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Social Security: Fix It or Lose it!

By: Frank Armstrong

By: By: Frank Armstrong, CFP, AIF

In a Ponzi Scheme money is shuffled to a few “winners” from early “investors” who in turn will be paid off by later investors until the whole scheme collapses under its own weight. No real business or investments are required. As long as enough new investors can be attracted, all is well. But, eventually, the scheme runs through the supply of gullible new investors, and the predictable melt down occurs. Substitute “beneficiaries” for “winners”, and “taxpayers” for “investors” and you have Social Security.

Waiting for the Crash

The math is crystal clear: In an unfunded pension plan when lots of people contribute with few current beneficiaries, the plan will run a surplus. If the ratio of participants changes to few contributors and lots of beneficiaries, the system runs a deficit. Eventually it crashes. Tinkering with the contribution rate, retirement age, or benefit levels changes the tilt point a little, but the crash is inevitable.

Currently, lots of people contribute, and there are a tolerably few beneficiaries. So the system is running a surplus. The government systematically steals this surplus from the Social Security System and spends it each year for the general account. Make no mistake about it, there is not one single penny in the Social Security Trust Fund. This allows them to show a much smaller federal deficit than if they were honestly accounting to the taxpayers. Enron’s accountants were small fry cheats compared to the government’s accountants.

The government gets another benefit from this scheme. They can use the surplus from the Social Security payroll tax to cut income taxes. By increasing Social Security taxes – which they then steal – and decreasing income taxes, they shift the tax burden to the poorest segment of society because the Social Security Payroll Tax is among the most regressive of our tax systems, falling hardest on the lowest paid workers. This fact has not been lost on the current administration.

The American people are willing co-conspirators in this fraud. If we make promises to one other but don’t fund the obligation, who do we have to blame but ourselves when there is no money in the pot when it comes time to pay? Of course, we can blame the pandering politicians. But, deep down inside we know that the system is broke and we refuse to consider fixing it. No one wants to hear the truth. Our attitude just screams: “Lie to me, Baby!” So, predictably, the politicians oblige.

Enter the Chairman

Federal Reserve Chairman Alan Greenspan’s proposal to cut Social Security benefits in recent Congressional testimony may trigger a process of review and reform sometime before time runs out. The Fed Chairman can say things like that. He doesn’t run for election, and his pension is secure. For the rest of Washington, the subject is radioactive. It would be optimistic indeed to expect meaningful action during an election year, but once the unthinkable idea has been floated, perhaps the idea of reform will gain some traction. Or, perhaps, I have just lost my mind or had a flashback to my misspent youth when I believed that all problems could actually be solved by men of good will.

Funded Pension Plans

A private pension plan must invest on a regular basis enough to fully fund their future obligations. When a beneficiary retires, there is money enough in the pot to pay the obligation. At each point in its life a pension must have enough investments so that coupled with future contributions and earnings there will be at least enough to cover all obligations to all future beneficiaries.

In a blinding glimpse of the obvious, a few wild eyed, hard core, dangerously radical crazed right wing economists have suggested funding Social Security. This of course implies that the government will actually stop stealing the surplus and invest it. In Washington, supposedly the capital of a capitalist country, this idea is considered heresy, and unfit for serious political discussion. Strangely enough, countries like Chile, Georgia, Mexico and Poland have adopted this strategy with positive results.

The idea of Privatization of Social Security has been floated and quickly sunk several times. Frankly, the word invokes nightmare images of commission crazed variable annuity salesmen turned loose on an unsuspecting gullible public. My cynical mind conjures up visions of fat cat financial institutions – not just coincidently political donors – raking in obscene profits on huge pools of taxpayer money. But, those are details. The core issue of actually funding the plan is the only solution that flies. Absent funding, the system crashes.

The system is broken and must be fixed. The important issue is funding, not privatization. To get any kind of funded system, the first thing we must do is resolve to stop diverting the present surplus for other purposes. It follows that the next step is to honestly project the government’s budget. This will bring a certain clarity to the budgeting process that is sorely needed. Now, don’t expect the politicians to come to these conclusions by themselves. They will need to hear from all of us.

Funding Social Security and actually investing the money will not make the system more risky. That’s cheap political rhetoric. Every solution that actually invests the money is safer for the system than just stealing it.

No one needs to lose benefits. That’s more cheap political rhetoric. Everybody will be better off when the system is actually funded. Chile, for instance, managed to transition where every citizen could opt to remain in th old system or take a new funded approach. Those who opted into the new system had their current benefits fully guaranteed with future benefits funded. The vast majority of participants opted for the new system, creating private wealth where none existed previously, a huge pool of capital to fuel Chile’s economic expansion, and a growing (funded) benefit level for participants. Is there anything wrong with that?

The details are important. It would be a giant mistake to turn over the funds to Wall Street whose ability to inflate costs and swindle investors is unchallenged. However, an independent government agency along the lines of that Jack Bogle could economically and effectively oversee the fund for the benefit of all of us.