How Did We Manage To Lose That Much Money?

by JoeTheEconomist December 2, 2011 4:51 AM

Depending upon whom you ask, the Social Security trust fund is either the “greatest accomplishment in the history of government” or nothing more than a “collection of accounting tricks designed to benefit the political class at the expense of the working class.” Both statements have been used to describe the exact same system.

Compounding the problem is the fact that both sides point to the same source of data, the Social Security Trustees Report for 2011, to support their claim. Proponents of the system point to the projection that the system is projected to be solvent until 2036 (page 1). The other side of the argument points to a different page in the same report (page 14) that says that the system has made 20.4 trillion dollars of promises for which there is 2.5 trillion held in trust leaving a 17.9 trillion dollar shortfall. How are polar opposites possible?

In Washington, the number of beans is never as important as how you count them. In 1944, the Chairman of the Social Security Board testified that “There is no question that the benefits promised under the present Federal old-age and survivors insurance system will cost far more than the 2 percent of payrolls now being collected.” He projected that real cost of the system was closer to 7% of payrolls.

Of course, Mr. Altmeyer counts in one way, and Congress counts in another.  Congress treats payroll taxes as revenue, and includes the cost only when it is paid. So payroll taxes collected in 1940 are revenue in 1940, where as the promises associated with that revenue are a distant future expense. Those costs from 1940 would filter slowly into the system through 1990. So when someone says that there is a surplus or that Social Security has “made money every year for 70 years” it is based on the idea that the promises to take that money have no cost. It is easy to make money when you take money from 16 people and only count the cost of 1 of them.

In other words, payroll taxes were basically free money. It should surprise no one that Congress spent it like drunken sailors. Congress waived every one of the payroll taxes increases promulgated under the original law. Instead increasing the costs to the recommended level, Congress increased benefits in 1950, 1952, 1956, 1958, 1960, 1961, and 1965. While costs increased, the cost of old age retirement insurance would not reach the 7% level requested in 1944 until 1981! By 1983 – the system was insolvent and had to borrow funds to pay benefits.

In 1983, the Social Security system had zero cash, and the overhang of costs that had been accumulating untabulated since the start of the system.  Washington chose to ignore the long-term costs, and came up with a short-term solution, raise taxes and cut benefits. The reality is that every payroll tax dollar received was either spent on early expenses or held in the trust against the accumulating costs of promises held in the system. 

We increased taxes and cut benefits 3 different times; in 1977, 1983, and 1993. Each time we were assured that the system would be sound for the next 50 years. Each time the promise lasted last than 10 years.  In 1977, the government projected that the system would be whole for the next 50 years, and within 6 it was completely insolvent.

Supporters of the system believe that these costs will be carried by future generations. Ben Bernanke has said that the higher costs should be borne by future generations because he believes that they will have a higher level of productivity to offset the higher costs. In this sense they justify the accounting that the costs should be associated with the future expense.

His statements are not supported well by the data. When Social Security says that the system is solvent until 2036, it assumes that future generations will be contribute to the system at the same rate as they have in the past. By comparison, workers of today have very low income tax burdens. In 2010, nearly 50% of the public has no income tax obligation. It is a generous assumption that future generations will be able to maintain the same contribution rate in the face of rising income taxes needed to support the national debt. Basically, the assumption is that future generations will pay the taxes that we ourselves haven’t.

How reasonable is that assumption. The latest data coming from Pew Research suggests that it is highly unlikely. Their research shows that poverty in households lead by someone 35 and younger has doubled over the past 40 years to 22% . So we are depending upon a group of people to keep retirees out of poverty when the group has a hard time keeping itself out of poverty. Beyond being unable to escape poverty, this group has historic levels of look-through debt from the government on a per capita basis.

