"How Washington tackles the thorny issue of Social Security reform.
By Jim Jubak
Recently my 87-year-old father asked me a question that many other elderly are asking as politicians in Washington begin talking about "reforming" Social Security: "Am I going to get less in my Social Security?"
He's fine. And at 55, so am I. Right now, the average worker gets a Social Security benefit equal to 42% of earnings when he or she retires at 65. Over the next two decades, as the retirement age slowly moves up to 67, that contribution from Social Security is set to shrink to 36%.
But if my 9-year-old son or my 21-year-old friend Sam had asked the same question, I would tell them their benefits are going to get cut -- and cut deep -- and that their generations will be saddled with $2 trillion in debt to fund those "private retirement accounts" that are now getting so much attention.
These younger workers will pay into Social Security at the same tax rate as someone who retired in my generation or my father's, but they'll get back nearly 50% less in benefits, according to current proposals.Social Security.
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Why am I so sure? It's not because I've got some secret source. Or because I think the current system works so well. Or because I think the proposed changes will fix the problem.
No, my predictions are based on my understanding of how our government in Washington works. As I explained in my last column, "Uncle Sam gets an 'F' in money management," our government (and we as voters) are addicted to a set of financial rules that I'd summarize as: Spend now. Lie about the cost. And pay later. Much, much later.
Best of all, of course, would be Never. But if the day of reckoning is unavoidable then "Let the kids pay."
We've done it before
If you need a primer on how this works, you don't have to look any further than the Medicare drug benefit that President Bush championed and that Congress voted into law in 2003.
Spend now. Paying for prescription drugs is a big financial burden for many seniors, and the problem is getting worse day by day because drug costs are rising at a rate that far outstrips the rate of inflation. By creating a prescription drug benefit for seniors, the president and his party got the enthusiastic political backing of the 36-million-member AARP. That support was crucial to getting the bill through Congress.
Lie about the cost. Even so, Congress might not have passed the bill if the Bush administration hadn't pulled out the Washington accounting handbook to make the cost of the drug benefit look as small as possible. Fiscally conservative members of Congress were willing to spend $400 billion over 10 years, but no more, on the program. So all the president's men, including the chief actuary at Medicare, said this bill would cost -- surprise! -- $400 billion over 10 years. Medicare's chief actuary actually had calculated that the cost of the bill over 10 years was more like $500 billion to $600 billion. But he'd been warned not to tell Congress of the true cost before it voted.
Pay later. Even $500 billion to $600 billion isn't the true bill handed to future taxpayers. Because drug costs, along with other health-care costs, are climbing at a rate well above inflation, and because the huge baby boom generation is just starting to become eligible for this drug benefit, the 10-year costs of this program are just a fraction of the long-term bill. If you measured total present value of the total future obligations created by the Medicare drug benefit plan, according to the trustees of the Medicare Trust fund, the cost would be $16.6 trillion. Since that's an unsustainable sum, future generations of taxpayers will likely have to eliminate this benefit for themselves after paying for the drugs consumed by previous generations.
Think that calculating the cost of the Medicare drug benefit plan that way is unfair? Well, it's exactly the calculation that the Bush administration has used to come up with its figure of a $10.4 trillion shortfall in Social Security. But then, of course, the Bush administration wants to make the Social Security gap into a crisis. For that purpose, the bigger number is more useful. (The standard way to measure the shortfall is to look at the next 75 years. Measured that way, the Social Security shortfall is a smaller but still a very large $3.7 trillion, according to the Social Security Administration.)
Do the math
Now apply these same three steps to predict the most likely outcome of the Social Security debate.
Spend now I. Look at the demographics of AARP, certainly the most powerful lobbying group representing seniors and maybe the most powerful lobbying group in the country. AARP is fully mobilized for the fight over Social Security. The organization's goal is clear: to save Social Security for its members. President Bush has already conceded that he won't cut benefits for anyone who is retired or close to retirement. The battle now will be over how to define "close to retirement." AARP, I'm sure, will push hard toward 50.
Spend now II. "Saving" Social Security isn't much of a "sweetener" to offer younger workers, who are sufficiently cynical or realistic to doubt that the program will be around to pay them much of anything. The major new sweetener for these workers is private accounts, valuable to workers for whom retirement is a long, long way off. The sweetener is targeted at younger workers who already don't have much faith that they'll ever collect from Social Security. Hey, who under the age of 50 doesn't think they could invest their money better than the old fogies who run the Social Security trust fund? And don't forget that this sweetener will be funded by borrowing $2 trillion. Get the private accounts now and pay for them later.
Lie about the cost. All the debate about the cost of fixing Social Security has focused on how much it would cost to set up the new private accounts. Because money going into the accounts wouldn't be available for paying current Social Security benefits, the government would have to borrow something like $2 trillion to make up for the shortfall in pay-as-you-go Social Security benefits.
But that's not the cost number to watch. The true cost is buried so deep in the details of these proposals that we're all likely to fall asleep before we get to the bottom line.
Nobody in Congress wants to come right out and propose a tax hike or a benefit cut: that could be political suicide. So the current idea is to change the way that Social Security benefits are calculated.
The change sounds very simple. Right now, Social Security payments are indexed to increases in wages. As wages go up, Social Security benefit checks get larger so that retirees get a constant percentage of the average current wage in their checks. The proposal is to change the index to a ratio of the increase in the Consumer Price Index (commonly called price inflation) to the increase in wages beginning in 2009. Since wages climb more rapidly than prices, this would lower the rate at which benefits increase over time.
The change doesn't seem radical. But over time, the chief actuary of the Social Security Administration estimates, this one change would close the entire Social Security shortfall within 75 years. Make this one change and there is no Social Security crisis. (If you want to read all the details about how Social Security benefits are calculated and how indexing works now and would work under these proposals, follow this link to "How benefits are calculated.")
Pay later. Look at the size of bill to younger workers and children yet unborn that this one very-hard-to-understand change creates. The chief actuary of Social Security estimates that, under these rules, a worker born in 1977 who retires at 65 in 2042 would get 26% less than under the current rules. Instead of replacing 42% of average earnings, as Social Security does now, or the 36% as current benefit reductions phase in, this worker would see just 27% of his earnings replaced. For the worker retiring in 2075 -- a worker not yet born -- the benefits are 46% lower than under the current system: Social Security would replace just 20% of earnings.
Bad policy and bad karma
How did we get to this proposal? The Social Security Commission put them on the table in 2001 after it was charged by President Bush to "fix" the system but told that it could not consider any alternative that would increase revenue from the Social Security payroll tax, that it couldn't consider rolling back the 2001 tax cut to fund Social Security from general tax revenue, and that it couldn't dedicate some other tax, such as part of the estate tax, to Social Security. In other words, the only solution it could look at was to cut benefits. At the same time, it was to consider a proposal for private accounts that would increase the size of the Social Security gap and lead to larger benefit cuts.
I think trading this kind of certain reduction in the Social Security safety net -- it's insurance, not an investment account, which is precisely what makes it worth keeping --for the uncertain benefits of private investment accounts is a bad deal that I'd reject for myself.
But beyond that, there's something that sticks in my craw about maintaining my benefits at the cost of cutting those of young workers, of children not yet in the workforce, and of workers not yet born.
Would you feel good about explaining Spend Now, Pay Later to your kids? I know I wouldn't."