fairy will fix their cavities. It is another thing when politicians try to convince the public at large that there is no shortage of ways to reduce the growing gap between the projected revenue and expense of Social Security.
There is no free lunch anywhere in the system. If, for example, you remove the maximum taxable wage cap, the system will generate more revenue. At the same time, the change will make it harder to raise revenue for other governmental needs, such as paying down our debt. Increasing payroll taxes is a political statement that Social Security is relatively more important than other governmental priorities.
The Center for Retirement Research at Boston College released a study that suggests it has identified the free lunch solution for Social Security. They believe that we can solve the financial gaps by investing some of the existing surplus in marketable securities.
The research reached an astounding conclusion:
At the 50th percentile of outcomes, equity investing has the potential to maintain a healthy Trust Fund ratio through the 75- year period.
The concept holds the appeal of the easy solution. If we were just smarter about the way we handle the existing resources of the system, all of the difficulties in the program would melt away.
Is it possible? Maybe. The Social Security Administration (“SSA”) doesn’t belief so. Its research suggests that investing 40 percent of the surplus in marketable securities will increase the exhaustion point by a total of 1 year, rather than 75. So success isn’t a sure thing.
The success, or failure, of this concept largely rests upon the investment returns generated by the Trust Fund. Typically, the baseline for most of this type of research is based on historic market returns.
This theoretical assumption isn’t a realistic expectation. Social Security’s revenue is correlated to wages which is correlated to the stock markets. The connection means that Social Security will statistically overbuy market tops and under-invest in market bottoms. It is a statistical anti-dollar cost averaging concept.
Secondly, the index return does not incorporate the cost to buy and sell the security. This problem is largely overlooked today because capital inflows of the typical index fund are sufficient to meet redemptions.
That will not be the case with Social Security. The investment redemptions of Social Security will be priced at the bid. The size of these redemptions may well move the market down as the government sells its positions. A theoretical return of the index never prices in the spread.
The paper from CRR looks at the returns of the Wilshire 5000, an index that includes highly illiquid stocks. One example is Acme Corporation, ACU, a $20 stock which trades with a spread of $0.50 on an average daily volume of 2000 shares. In other words, the loss starts at 2.5 percent and rises as the price of the stock falls.
This solution does not fix Social Security. It redistributes the allocation of associated risk. Investing the surplus in marketable security lowers the risk of insolvency by investing in assets with higher returns that introduce credit risk that isn’t present today’s portfolio.
This concept introduces the possibility that Social Security will be adversely affected by a credit market disruption. That risk will be borne progressively by future workers. The possibility that a credit event will occur over the next 10 years is less than over the next 50 years. In this respect, the policy option is no different from the standard line that we will tax future workers more.
Redistributing risk might be a good idea. It isn’t a good idea to base that decision on market returns that Social Security will never achieve.
Sunday, June 16, 2019
Youth, 401Ks, and Fees
One problem that Boomers face today is not paying attention years ago to the cost of retirement savings. Years ago, while workers were enjoying tax-deferred savings, no one told about the leak in the boat, fees.
One of the things that surprised me was the difference between the performance of my retirement account and the company stock which was the largest component. What happened? Fees.
Fee structures have changed since I wrote this piece in 2013, but the average guy who is now approaching retirement paid a breathtaking amount in fees.
Getting anyone to listen to a piece on retirement planning is difficult on a good day, and almost impossible when the audience is younger Americans. But the topic isn't as irrelevant as many young people think, because retirement planning isn't just about you — it is a family issue. The news about retirement planning isn't good, either, according to this report by the think tank Demos, "Broke Boomers and the Coming Crisis of Elderly Poverty." While you may have heard that the problem is that we don't save enough, the larger problem is the way we save.
For most Americans, their largest expense in retirement planning — Social Security — will lose money. Behind Social Security, many Americans use 401Ks to create the personal savings accounts that Social Security will augment. The problem is that the 401K can also be a money loser, with trade-offs that few understand.