The system has made 20 trillion dollars of promises, and holds about 2.5 trillion in funds. The system increases the costs of production here by 15.3%. It is literally an anti-tariff, encouraging companies to produce goods elsewhere. And there are those who want to increase payroll taxes on the rich. One needs to explain to the next generation why we increased taxes to shore up our retirement system instead of controlling their debt. In the end, tax increases do nothing but shift more of our tax base to retirees and away from debt control and encourage companies to move more jobs off-shore. The status quo is insane. We need to recognize the costs of the system, and more importantly we are going to need to figure out how to pay for them. 

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The Results Of Chile And Other Privatization Efforts

by JoeTheEconomist November 26, 2011 12:35 PM

Many of the proponents of privatization point to the success of privatization in Chile and Galveston County.  These people would like to model a new version of Social Security based on the systems in place in these places.  The proponents claim that we will see similar results if we implement the plans here.  And the question that voters should ask is whether that is a reasonable assumption. 

Are the successes of these efforts likely to be repeated in the United States?  For example, it is possible for me to slam-dunk a basketball on the moon, where as it is not possible when I am on earth.  There are differences in the environment.  The voters should ask whether the environmental differences between Chile and/or Galveston County make a reasonable benchmark for the future results of a privatized Social Security system. 

There is a significant difference in timing.  Both Chile and Galveston County started in or near 1981.  So these systems coincided with probably the greatest bull market run in the history of the world.  And if we could go back in time, it would have been a good idea to replace Social Security in 1981 with a privatized system.  That does not mean that it is a good idea to replace Social Security with either system today.  Keep in mind, countries that privatized in the late 90s and early 2000s have not had similar success.  I have never been very good at timing markets, so to me it does not make a lot of sense to use systems which perfectly timed the bull-market as a benchmark.

I am not sure that the systems are that similar.  The Chilean system covers less than 50% of the population, not 96% of the work force as Social Security does.  The Galveston County system covers government workers which provides for longer employment duration than the United States as a whole.  Chile has a very different standard of poverty than America does.  So I am not sure that the success in Chile means much in terms of the United States and Social Security.  I really don't know.

This article may shed some light on the question.  "Social Security Privatization: What the Candidates Can Learn from Central Europe and Latin America" was published by the National Association Of Social Insurance.  I will caution you that the author seems a little biased against the concept of privatization: she sees privatization as "redistribution of wealth toward the wealthy".  That reasoning isn't explained.  The rest of the article is worth your consideration. 

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Privatization

Are You Serious About Social Security Reform

by JoeTheEconomist November 10, 2011 4:33 AM

I get a fair amount of email from people who have worked tirelessly on the issue of Social Security.  And they are frankly discouraged.  They have written letters, travelled to DC, published reasoned articles, and poured untold hours of effort into the cause.  The grand sum of their efforts is a form letter from a Congressman.  

If entitlement reform is important to you, the first thing you have to do is realize that you aren’t alone.  When you look at polls of Americans, roughly 80% believe that the system is heading for a crisis without a major reform.  Given that there are roughly 150 million voters in America, there are roughly 120 million people who think like you do.  You can’t throw rice at a wedding without hitting five people who think that the system is broken.

How is it that 120 million people want the system changed, and the politicians do nothing?  The answer is pretty simple.  The 120 million people aren’t organized.  Congress is willing to shutdown every American business because a handful of people who want to protect a animal with a name that they can’t pronounce.  Why is Congress so responsive to a vocal minority, and completely clueless on the issue of Social Security? 

The fact is that Congress is much more attuned to 500 organized people than the interests of 120 million individuals.  This may be the outcome that the media is much more attuned to an organization than an individual.  The only way that you will achieve any success in Entitlement Reform is to organize with like minded people.

The best place to organize is internet which is fully loaded with social media.  Sites, such as Facebook or GooglePlus, allow you to search for groups.  You should sign-up for as many groups as you can.  As you join more groups, the chance that you will connect with one that is successful increases.  You want to connect with as many people as possible, and suggest that they contact as many people as possible.

In terms of Fix Social Security Now, we have multiple Facebook pages and a number of groups on politically active sites.  We encourage people to join our community on Facebook.  We encourage them to start new efforts.  We would be only too happy to fold our page into a more successful page.   

