A Social Security Reform Plan

This is the first in a series of periodic investigations into so called “entitlement” programs which include Social Security, Welfare, Medicare, Medicaid and Unemployment Insurance.  I hope to address each one in a separate post and answer such questions as “Do we really have a problem with this program?”, “Is it Working?”, “Why was this program created?” and “Can we fix it?”

I’m working on these posts not because I’m an expert but because I want to learn more about them and posting my findings and proposals on my website and reading the comments and dissenting opinions is the best way I know how to do it.

This first post will look at Social Security.

History and Current Structure

There is a complete history (and pre-history) of the Social Security Administration (SSA) here and I’ll hit some of the high points below but I think the following paragraph from the SSA site describes the climate in the US right before the Social Security Act was passed.

“So as 1934 dawned the nation was deep in the throes of the Depression. Confidence in the old institutions was shaken. Social changes that started with the Industrial Revolution had long ago passed the point of no return. The traditional sources of economic security: assets; labor; family; and charity, had all failed in one degree or another. Radical proposals for action were springing like weeds from the soil of the nation’s discontent. President Franklin Roosevelt would choose the social insurance approach as the “cornerstone” of his attempts to deal with the problem of economic security.”

On 14-AUG-35 President Franklin Roosevelt signed the Social Security Act into law and gave the following statement:

“We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.”

 The SSA continues about the SSA’s humble beginnings (emphasis mine):

“The significance of the new social insurance program was that it sought to address the long-range problem of economic security for the aged through a contributory system in which the workers themselves contributed to their own future retirement benefit by making regular payments into a joint fund. It was thus distinct from the welfare benefits provided under Title I of the Act and from the various state “old-age pensions.” As President Roosevelt conceived of the Act, Title I was to be a temporary “relief” program that would eventually disappear as more people were able to obtain retirement income through the contributory system. The new social insurance system was also a very moderate alternative to the radical calls to action that were so common in the America of the 1930s.”

The Trust Fund started to receive money in January 1937 once the Federal Insurance Contributions Act was passed.  For anyone who has ever looked at their check stub, that is what a FICA is and why it gets 7.65% of everything you make (6.2% for Social Security and 1.45% for Medicare).   Everyone should also know that the employer also pays a 6.2% tax on the employee’s payroll to fund Social Security so every working American would get a 13.85% raise if we didn’t have these two entitlement programs.  But I’m getting ahead of myself…..

More on FICA from the SSA website:

“After Social Security numbers were assigned, the first Federal Insurance Contributions Act (FICA) taxes were collected, beginning in January 1937. Special Trust Funds were created for these dedicated revenues. Benefits were then paid from the money in the Social Security Trust Funds. “

Through the years various modifications were made:  

Cost of Living Adjustments (COLA) started in 1950 and continued periodically until the COLA was made automatic with legislation passed in 1972.

In 1954 payments were added to cover disabled adult children and those ages 50-64 who were disabled and then Congress expanded these benefits in 1960 to include any age worker and their disabled children.

In 1961 the retirement age was lowered to 62.

In 1977 it was discovered that the Trust Fund would run out of money (GASP!) in a couple of years so a law was passed to increase the payroll tax, broaden the tax base and reduce benefits (note that this would be done again in 1983).

In 2000, a new law allowed someone who was at or above the Normal Retirement Age (NRA), which is 70 years old right now, to work and collect Social Security benefits.

In 1937 Social Security had 53,236 recipients and $1.278 million in outlays.

In 2008 Social Security had 50,898,244 recipients and $615.34 billion in outlays.

Do We Have a Problem?

According to this site, we will have enough money in the Social Security Trust Fund to keep it solvent through 2037.  But what is this mythical Social Security Trust Fund?

According to the SSA, everything is fine and the Trust Fund has enough money in it to pay its projected bills anywhere from 25 to 75 years from now but according to the US Chamber of Commerce, the Trust Fund is just an accounting mirage:

“The government does not save our Social Security taxes for future retirees. Congress borrows this extra money and uses it to make up for deficits elsewhere in the budget. Thus the Social Security trust fund contains nothing but IOUs the government has written to itself. And when Uncle Sam goes to repay those IOUs, you know who pays the bill: we do. That means that in order to repay those IOUs, the government will have to either raise taxes or cut programs.  Social Security is already the biggest tax that most workers pay, but to keep the system afloat payroll taxes will have to rise even higher—to 20 percent of each worker’s wages.”

