MIT’s way of reminding the Class of 1982 (average age: 57) that we are going to be dying soon was to schedule Nobel-winning economist Peter Diamond to speak on the subject of Social Security at our reunion dinner.
Why should running a retirement system be challenging? Why not take citizens’ money, save it for them, and give it back to them, plus interest, when they’re old? Singapore does this:
In contrast to the majority of other publicly managed pension schemes, the Singaporean system operates on a fully funded basis. The CPF does not include social risk pooling and redistributive elements. Individuals rely exclusively on defined contribution funds accumulating in individual accounts. The CPF covers private and most public sector employees as well as the self-employed, who may join on a voluntary basis.
This kind of system is bulletproof.
FDR and his fellow politicians in the 1930s couldn’t do this, however, because in order to get votes they wanted to start ladling out the cash immediately, to people who had put next to nothing in. So we tax currently working Americans to pay currently retired Americans. (Essentially everyone born prior to 1940 got more than they put in.) This is sustainable only with either a growing population or a growing labor force participation rate. Despite spreading out the welcome mat for immigrants, our population isn’t growing fast enough to offset increased longevity. Our labor force participation rate is falling as Americans discover the wonders of SSDI and OxyContin and/or collecting child support or alimony. Thus Social Security is always at risk of crisis.
Sometimes the roots of the crisis are easy to understand. Professor Diamond explained that in 1972, for example, Congress approved an inflation indexing scheme for Social Security that the experts in the Nixon Administration knew would “over-index” payments such that recipients would actually be better off in a high-inflation scenario. At least some senators knew this as well. Congress cheerfully passed the scheme into law because everyone knew that the U.S. would never have high inflation rates. By 1977 the system hit a wall and another emergency fix was required in 1983. (Our next scheduled emergency is in 2034 (source), when the trust fund is forecast to run dry and benefits will exceed contributions.)
Why does it matter? There is no law against Americans saving for their own retirement. However, most Americans spend like drug dealers. Presumably part of this is our nature, but we have a lot of structural discouragements to savings. Married with kids? Save and you’ll be punished by colleges in the financial aid process. Getting paid child support or alimony? Savings could be used against you in court; if you’re able to save maybe you don’t need child support and alimony (amounts always discretionary with the judge) at the current levels. Income below the median? Savings could disqualify you from various means-tested welfare programs, such as free or subsidized housing. Want to save up and buy a house? You will just be cheating yourself out of the mortgage interest deduction.
The result is “Among elderly Social Security beneficiaries, 48% of married couples and 71% of unmarried persons receive 50% or more of their income from Social Security.” (source) I.e., a lot of older Americans don’t have significant savings.
Professor Diamond laid out the history of political arguments about how to patch the actuarial holes in the system. He said that, to a first approximation, Democrats always propose higher taxes and Republicans always propose cutting benefits, except on the poorest recipients, for whom Republicans would like to see higher payments. He explained that politicians are never candid (not to suggest that they might lie!) regarding these proposals, e.g., disguising a benefit cut as a delayed cost-of-living increase or an increase in retirement age.
As with most other government programs, it gets sold to the public as a way of taking money from the fortunate to help the unfortunate. Social Security is advertised as “progressive” because people who had a low income get a larger percentage of their contributions back than high-income participants. In fact, this is undone because high-income participants tend to live longer and high-income participants are more likely to have a nonworking spouse who gets a kicker “spousal benefit” (if Nadine Nevermarried and Meredith Married put in the same amount over the same number of years, but Meredith was super attractive and had a boytoy husband at home, Meredith’s household gets about 1.5X the payments from Social Security). On average, Social Security doesn’t do anything to address the income inequality that has come to obsess at least some Americans.
The latest magic for plugging the most obvious holes? Democrats want higher rates on everyone and a special tax on earnings about $400,000 (soak the 1%!). What if the 1% get motivated and, like Eisenhower, manage to convert what would have been regular income into capital gains? That won’t help them because Democrats also want to tax investment income to feed Social Security. Republicans are opposed to these higher taxes, but they can’t just go on TV and shock Americans with “you have to work if you want money.” Diamond said that the likely fix is that Congress will change the law so that Social Security can borrow, like the rest of the Federal Government. If Social Security borrows approximately 100 percent of GDP, the system can keep working for about 75 more years (assuming that there are no advances in medical technology that increase longevity, for example, nor any further withdrawals by Americans from the labor force).
Borrowing doesn’t seem like the obvious solution to a long-term systemic problem of overspending. Are we going to be way richer than forecast in the future somehow? Have fewer old people around? Nobody seems to think so. However, in Diamond’s opinion, borrowing is the one option that will be palatable to both Democrats and Republicans (and certainly the two parties have cooperated to borrow more than 100 percent of GDP already).