We encourage people to take our logo as their profile picture.  The point here is that you want people to see and think about Social Security reform every day in forums across the political spectrum.   You want the visible presence to get new users to ask about the cause, and for existing members to see that they are not alone.  You want staffers, lobbyists, and Congressman to know that you are organized. 

If you are going to lobby Congress, your members have to adhere to the same script.  If 10,000 people call to support Social Security Reform, it is 10,000 calls.  If 10,000 people call and say the exact same words, it is an organization.  One is heard and the other is just 10,000 calls.

It is not enough to tell your kids that you wanted Social Security Reform.  You need to show them that you did something about it.

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Social Security And The Constitution

by JoeTheEconomist November 4, 2011 5:50 AM

First, I don't know whether Social Security is constitutional or not.  Personally, I don't see the authority granted in the Constitution, but I don't get paid to interpret the Constitution.  The nine Americans who do get paid to struggle with the meaning of the Constitution say that it is constitutional.  The governance of our country gives this power to these nine people whether I agree with their decisions or not.

I don't get involved in the discussion because whether it is constitutional or not will not change the outcome of 70 years of an unconstitutional government program.  Over those years, Social Security transferred wealth from the working generation to seniors.  As a result, we cured poverty in the elderly class by creating it in the working class.  Proponents say that Social Security keeps 13 million seniors out of poverty, but they strangely never ask how it is that 13 million seniors arrived at retirement in poverty.  Well the answer is Social Security.

As payroll taxes have risen, we have seen a corresponding drop in savings. People have less from which to save once the first 12.4% of their income has been taken and distributed to other beneficiaries. As people save less, they lose not only their contributions but the earnings on their contributions. For the person born in 1970, the average cost of Social Security has been more than $500,000 in lost savings.

So if we decide that Social Security is unconstitutional, what happens?  There are millions of people in the 40-55 year-old bracket that have lost savings.  Do they simply lose out? Unless you are ready to make them wards of the state, another unconstitutional concept, we will have poverty levels never seen in this country's history as people who were deprived of savings reach retirement with no nest egg on which to retire.

The crisis is on the way.  We have increased our payroll taxes in large part by decreasing our income taxes.  Today roughly 50% of the country has no tax obligation.  Many of these people pay payroll taxes from which there are no exemptions, deductions or credits.  While we have been funding our retirement account, we have put the rest of government on the children's credit card.  Now we expect our children to both retire our debt and provide income to supplement our retirement.  We expect them to do what no generation in history has done.

Today, we are largely blind to the crisis because we are able to print money or issue debt obligations that make the system work.  Debt is simply more demands on the future revenue that we need to keep Social Security solvent.  When we lose the ability to issue debt, and we will at some point, the crisis of Social Security will start in earnest.  At that time, the working generation will face a choice they can either pay more in income taxes to pay down their parent's debt or they can pay more in payroll taxes in order to support the retirees who created the debt.

The crisis will require government action that will be unconstitutional.  So if I don't ask whether Social Security is constitutional it is largely because I know that the cure will not be. 

 

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Social Security Adds To The Deficit Every Year

by JoeTheEconomist October 22, 2011 6:26 AM

One of the talking points in DC today says that Social Security has not added one penny to the federal government’s  budget deficit.  In its most extreme form, you will hear that Social Security has actually reduced the deficit.  When you hear it, keep one fact in mind: in politics, the number of beans is never as important as how you count them.

Only in DC can you spend ½ a trillion dollar every year, and it is not part of your deficit.  Better yet, only in DC can you spend ½ a trillion dollars every year, and it cuts your deficit.  It is like when I tell my wife that the cheese cake I am eating actually burns calories as I move the fork to my mouth.  Yes, it is absurd.

The politicians say it because voters want to hear it, just like you want to hear about a weight control program that consists of cheese cake.  In the minds of these politicians, Social Security is a closed system which operates in a world in which people like taxes.  In such a world, Social Security would not contribute to the deficit.