There is also this article from CNN Money making the case why this Trust Fund (which had a reported value of $2.6 trillion at the end of 2010) is the biggest accounting farce in the United States.  Do you really think our Federal Government, which is so addicted to spending, would leave $2.6 trillion sitting on the sidelines?  They wouldn’t and the only reason the Trust Fund hasn’t been raided is because it doesn’t exist.

So for the sake of my analysis I’m going to assume the worst case scenario – The Trust Fund doesn’t exist and all the revenue the SSA takes in each year goes to pay current retirees. 

In addition to neglecting the Trust Fund, I’ll need to make some other assumptions to run the numbers.

There are actually two [2] components of the Social Security system: The Old-Age and Survivors Insurance (OASI) which pays for retirement and survivors benefits and the Disability Insurance (DI) which pays disability benefits.  For the sake of this analysis I’ll combine both of these and call them the OASDI but keep in mind that the OASI piece is over 80% of the total OASDI. 

The following table shows the estimated increase in OASI and DI costs for each year (as a percentage of GDP) through 2085.   According to the SSA report, the outlays from OASI will increase as the baby-boom generation starts receiving Social Security benefits, peak around 2035 and level off at a set percent of GDP (in this case around 6%).

“Costs for both programs increase substantially through 2035 because (1) the number of beneficiaries rises rapidly as the baby-boom generation retires and (2) the lower birth rates that have persisted since the baby boom cause slower growth of both the labor force and GDP. Social Security’s projected annual cost increases to about 6.2 percent of GDP in 2035, declines to 6.0 percent by 2050, and remains at about that level through 2085. Under current law, projected Medicare cost increases to 5.6 percent of GDP by 2035, reaching 6.2 percent in 2085, driven in the latter period largely by the rising cost of health care services per beneficiary. These projected costs may well be exceeded because they are based on the assumptions that the deep reductions in physician fees required by the sustainable growth rate system are not waived by legislation and the Affordable Care Act’s reduced provider payment updates are sustainable over the long run.”

For my analysis I am interested in actual outlay dollars and not % of GDP so I need to understand the estimated GDP growth that the SSA assumed and then use the SSA estimates (which take a percentage of that GDP) to get the projected outlays for each year.  Using the SSA projections for actual OASDI outlay dollars (through 2020) and their % of GDP numbers, I back-calculated the estimated starting GDP in 2013 to be $16.8 trillion and then empirically derived a constant GDP growth rate of 5% that matched the remaining OASDI outlays through 2020.  Since this matched their data from 2013 to 2020 (and since we don’t have a crystal ball to predict GDP growth rates past a few months much less decades) I’ll assume the SSA used this same constant 5% GDP growth rate for all their yearly projections through 2085.

It is interesting to note that the 5% GDP growth rate is ambitious and I would’ve chosen a 3% growth rate based on the following graph which shows over recent history that is about what is expected.

But I’ll use 5% for the sake of this analysis and based on this, here are the projected outlays from OASDI through 2068.

Yes, I’d say we have a problem!

My Solution

There are many proposals to reform the Social Security system to improve its solvency and ensure its long term health and they range from investing the mythical trust fund in the stock market, reducing participant benefits, increasing the retirement age, increasing the payroll deductions (which is normally 6.2% but is currently 4.2% thanks to our Congress and the payroll tax reduction bill) or having companies pay more (I mentioned earlier that companies also pay 6.2% of their employees’ salaries into the Social Security system).

But I’m not in favor of reforming it – I want to eliminate it.  I’d rather take that 6.2% deducted from my paycheck and put that in either stocks/bonds or a 401k plan.  I would rather have the responsibility of my retirement resting with me rather than entrusting it to the Federal Government and all this extra investment in companies will help the economy as well. 

I do, however, favor keeping the DI portion of the Social Security plan because I feel we do have a duty to take care of our disabled citizens and especially those who are elderly.  So even though my analysis considers all the OASDI, I would like to see another analysis where we keep the DI portion.   

My proposal is to eliminate the OASDI but we can’t do that immediately since there are people in the system and there are people who are very close to entering the system that have been promised this benefit and we owe it to them to make good on that promise.  But as we saw above the projections for outlays in the coming decades are unsustainable so we have to stop sometime and there will need to be a generation to make the sacrifice of paying into a system to keep it solvent for existing recipients but be willing to take care of their own retirement and not rely on the Federal Government. 