401Ks have a place in an investment portfolio, but you should understand the rules before you invest
through one. 401Ks are not tax-free accounts. They are tax-deferred. Tax-deferred means that you are trading the tax rate today for one that is unknown in the future. You will pay tax on the income at some point.
For money deposited today, that trade is largely a bad decision. The current tax structure is historically favorable, particularly for lower-wage Americans. According to the CBO, people in the lowest quintile of income pay about a 1% effective tax rate on income. In fact, many Americans pay 0% for long-term capital gains. So passing income through a 401K can create a needless tax liability where there was none.
Furthermore, few people consider the tax consequences of 401Ks, as evidenced by participation in Roth-401Ks. One reason that people do not follow these accounts closely is because these accounts reserve wealth for far in the future. Separately, employers pay employees to make the mistake. Some employers offer 100% matches of your contributions. Employees see that match as doubling their money.
How can free money go wrong? Fees. Fees hit younger Americans harder because the fees accrue over a longer period of time. How much are fees? Consider accounts earning 5% real (roughly an average rolling 40-year return). A dollar invested in 45 years without fees is worth more than $9. Two dollars invested in a 401K subject to 2% fees grows to about $7.50. The 100% match does not even cover the fees if you are 30 or under.
How much 401Ks cost depends upon where you work because fees vary from plan to plan. Brightscope.com, a retirement planning service, projects that workers of Darden Restaurants lose over $200,000 in fees, or up to 21 years of additional work. Demos projects that "over a lifetime, fees can cost a median-income two-earner family nearly $155,000 and consume nearly one-third of their investment returns." Every plan is different, and Brightscope.Com will tell you about the specifics of your plan.
What do you get for the money? Mostly you get the right to not use your money. These accounts require younger workers who tend to be less established to lock up their money for a longer period of time. In the real world, you are supposed to get paid to make extended commitments of capital. For example, the 30-year Treasury bond pays roughly 4% compared to 1% for the one-year bond. 401Ks do not compensate the holder for the commitment.
For millennials, the commitment means that your money is not available when your life changes. Whether it is to start a new business or for health reasons, you will probably need to dip into your savings sooner than you think. Putting your money into a 401K not only exposes your investment to the risk of the market, but makes it certain you'll be assessed penalties for early withdrawal.
For Baby Boomers, forced 401K distributions create the risk of triggering Social Security's means-test. The IRS applies a means-tested clawback of benefits on people who have "substantial" outside income. (In fact, up to one-third of retirees trigger this test). So it is possible that your savings will trigger a negative savings rate.
This isn't to suggest that 401Ks are evil or that anyone is stealing your retirement money. These accounts are a structured investment tool, with costs and rules. If you don't understand the costs and rules, you could pay a severe price.
One of the things that surprised me was the difference between the performance of my retirement account and the company stock which was the largest component. What happened? Fees.
Fee structures have changed since I wrote this piece in 2013, but the average guy who is now approaching retirement paid a breathtaking amount in fees.
Getting anyone to listen to a piece on retirement planning is difficult on a good day, and almost impossible when the audience is younger Americans. But the topic isn't as irrelevant as many young people think, because retirement planning isn't just about you — it is a family issue. The news about retirement planning isn't good, either, according to this report by the think tank Demos, "Broke Boomers and the Coming Crisis of Elderly Poverty." While you may have heard that the problem is that we don't save enough, the larger problem is the way we save.
For most Americans, their largest expense in retirement planning — Social Security — will lose money. Behind Social Security, many Americans use 401Ks to create the personal savings accounts that Social Security will augment. The problem is that the 401K can also be a money loser, with trade-offs that few understand.
401Ks have a place in an investment portfolio, but you should understand the rules before you invest
through one. 401Ks are not tax-free accounts. They are tax-deferred. Tax-deferred means that you are trading the tax rate today for one that is unknown in the future. You will pay tax on the income at some point.
For money deposited today, that trade is largely a bad decision. The current tax structure is historically favorable, particularly for lower-wage Americans. According to the CBO, people in the lowest quintile of income pay about a 1% effective tax rate on income. In fact, many Americans pay 0% for long-term capital gains. So passing income through a 401K can create a needless tax liability where there was none.