The problem is of course that Social Security is not a closed system and people do not like taxes.  Payroll taxes affect jobs.  In fact, they kill jobs.  According to the Congressional Budget Office, lowering payroll taxes from 15.3% to 13.3% will create as many as 7 million jobs.   Social Security portion of payroll taxes is 10.6%, not 2%.  So Social Security costs millions of jobs and billions in income tax revenue.  Of course, in the mind of politicians, Social Security taxes do not affect jobs.

Payroll taxes increase cost of hiring Americans by 15.3% which makes our goods less competitive in world markets.  In my case, I was a programmer in a world where the government added 15.3% to my labor cost but didn’t add it to imported labor.  Technology is a very labor intensive business.  So a major part of that industry is now offshore.  But in the world of the politicians there are no job losses.

Payroll taxes decrease the incentive to work overtime or work longer in your career.  Payroll taxes reduce your take home pay by 15.3%.  Payroll taxes can reduce your take home by more than $15,000.  In the case of older workers, this cost will have little impact on their benefits.    So many older workers retire early who value their time.   The problem is that this group is apt to be concentrated in high-income earners who would be paying income taxes.  But in the world of the politicians, no one retires early.

Payroll taxes also affect income taxes.  As payroll taxes go up, income taxes have to come down, unless people like taxes.  There is a maximum amount of taxation that the economy can carry.  When one tax goes up, others have to come down in order to maintain the balance.  Historically 19.5% of GDP is roughly the maximum.  When payroll taxes are 15.3%, it leaves very little left over to collect for low-wage workers to pay income taxes.  This is why people who earn the top 51% American households have no income tax obligation.  Basically we are paying into our retirement accounts, and putting the rest of the government on the credit card.  I am not sure how that doesn’t add to the deficit in the minds of politicians. 

Washington Record On Safety And Soundness

by JoeTheEconomist October 12, 2011 10:39 AM

In 2008 we learned that Washington does not fully appreciate financial risk.  They failed to take any precautions, and described the events fast-moving.  In constrast, Warren Buffett warned us in 2002 about the dangers of derivatives.  In 2007 and well into 2008, Washingon continually underestimated the seriousness of the problem.  It produced one bad solution after the next.  From the "Super-Fund" to the Bear Bail-out, Washington always had an idea that was too little too late.

These events weren't unforeseeable.  Buffett forsaw the crisis, and built a 35 billion dollar reserve to take advantage of the crisis.   

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other….  In our view derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal..”

~Berkshire Hathaway Annual Report 2002

 Fair enough.  How successful has Washington been in protecting the safety and soundness of any system.  Let’s look at banking.  The government was surprised by the dangers of 35 to 1 leverage in the banking industry.  Washington described “derivatives” as useful tools held in the hands of well-capitalized sophisticated investors.   Half were, and the other half was in the hands of AIG.  Over a period of a few months, these investments wiped out Bear Stearns, Lehman Brothers, and AIG costing the tax payers hundreds of billions of dollars. 

How did you possibly miss the housing bubble? How could you say at the peak of this three-Sigma event--a one in 1,000 year event at the top of 2006--how could you say the U.S. housing market merely reflects a strong U.S. economy? Surrounded as you are by all this statistical help, and with your experience with the Great Depression, how could you miss it?

~Jeremy Granthom A Question For Ben Bernanke

Let’s look at housing.  In 2006, Washington said that the strength of housing prices reflected a strong economy.  Washington didn't just misgauge the housing market.  It suggested that the housing market was fine despite being a levels of overvaluation that occur about every 1,000 years. 

And you want to allow government to define how you can invest your retirement funds?

 

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Guarantees Will Create Risk, Investment Lists Will Concentrate It

by JoeTheEconomist October 12, 2011 10:25 AM
Investment without risk is like Christianity without Hell.”

