In 2010 President Obama’s Deficit Commission (ODC) announced some findings regarding, among other areas, Social Security. The result of all this political brain power are proposals to raise the full retirement age (again), raise the income subject to taxation (again), raise the minimum benefit amount (again), add (more) means testing, lower the cost of living adjustment (by changing how it is calculated) and enact a variety of bureaucratic administrative changes. Their combined efforts amount to little more than rough tweaking and kicking the SSA can down the road another 50 years. So they say. Given the obvious failure of the 1983 Greenspan Social Security Commission whose “solutions” didn’t even last 30 years it is highly unlikely that the ODC proposals will make it that far if they even see the legal light of day.
Missing from the political discussions of Social Security (SSA) is any description of the of actual program versus the rhetoric used to describe the program. Rhetoric from opponents of SSA claim individuals could obtain higher retirement benefits if they invested their own social security taxes and that SSA bankrupts the young to support the old. Rhetoric from supporters of SSA claim it is good social policy with descriptions ranging from insurance against senior poverty to wholly earned benefits. Neither side provides even a basic understanding of the actual SSA program. Instead they are content with tossing rhetorical fire bombs left and right.
To examine today’s SSA program in operation it is useful to determine how initial benefits payments related to the SSA taxes paid in to the system over a theoretical working career. If taxes paid amounted to less than benefits received then the recipient would be receiving some portion of welfare in their SSA benefits. If taxes paid were more than the benefits received then those individuals would, in effect, be subsidizing the benefits of the welfare group. One could certainly consider that subsidy as an ongoing “tax” paid by those, usually higher income, workers.
Chart #1 depicts the initial maximum SSA benefit provided in the year of retirement versus the level of benefit provided by the assumed SSA Earned Annuity. The earned annuity is a fixed payment lasting for 22 years and is dependent on the amount of SSA taxes paid. The higher the tax paid the higher the initial annuity. Thus the annuity beginning in 2007 is much higher than the annuity in 1987. And so were the SSA taxes. The initial SSA benefit assumes the maximum benefit payout in the year of retirement. While there was a flattening of this curve from 2002-2004 it otherwise is rising each year.
The key point in this chart is the difference between the two curves. From 1987 through about 1998 the maximum SSA benefit was far above the assumed earned annuity. The difference represents a welfare payment to the benefit recipient. In later years, starting about 2000 the earned annuity rose above the initial maximum SSA benefit. The difference this time represents earned income that is taxed away.
Using data from the SSA website I created a spreadsheet that links maximum tax payments with maximum SSA benefits over the period 1937 through 2010. For its own reasons the SSA website assumes a 40 year working career. Thus someone retiring at the end of 1976 who worked the full 40 years and who paid in the maximum amount of taxation each year would have paid a total of $6,962 in SSA taxes. Their employer would have paid the same amount. Upon retirement at the end of 1976 this worker would be eligible to receive an SSA benefit of $3,427 per year. In just under two years this worker would have received back every dime they paid in SSA taxes. And this assumes the worker retires with reduced benefits at age 62.
That same worker retiring at 65 would receive $4,368 per year if a man and $4,546 per year if a woman. [There is a period from 1962 through 1977 when women aged 65 received a larger maximum SSA payment than men. It was 1962 through 1974 for women aged 62.] A woman retiring at 65 in 1976 would receive her entire SSA contributions back in just under 1 ½ years. A man would receive his back in just over 1 ½ years. But each would continue to receive those payments, along with inflation adjustments for the rest of their lives. Was that benefit earned or is it welfare?
Reasonable arguments regarding the earned versus welfare aspect of SSA benefits can be made on three grounds: (1) employer contributions are not included; (2) prospective earnings on the SSA contributions are not included; and, as always, (3) the situation is different now. Fair enough.