Furthermore, few people consider the tax consequences of 401Ks, as evidenced by participation in Roth-401Ks. One reason that people do not follow these accounts closely is because these accounts reserve wealth for far in the future. Separately, employers pay employees to make the mistake. Some employers offer 100% matches of your contributions. Employees see that match as doubling their money.
How can free money go wrong? Fees. Fees hit younger Americans harder because the fees accrue over a longer period of time. How much are fees? Consider accounts earning 5% real (roughly an average rolling 40-year return). A dollar invested in 45 years without fees is worth more than $9. Two dollars invested in a 401K subject to 2% fees grows to about $7.50. The 100% match does not even cover the fees if you are 30 or under.
How much 401Ks cost depends upon where you work because fees vary from plan to plan. Brightscope.com, a retirement planning service, projects that workers of Darden Restaurants lose over $200,000 in fees, or up to 21 years of additional work. Demos projects that "over a lifetime, fees can cost a median-income two-earner family nearly $155,000 and consume nearly one-third of their investment returns." Every plan is different, and Brightscope.Com will tell you about the specifics of your plan.
What do you get for the money? Mostly you get the right to not use your money. These accounts require younger workers who tend to be less established to lock up their money for a longer period of time. In the real world, you are supposed to get paid to make extended commitments of capital. For example, the 30-year Treasury bond pays roughly 4% compared to 1% for the one-year bond. 401Ks do not compensate the holder for the commitment.
For millennials, the commitment means that your money is not available when your life changes. Whether it is to start a new business or for health reasons, you will probably need to dip into your savings sooner than you think. Putting your money into a 401K not only exposes your investment to the risk of the market, but makes it certain you'll be assessed penalties for early withdrawal.
For Baby Boomers, forced 401K distributions create the risk of triggering Social Security's means-test. The IRS applies a means-tested clawback of benefits on people who have "substantial" outside income. (In fact, up to one-third of retirees trigger this test). So it is possible that your savings will trigger a negative savings rate.
This isn't to suggest that 401Ks are evil or that anyone is stealing your retirement money. These accounts are a structured investment tool, with costs and rules. If you don't understand the costs and rules, you could pay a severe price.
Friday, June 7, 2019
Social Security is not an anti-poverty program
One of the most pervasive myths in the debate about Social Security
promotes the role of the program in the alleviation of poverty.
Common sense should tell us that something is amiss with this endearing myth. Social Security does not pay a penny of benefit based on need. The system does not even have visibility into need. So at best any benefit that goes to a poor person is more a matter of luck than systemic policy.
The benefit formula of the program is designed to make that outcome less than likely though. The system allocates benefits based on among other things wages and the number of years worked. So until working a long and productive career causes poverty, Social Security will never be an anti-poverty program.
Some Americans are not even eligible for its benefits. Again, until Social Security is universal, it will never be a safety-net.
Facts support common-sense. The IRS reports that in 2012 70% of tax returns filed with Social Security benefits triggered rules for filers with substantial outside income. Pew Research reports that households headed by someone 65 and older have the highest median net-worth of any age demographic.
How is it possible that anyone can confuse a system that actually pays the wealthiest segment of our society based on how much they have earned in the past with poverty alleviation?
The myth largely demonstrates that statistics remain the greatest lie. The statistic starts at the US Census Bureau, with this statement.
"Without adding Social Security benefits to income, the supplemental poverty rate overall would have been 8.6 percentage points higher (or 24.1 percent rather than 15.5 percent). People 65 and older had a supplemental poverty rate of 14.6 percent, equating to 6.5 million. Excluding Social Security would leave the majority of this population (52.6 percent or 23.4 million) in poverty." ~ U.S. Census Bureau
The factoid subsequently spins out of control on the internet. The natural extension of the raw data is that Social Security is a safety net without which a majority of U.S. seniors would be poor. The extension of that extension is that without Social Security there would be people starving in our streets when they weren't dying from exposure.