~Warren Buffett

Washington's Idea Is Bad

We oppose guarantees because they encourage unwarranted risk taking.  Guarantees enable workers to invest on unnatural terms.  If the investment wins, I win.  If investment loses, the taxpayer loses.  This will create very lazy investors, who are solely interested in chasing assets that generate a maximum return.  This is the exact mind set which enabled our economy to position itself on a financial apocalypse in 2008.

Washington's Solution Is Worse

Washington expresses its concern by seeking to create oversight boards.  The idea is that an investment board will select safe investments.  Unfortunately, these policy wonks clearly miss the point.  Risk isn’t just in the viability of the business.  Risk is expressed in the price of ANY asset.  If Washington creates a narrow list of approved investment, risk-tolerant money will chase safe investments until they are risky.  When you subsidize risk, you will create risk. 

In short, Washington’s solution is to create risk in our most stable companies.

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Privatization

Guarantees And Private Accounts

by JoeTheEconomist October 12, 2011 10:09 AM

We are very critical of the idea that workers should be able to invest retirement money in accounts which are guaranteed by the government. 

WASHINGTON DOES NOT UNDERSTAND RISK

Virtually all of these plans create some kind of investment list which is intended to limit the free-risk that workers can take.  This idea tells you how little that Washington understands risk.  This approach doesn't limit risk, it concentrates risk in whatever assets are on the approved list.  learn more

WASHINGTON'S RECORD AT PROMOTING SAFETY AND SOUNDNESS IS AWFUL

Washington's record for monitoring the saftey and soundness of any financial system is awful.  They failed to protect housing.  They failed to protect banking.  What makes anyone think that Washington will be any more successful at protecting worker's retirement.learn more

WHO WILL PROTECT THE SYSTEM FROM WASHINGTON

This approach will increase the footprint that Washington creates in our stock markets.  When Washington creates a list of approved companies, it creates "access".  Access to the approved list will be highly valued.  It is a matter of prestige.  It is a matter of cost of funds.  Access will be worth a LOT OF MONEY.  To give you some prospective, the S&P 500 is a similar list which drives investment decisions.  Access to this list can be worth hundreds of millions of dollars.  It is difficult to imagine how Washington plans to protect retirees from political influence because every district will have a company that wants "access" to cheap-funds.

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Privatization

The Problem With Guaranteeing Privatized Accounts

by JoeTheEconomist October 12, 2011 9:31 AM
Investment without risk is like Christianity without Hell.”

~Warren Buffett

We generally oppose any privatized solution which guarantees the investment returns of a retirement account.  If workers want to invest their retirement money in lottery tickets, it is up to them and they must accept the consequences.   This isn't cruel.  It is necessary to protect the rest of us from fools armed with other people's money.

Guarantees encourage unwarranted risk taking.  Guarantees enable workers to invest on unnatural terms.  If the investment wins, I win.  If investment loses, the taxpayer loses.  This is the exact mindset which enabled our economy to position itself on a financial apocalypse. 

Washington expresses its concern by seeking to create oversight boards.  These policy wonks who have never bought or sold a stock completely miss the point of risk.  Risk isn’t just in the viability of the business.  It is expressed in the price of ANY asset.  If Washington creates a narrow list of approved investment, risk-tolerant money will chase safe investments until they are risky.  When you subsidize risk, you will create risk.  In short, Washington’s solution is to create risk in our most stable companies.

On a very good day, this idea is simply foolish.  It strays into the realm of dangerous because Washington, which clearly does not understand risk, wants to be in the position to manage risk on our behalf.  They want to create an investment list of suitable investment to ensure the safety and soundness of the system.  

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other….  In our view derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal..”

~Berkshire Hathaway Annual Report 2002

 Fair enough.  How successful has Washington been in protecting the safety and soundness of any system.  Let’s look at banking.  The government was surprised by the dangers of 35 to 1 leverage in the banking industry.  Washington described “derivatives” as useful tools held in the hands of well-capitalized sophisticated investors.   Half were, and the other half was in the hands of AIG.  Over a period of a few months, these investments wiped out Bear Stearns, Lehman Brothers, and AIG costing the tax payers hundreds of billions of dollars. 