Using a retirement calculator, assuming you put 15% of your salary in a 401k and have a balanced portfolio, a person will need a at least 20 years to sufficiently plan for their retirement (living during the retirement years on 50% of what they made while employed) so my proposal is to cutoff new social security recipients starting in 2034.  That means that the last year to enter Social Security is 2033 and therefore those people who will be 45 years old in 2013 will be the last people to enter Social Security (I’m also setting the retirement age at 65 years old).  Those, like myself, who will be younger than 45 next year will have at least 21 years to plan for our retirement by the time we reach 65 years old (2034) and can, of course, choose to work longer as many are doing now.

Assuming we execute on this plan – when will we be officially done with Social Security (no more outlays because there are no longer any living recipients)?

Since my plan has no change until 2033, the growth rate of Social Security outlays will track the Social Security projections during that time but starting in 2034 I need to reduce each year’s outlays by an amount equal to the number of people that would have been entering the Social Security program.  A little thought needs to be put into how I arrive at this yearly reduction.

Without the mythical Trust Fund, the Social Security program is now set up so that those entering the system will be offset by those who died that year so there won’t be any additional outlays other than cost of living.  We know this will not be true when the baby boomers start entering the system but that surge of new participants will be over around 2030 so for my analysis I am going to assume that starting in 2034, I can reduce my yearly outlays by a percentage that corresponds to the mortality rate of people who will die in that year (those who die will not be replaced by new participants).

To do this I need to obtain mortality rates for various age groups and I used this link.  For ages 65-74 the mortality rate is 2% and for ages 75-84 the mortality rate is 5%.  Note that the mortality rate increases to 14% for ages 85-94 but as you’ll see in a moment, we won’t need to use this.

To make this a worst case analysis, I’ll assume that the ages for all Social Security participants starting in 2034 are the youngest possible at 65 years old.  We know this will not be true and that there will be those much older than that on the Social Security system and those older participants will have a higher mortality rate but to keep things simple and come up with a worst case analysis stay with me.

So for the first year 2034, the normal outlays as predicted by SSA will be reduced by 2%.  The next year, 2035, will have its outlays reduced by 4% (another 2 percent have died) and so on until year 2045 when the mortality rate increases by 5% each year because the participant population is now at least 75 years old.  In 2055 we’d be seeing 85 year olds and the mortality rate should increase by 14% per year but I can’t do that because we are already reducing the previous year by 80% so another couple years and we’d be over 100% which means, statistically, all Social Security participants would have died.  I kept the simulation adding another 5% mortality rate until I reached a 100% reduction which was in year 2059.  The last of the 65 year olds that enter the Social Security system in 2033 would be 91 years old in 2059 so we are safe in making the claim that the system would be practically finished at this point.

Let’s see what that outlay graph looks like.

Not bad and when you over lay both the current and proposed plan on top of each other the difference really is startling.

In 2060 the current system will have Social Security outlays at close to $10 trillion and under my proposal we will be ending the program for all intents and purposes in 2060. 

And that means starting in 2034 (the year newborns in 2010 would be seriously entering the workforce), the amount of taxes paid by US citizens and companies will start going down and in 2060 the payroll tax that both workers and companies pay for Social Security will be gone.   That means our grandchildren will grow up in a world where they will never have to pay social security through payroll taxes.

That should be the goal – handing the country over to our children in better shape than we found it.  We can’t do that without eliminating at least 80% of Social Security entitlements and we owe it to them to make that sacrifice now.  I’m willing to do this and I think many other Americans are with me.

Addendum – Further Study

As I stated earlier, I don’t feel right about eliminating the DI portion of Social Security and I think this should stay and another analysis should be done showing what minimal outlays would remain in that program but that would still cause a significant reduction in payroll taxes paid by workers and their employers.  If the DI portion is only 20% of the current system we can assume that the current rate of 6.2% would be reduced to 1.25% and that would still leave another 10% of extra income for each American worker to use for investment, consumption and retirement planning.

While a significant amount of detailed calculations went into this analysis, I concede that this isn’t the end all study.  I would like to see those in Government who have better modeling tools replicate this study and determine the optimum cutoff point as well as the end date used in that analysis.  Reality will be different than these results but I think it will be better because I used a worst case model (lower mortality rates, including DI in the outlays, etc.).

For those who would like to check my math, here is my spreadsheet.

Social Security Analysis

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