The primary problem with the statistic is that US Census Bureau measures poverty by income. The fact is that income measures productivity, not poverty. Income level may cause poverty, but it is not a sensible measurement of it. Poverty should be measured by net-worth.
The second problem is that people engaged in the debate about Social Security do not read disclosures. Both the Social Security Administration and the Census Bureau warn readers that the definition of income excludes a range of revenue on which seniors depend. Separately the authors provides a disclaimer, cautioning readers that respondents tend to under-report non-wage income. In other words, Census’s measure of poverty is based on an incomplete and imprecise measure that is known to overstate poverty in the elderly.
The US Census report does not include a disclaimer that should be present. The IRS tax rules on Social Security benefits for people with substantial outside income create a significant incentive for the elderly to appear poor. The Congressional Budget Office reports that these tax rates can approach 47%. These rules are triggered near the poverty line.
The statistics also exclude a significant factor, the cost of Social Security. If we ignore cost, any government program provides poverty alleviation. For example, pay-outs from the lottery are a great poverty alleviation tool as well. The reality of the lottery is however that you are spending a dollar to buy a dime. If we ignore the dollar of poverty, the dime of cure appears to be the greatest social program ever designed to lift people out middle-classdom.
In terms of the cost of Social Security, an average couple retiring in 2010, lost roughly $600,000 in savings over their lifetime funding the retirement of others. Is it reasonable to say that Social Security lifted that couple out of poverty by returning $30,000 in a given year? If we are going to say that Social Security lifted some millions of people out of poverty, should that figure not be net of those younger Americans who were put into poverty by the system?
Americans really do not need to know the details of how Social Security interacts with poverty. Voters need to know that someone in Washington is paying attention. Politicians, pundits, and policy experts have set policy for the program around statistics that they haven’t bothered to fully research, allowing the raison d'etre of the system to drift into a Bizarro social policy skit from Seinfeld.
I have no idea how Social Security interacts with poverty. I am pretty confident that the politicians who quote this data do not either, and I doubt that they care.
Common sense should tell us that something is amiss with this endearing myth. Social Security does not pay a penny of benefit based on need. The system does not even have visibility into need. So at best any benefit that goes to a poor person is more a matter of luck than systemic policy.
The benefit formula of the program is designed to make that outcome less than likely though. The system allocates benefits based on among other things wages and the number of years worked. So until working a long and productive career causes poverty, Social Security will never be an anti-poverty program.
Some Americans are not even eligible for its benefits. Again, until Social Security is universal, it will never be a safety-net.
Facts support common-sense. The IRS reports that in 2012 70% of tax returns filed with Social Security benefits triggered rules for filers with substantial outside income. Pew Research reports that households headed by someone 65 and older have the highest median net-worth of any age demographic.
How is it possible that anyone can confuse a system that actually pays the wealthiest segment of our society based on how much they have earned in the past with poverty alleviation?
The myth largely demonstrates that statistics remain the greatest lie. The statistic starts at the US Census Bureau, with this statement.
"Without adding Social Security benefits to income, the supplemental poverty rate overall would have been 8.6 percentage points higher (or 24.1 percent rather than 15.5 percent). People 65 and older had a supplemental poverty rate of 14.6 percent, equating to 6.5 million. Excluding Social Security would leave the majority of this population (52.6 percent or 23.4 million) in poverty." ~ U.S. Census Bureau
The factoid subsequently spins out of control on the internet. The natural extension of the raw data is that Social Security is a safety net without which a majority of U.S. seniors would be poor. The extension of that extension is that without Social Security there would be people starving in our streets when they weren't dying from exposure.
The primary problem with the statistic is that US Census Bureau measures poverty by income. The fact is that income measures productivity, not poverty. Income level may cause poverty, but it is not a sensible measurement of it. Poverty should be measured by net-worth.
The second problem is that people engaged in the debate about Social Security do not read disclosures. Both the Social Security Administration and the Census Bureau warn readers that the definition of income excludes a range of revenue on which seniors depend. Separately the authors provides a disclaimer, cautioning readers that respondents tend to under-report non-wage income. In other words, Census’s measure of poverty is based on an incomplete and imprecise measure that is known to overstate poverty in the elderly.