How did you possibly miss the housing bubble? How could you say at the peak of this three-Sigma event--a one in 1,000 year event at the top of 2006--how could you say the U.S. housing market merely reflects a strong U.S. economy? Surrounded as you are by all this statistical help, and with your experience with the Great Depression, how could you miss it?

~Jeremy Granthom A Question For Ben Bernanke

Let’s look at housing.  In 2006, Washington said that the strength of housing prices reflected a strong economy.  Washington didn't just misgauge the housing market.  It suggested that the housing market was fine despite being a levels of overvaluation that occurs about every 1,000 years.  And you want to allow government to define how you can invest your retirement funds?

 

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Privatization

Commentary On Plans Which End Social Security

by JoeTheEconomist October 6, 2011 7:44 AM

Some people have come to the conclusion that the Social Security system cannot be saved.  They believe that Social Security is mathematically certain to fail.  Some analysis is limited to the size of the unfunded liability that exists today.  Others point out that the mathematics of the system are unable to succeed regardless of what we do to taxes and wages.

Our general opinion is that we should fix the structural problems within the Social Security system before we come to that conclusion.   But it is difficult to fault anyone who bypasses this step given the gridlock in politics today.  So the question is: what makes one plan better than another?

Our goal is to ensure that the system does not meet an unplanned end.  We believe the worst versions of this idea protect current retirees and those near retirement.  We believe that this approach has the greatest chance of creating an unstable end.  We believe that this approach will only foster inter-generational tension that will make Social Security a massive target , once the tension builds into a voting majority.  When that end comes, it will be swift and unplanned.

An unplanned end will have significant repercussions.  The lesson from the financial crisis of 2008 is that our economy is interconnected.  As one part fails, another part of the economy suffers.  When one bank failed in NY, an auto dealer in Georgia was forced to lay-off employees.  Social Security is more than a trillion dollar business, directly affecting more than 50 million Americans.  The interconnectivity of that failure will be much larger than that of the Financial Crisis of 2008.

We believe that the majority of these plans face a significant problem. Virtually all of these plans all depend upon young workers continuing to contribute to Social Security fully knowing that they will get nothing.   Today, Social Security taxes are loosely connected with benefits in the mind of the taxpayer.  Even if it is a terrible deal, workers believe that they will get something back.  The view of payroll taxes will change once we sunset the system.  The view will change from it is a bad deal to it is a tax. 

We envision that this change in perception will foster a considerable amount of inter-generation tension at the ballot box.  Every year, the voter's perception will get worse has you add young workers who experience a tax, and a declining number of people who still get benefits.  Voters will already blame retirees for the budget deficit that the workers have to support.  In conjunction, we envision Social Security coming to an unpredictable end as the most likely outcome.

Here are the things that we look for in a sunset-plan:

First, and most importantly, if these people are correct – and they well may be – Social Security is a national problem.  The solution must be passed on to all Americans; not a narrow group. 

Second, the shared-solution must persist over time.  We strongly believe that no voting majority should be able to insulate itself from the pain of unwinding process. If such protection occurs once, it will occur again once the mix of the majority changes.  The worst solutions imaginable are those that protect the beneficiaries today.  This will only shift the costs of dissolving the system to other Americans.  If the burden is placed on younger workers, we envision that they will become a voting majority overtime, and vote the whole system away.

Third, the solution should recognize that today’s workers have contributed significantly more to the system than any other generation.  Their contribution has largely created a pocket of lost-retirement savings.    

Fourth, in 2008, the nation learned about the interconnectivity of the economy.  The problem for the economy wasn’t the failure of one bank, but the failure of parts of the economy which failed because of the failure of one bank.  It is not possible to sunset a trillion dollar business without seeing connectivity to other parts of the economy.  The plans should take into account how sunsetting Social Security will affect other industries.

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