Employer Contributions: as a small business owner and employer, if I was not required to pay SSA taxes based on employee wages that money would not accrue to my employees. This is after all a tax on my status as an employer. If I had partners or utilized sub-contractors no SSA tax would be charged. Certainly some of that tax might find its way to the employees for competitive reasons but it is highly unlikely that all of it would accrue to them. More importantly that tax is no more the employee’s money than the income tax, property tax, unemployment tax or worker’s compensation tax. However, there is a substantial argument regarding the employer portion of SSA taxes. That money provides a revenue stream to the government be used for the other benefits (disability, spouse, etc.) currently provided by SSA.
Earnings on Contributions: this argument could turn either way depending on the investment return being assumed. It may or may not be sufficient to cover a retirees SSA benefits. There is a myth that individuals could have earned a far better return on their SSA tax than is implied by the benefits paid. Maybe, but not very likely. Consider that as long term retirement savings it is not reasonable to assume that individuals would be able to invest their SSA taxes in the stock market (or any other market). No rational person wants the government to do so and politics argues against letting individuals do so on their own behalf. If individual investors or markets temporarily failed it could result in a massive taxpayer cost for outright welfare support during retirement. (Politics would require a bailout whether I agree or not.) That would be a prime example of public risk versus private gain albeit on an individual basis. There is another alterative the Retirement Certificate of Deposit (RCD).
In order to estimate the earnings power of SSA taxes I assumed that individual employee SSA taxes earn the higher of 6% or the 10 year treasury bond rate and that all earnings be tax free. Accumulated contributions would be compounded annually and the rate would adjust annually depending on the then current 10 year treasury bond rate. Note that since 1968, 30 years had a 10 year treasury bond rate above 6%. This may seem rather conservative but then again, a conservative investment policy for retirement funds is wholly reasonable. As a example of how this might work we could assume all SSA taxes are held in a bank retirement certificate of deposit or RCD on behalf of each individual worker. Each year the bank accrues the current taxes and then pays the higher of 6% or the 10 year treasury bond interest rate on the total sum which is compounded annually. Note that a 6%, tax free, guaranteed rate of return provides good value compared to the 10% average historical stock market returns. Yes, government would be required to subsidize the interest rate as necessary to ensure the minimum 6% rate of return. Where might that money come from? From the employer portion of the SSA tax.
On this basis our worker who retired in 1976 after 40 years work, paying SSA tax at the maximum rate and receiving the aforementioned return on those taxes would accumulate a total of $14,439 of which $6,962 was actual taxes. At the maximum SSA benefit level of $3427 per year at age 62 the payback takes just under 4 ¼ years. At $5069 for women age 65 the payback takes just over 3 years 2 months. But the payments continue, with partial inflation adjustments for the rest of their lives. Since SSA uses a life expectancy of 22 years that means roughly 18-19 years of welfare payments for the 1976 retiree.
It’s Different Now: yes, actually it is different now but not all that much. It was earlier noted that the employer portion of SSA taxes is unlikely to accrue to the individual employee. Either because the employer would retain all or a portion of them or the government would utilize that revenue stream for other purposes. And, in all likelihood that’s exactly what would happen. So only the individual portion of SSA tax could be invested in a bank RCD on behalf of each individual while the employer portion of the tax would be retained by the government. It would be used for such purposes as: (a) subsidize the 6% retirement earnings as necessary; (b) provide for the disabled; (c) provide for non-working spouses or other individuals; and (d) pay existing retirees their benefits. Note that items (b), (c) and (d) are existing SSA programs. Good arguments can be made to shift all or some of those existing programs to general welfare as a more appropriate funding source but that’s another issue.
It is reasonable then to only look at the individual portion of SSA taxes versus benefits to determine how much welfare – if any – exists in the program today. An individual retiring at the end of 2009 (the first of the baby boomers) after working 40 years and who paid the maximum amount of SSA taxes would have paid in $115,800. If we assume the 6% RCD earnings scheme noted above the taxes plus earnings would amount to a combined total of $333,826. Continuing the 6% earnings scheme through retirement and assuming a life expectancy of 22 years that amount provides an annual annuity of $27,723. But only for 22 years. And no inflation adjustment either.