The US Census report does not include a disclaimer that should be present. The IRS tax rules on Social Security benefits for people with substantial outside income create a significant incentive for the elderly to appear poor. The Congressional Budget Office reports that these tax rates can approach 47%. These rules are triggered near the poverty line.
The statistics also exclude a significant factor, the cost of Social Security. If we ignore cost, any government program provides poverty alleviation. For example, pay-outs from the lottery are a great poverty alleviation tool as well. The reality of the lottery is however that you are spending a dollar to buy a dime. If we ignore the dollar of poverty, the dime of cure appears to be the greatest social program ever designed to lift people out middle-classdom.
In terms of the cost of Social Security, an average couple retiring in 2010, lost roughly $600,000 in savings over their lifetime funding the retirement of others. Is it reasonable to say that Social Security lifted that couple out of poverty by returning $30,000 in a given year? If we are going to say that Social Security lifted some millions of people out of poverty, should that figure not be net of those younger Americans who were put into poverty by the system?
Americans really do not need to know the details of how Social Security interacts with poverty. Voters need to know that someone in Washington is paying attention. Politicians, pundits, and policy experts have set policy for the program around statistics that they haven’t bothered to fully research, allowing the raison d'etre of the system to drift into a Bizarro social policy skit from Seinfeld.
I have no idea how Social Security interacts with poverty. I am pretty confident that the politicians who quote this data do not either, and I doubt that they care.
Friday, May 17, 2019
In the discussion of Social
Security, little is more unproductive and contentious than the assertion
that Social Security is a Ponzi scheme. It marks the point where the
discussion stops and the fight begins.
Is Social Security a Ponzi scheme? That entirely depends upon your meaning of the phrase.
If you use the term loosely to
describe current investors relying on more future investors, it is. But
there are many of these arrangements around if you define the word so
broadly. On the other hand, some over-qualify the term to a point where
nothing qualifies.
Who Were Charles Ponzi and Bernie Madoff?
Ponzi sold investors on a complicated investment idea that was guaranteed to make them large returns over a short period of time. Instead, he paid early "investors" with the money eagerly supplied by those who came later — pocketing millions for himself. His ruse lasted only a few months, collapsing under the weight of its own absurdity.Madoff sold investors on the simple idea of safety, promising stable returns over long periods of time. In reality, he followed Ponzi's example of paying early investors with the money from later investors — pocketing billions for himself. Madoff's scheme lasted decades, and only collapsed amid a black-swan financial crisis during which spooked investors actually wanted to hold their own money.
What Do They Have In Common?
The one thing that these men have in common is that they personally benefited from the transaction. In every dollar invested, there was a substantial probability that a portion of it would wind up in the pocket of the operator. They have little else in common to bind them together in minds of Americans.Would Social Security Have Made Madoff Proud?
The answer is no. It would have made him angry, period. While there are widely accepted rumors that the government has profited from Social Security, there is no actual evidence of it.Today, the Social Security Trust Fund holds about $2.8 trillion. That reserve sounds like a lot of profit pocketed by the government until you break it down by source. Most of the sum comes from interest, which is a cost to the government for borrowing money from the program. Since inception, the program has collected about $1.9 trillion in interest and interest on interest. Separately, the government has paid subsidies of more than $600 billion to the system from the General Fund. Thus, virtually everything in the trust fund actually represents a cost to the government.
So What Happened To The Trillions?
Virtually all of the money ever contributed by workers (nearly 99%) has been spent on beneficiaries. Since inception, the program has collected $14.8 trillion in payroll taxes, and has distributed about $14.5 trillion in payments.. In total, the excess contribution borrowed by the government is not enough even to pay for the subsidies that have been made to the system. As a result, the government has lost nearly half a trillion dollars on the program.Is Social Security Collecting A Fair Return?
