Social Insecurity (June, 2010)

This month I decided to write on a topic that affects everyone and is a cause for great concern: Social Security. While I could write a 12 month series on the subject, I am going to narrow it down to just two! A fix to this unsustainable program is long overdue.

The other day, I received my most recent Social Security statement along with a flyer entitled “What young workers should know about Social Security and saving.” The words I read were infuriating. In big, bold print, the flyer presents the question: “Will Social Security still be around when I retire?” Of course their answer is “Yes.” but it is followed by the fact that the Social Security Board of Trustees now estimates that based on current law, in 2037, the Trust Funds will be depleted. Just last year, the year of depletion was 2041. As a 26 year old, I’ll be 53 when the Social Security program estimates that it cannot pay all scheduled benefits, still several years away from my full retirement age which is to-be-determined. I know that I am definitely on the younger end of the spectrum of workers paying into the Social Security system, but that is irrelevant. No matter what age or political affiliation, every American should be concerned with the logic behind this program and the direction it is headed.

First, let’s take a moment to define what this “Trust Fund” actually is. Most people think of a trust fund as an account with money in it. Social Security uses this term to describe the balance of taxes taken in verses benefits paid out. Over the years, Social Security has taken in about 1.2 trillion dollars more than it has paid out. This money has been used to purchase bonds of the federal government. The interest earned on these bonds has been paid back to the Trust Fund in the form of yet more bonds. As of the end of 2009, the Trust Fund now holds 2.5 trillion dollars worth of these bonds.

This whole process of course is absurd. You can’t lend or borrow money from yourself. The reality is that this excess cash that the government has been receiving over the years has simply been spent. Therefore, the source of the money used to pay the monthly Social Security benefits currently comes from that month’s payroll taxes. It is estimated that in 2017 we will reach the point where Social Security outflows are greater than payroll tax inflows. This is really when Social Security becomes insolvent. The 2037 date mentioned earlier is when the scheduled benefit payments will even consume what is in this supposed Trust Fund.

Reading on in the flyer I received, I am reassured that just because the trust fund will depleted does not mean that my benefit payments would disappear. There should still be enough funds to pay about $760 for every $1,000 in benefits scheduled. If I’m going to receive less benefits, that means I should pay less into the system, right? No way. As you will see in a moment, there has been a severe upward trend in taxes paid since origination of the Social Security system. But tax increases alone would not be anywhere close to enough to make Social Security sustainable. There has also been a lot of talk about changing the indexing of benefits to include all years instead of just the highest 35 years and raising the retirement age, both of which decrease the benefits we receive without lowering our tax burden, clearly a lose-lose situation for every taxpayer. Not to mention the government thinks it is acceptable to tax up to 85% of the Social Security benefits some retirees receive after they have already paid taxes on that income.

Let’s take a quick look back at Social Security in the beginning. It was signed into law by Franklin D. Roosevelt in 1935 as part of the New Deal. Its main components are Old Age, Survivors and Disability Insurance, with Disability only accounting for a fraction of the tax revenue and expenditures as one has to be pretty much desolate to qualify. It is important to understand that the system today has little resemblance to the system 60 years ago. One of the biggest, and worst, changes in the management of this program occurred when the LBJ administration and Congress merged the Social Security tax receipts into the general fund of the Federal government in 1968. This was done to mask the size of the increased spending and budget deficits of the Federal government.

Another major change over the years has been in the level of wages that are subject to Social Security taxes. The original limit when the system was started was $3,000. This means that the employee and employer only paid SS taxes on the first $3,000 the employee earned per year. In addition, the tax rate was only 3% (1.5% each). This limit was not put in place to give the wealthy a break. Instead, it was created to establish a sensible link between the amount paid in and the benefits paid out for an individual. Although the income cap and tax percentage rate were periodically raised, there was still a reasonable relationship between the amount one received from disability, survivor or retirement benefits and the lifetime taxes paid. In 1970 this limit was $7,800 and the tax rate was 7.3%. It is interesting to note that between wage limit increases and tax rate increases, the total annual taxes paid increased 2.5 times during the 1960’s – the first sign of trouble.

Year	Wage Limit	Old Age and Survivor’s Tax Rate
1950	$3,000	3%
1960	$4,800	5.5%
1970	$7,800	7.3%
1980	$25,900	9.04%
1990	$51,300	11.2%
2000	$76,200	10.6%
2010	$106,800	10.6%

After Social Security was merged into the general fund the program became nothing more than a tax collection tool for every other expense in the federal budget. There is no better evidence of this than the fact that the cap today is $106,800 with an applicable tax rate of 10.6%. President Obama has proposed raising the income cap and has said “the nation's "most regressive tax" needs to be revamped to increase revenues to the retirement fund and spread the burden of paying for the program more evenly.”

When I flip over the page of the flyer, I am lectured on the need to save and invest as Social Security is only meant to replace about 40% of annual preretirement earnings. As a financial planner, I fully appreciate the benefits of saving and encourage everyone to do so. That being said, I have to make the following point. Study after study has shown that if a person saves 10% of all income over their working years, he or she will be able to retire comfortably. Between my employer’s contribution to Social Security on my behalf (which could be paid to me in salary if not owed to the government) and my contribution, I am “saving” 10.6% per year, but I’m only supposed to receive 76% of 40% of my preretirement income. The math just does not work out in my favor! And by the way, I am saving this money into the general funds of the federal government which is then used to fund all sorts of government expenditures.

I’ve grown up being told not to count on Social Security being around when I retire, but NOTHING has been done to correct or even mitigate the forthcoming disaster. So what is the solution? One word: privatization. And no, that does not mean trusting your retirement to the whims of the stock market! Why would anyone think it is a good idea for the government to manage money when they currently have a 1.3 trillion dollar deficit and can’t seem to stop spending? Stay tuned as next month I will discuss privatization and its criticisms as well as other proposed alternatives.