However, an individual with that work history who retires at age 62 at the end of 2009 would today be awarded an SSA benefit of only $21,228 per year. Thus today’s baby boomer retiree would be forgoing earned benefits of $6,495 per year (reduced by any future inflation adjustment). However, if that worker were married their spousal benefits would be $10,614 or $4,119 in net unearned – welfare – benefits. Of course that would be reduced by the work history and SSA taxes of the spouse.
Chart #2 is similar to Chart #1 except that it shows the SSA benefits as of the beginning of 2011 instead of the initial maximum at retirement. While the earned annuity curve has not changed the series of cost of living adjustments (COLA) has raised the SSA benefit level well above the annuity curve until the year 2004. Retirees from 2004 to the present who paid the maximum SSA tax and who could receive the earned annuity amount are actually receiving less from SSA than they would from the assumed annuity. More recent retirees are receiving considerably less. Again, this represents a tax on high earning retirees.
If instead this boomer retires at the end of 2009 at age 65 their SSA benefit would be $26,064 or $1,659 below their “earned” amount. Of course spousal benefits would raise the total accordingly well above the “earned” amount depending on the spouse’s work history. The significant point is that while SSA Welfare isn’t as substantial for boomers as it is for WWII’ers even today’s boomer retirees could receive major welfare payments (if married) in the guise of SSA benefits. Single retirees however, end up subsidizing others. So, yes it is different today but only in degree.
Millennials: How will it be tomorrow for today’s millennials? Well, the bottom line is that since 1999 high earners (if single) began receiving less in SSA benefits than they would by investing and annuitizing their own tax payments. This trend will only be exacerbated as full retirement age is increased, as income levels are raised and as the tax rate inevitably increases. The trend then is for the upper earner millennial to become more and more a subsidizer of lower income earners. At some point in the future even the addition of spousal benefits may not shift a high earner into a welfare recipient. This can only be considered as a stealth tax on high earning millennials above the federal income tax and hidden from view by bureaucratic dictate.
What is important to take away from this exercise is that whatever the rhetoric, social security was clearly designed in the form of a massive Ponzi scheme that required an ever larger number of workers to support current retirees. When that quickly became impractical the tax rates and income levels were raised in lieu of additional workers. Indeed, were it not for those who die before receiving benefits or who die early after receiving benefits (thus cheating their families out of their tax payments) the SSA program would have long since imploded. Adding fiscal injury to monetary insult one Congress after another purchased votes by raising benefits, expanding eligibility, and adding inflation protections. Again the total cost as well as tax rates and income levels rose dramatically. From an original 1% tax on the first $3000 of wages in 1937 (over $45,000 in current dollars) the cost has risen twelve fold to a 6.2% tax on $106,800 (and rising) of wages. The worst of both worlds.
Regrettably as the 1983 Greenspan Social Security Commission did so does the Obama Deficit Commission. Both simply tweak the system and kick the SSA can down the road. There is no discussion of the inherent structural flaw of the SSA program. By continuing the dishonest assumption that SSA benefits are somehow fully “earned” workers (and non-workers) continue to expect to receive those benefits. Yet even today a high earner with a non-working spouse continues to receive unearned benefits especially as they live beyond the actuarial life span. A more honest explanation of the structural flaws in the program would provide a firm basis to propose more realistic and responsible long term solutions that might provide some financial security for individuals and their families without robbing their neighbors or their children. It’s time to trust the people with the truth.
My proposal is to vest individual SSA tax payments in an RCD investment vehicle with a minimum return and taxpayer guarantee. This provides a wealth creation mechanism for the working class and ensures that future Congresses cannot borrow and spend that money and that Wall Street will never get their hands on those funds. At the same time the employer portion can provide benefits for the non-working spouse, the disabled and those who exceed their actuarial life span as well as the minimum investment subsidy. However, some SSA programs such as disability should be transferred to general welfare.