Maybe the government benefited from access to the cash. Specifically, some economists argue that the excess cash that accumulated over years enabled the government to borrow at lower rates. In theory, it is possible because Social Security has created an undisputable supply of cash locked into government securities.On the other hand, the math tends to discount the size of the savings. The interest rate earned on bonds held by Social Security is based on the yield of longer-term maturities traded in the public markets. That rate is applied to whatever cash is available in June of the year. Provided the long end of the yield curve is higher than the short-end, the government isn't making a killing on the program.
Did Early "Investors" Make Money?
Yes, they did. Typically, we hear about Ida May Fuller, the first beneficiary of the program who collected nearly $23,000 over the course of her lifetime against a contribution totaling less than $25.The lesser-known fact is that she lived nearly triple the time in retirement as an average retiree of that era. Moreover, she had the good fortune to live through a series of expansions to the program via Congressional mandate, which accounted for the vast majority of her returns. As a consequence, it is exceedingly difficult to determine where the pork barrel politics ends and the Ponzi scheme starts.
To illustrate the distinction, the first farmer to receive agriculture subsidies enjoyed tremendous economic gains. Does that make agriculture subsidies a Ponzi scheme?
What Is In A Word?
The label "Ponzi scheme" isn't contributing to an informed discussion about Social Security or its financial challenges. It is a pejorative meant to scuttle the debate. The label offers no solution, and generates a bottomless rabbit hole of pointless bickering.Sunday, May 12, 2019
(Originally published on TheHill.Com)
Traditional coverage of Social Security tells voters
that if Congress does nothing, the system will continue to pay scheduled
benefits for nearly two decades.
The problem with the analysis is of course that Congress is not in a position to do nothing. It cannot ignore Social Security as the relationship between Congress and the system evolves from private banker to creditor. Over the next 15 years, Congress will have to refinance debt held by the Trust Fund much to the chagrin of those who claim that the Trust Fund doesn't exist.
The
media and experts tend to view this process as a seamless transaction
that will go unnoticed by the public markets. The reality is that the
government will have to borrow more from the public markets at uncertain
rates as it competes with private borrowers for cash. This likely means
higher rates for both the U.S. Treasury and for private businesses.The problem with the analysis is of course that Congress is not in a position to do nothing. It cannot ignore Social Security as the relationship between Congress and the system evolves from private banker to creditor. Over the next 15 years, Congress will have to refinance debt held by the Trust Fund much to the chagrin of those who claim that the Trust Fund doesn't exist.
The relationship of Congress and the Social Security Trust Fund was largely shaped by the 1983 Social Security Amendments which increased taxes and reduced benefit levels. The combine changes allowed the Social Security system to grow into the largest customer of the US Treasury Department, buying nearly $3 trillion dollars of debt from the government between 1983 and today.
This pool of money largely insulated the government from the reality of borrowing in the public markets. As excess cash from Social Security flowed into government securities, the borrowing cost of the government dropped from 10.8 percent to 2.9 percent. The latest round of borrowing from Social Security was completed at 2.5 percent.
There is nothing illegal or unreasonable about this relationship. What is unreasonable is to fail to acknowledge that the relationship is changing, and how the consequences will affect the way we pay for government.
We are looking at unwinding 30 years of subsidized borrowing over a relatively short period of time. When the Social Security Trust Fund redeems a bond for cash, the Treasury Department must find a source of funds. The government has two options: It can increase taxes in order to buy the debt or sell new debt to a new lender.
This refinancing burden arrives at the exact time that Social Security is reducing its role as the nation's private banker. In short, the best customer of the Treasury is about to become a direct competitor. Consider, if you owned a shoe store, and your best client was leaving you, it would be a worrisome event. The problem in this case is exponentially larger because the best client is leaving you so that he can open his own shoe store next door to yours.
This process is unfolding quickly. Since 2010, Social Security has largely been a player on the sidelines, financing much of the interest that it charges the government for the use of the money. For the last 5 years, the Trust Fund largely allowed Congress to stand still while the imbalances continue to grow. Every year from now on, Social Security will provide less buffer between Congress and its profligate ways.
It would be wonderful if Congress could do nothing.
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