Burdened further by the recession
Just last year Social Security was projecting a cash surplus of $87 billion this year and $88 billion next year. These were to be the peak cash-generating years, followed by a cash-flow decline, followed by cash outlays exceeding inflows starting in 2017.
But in this year's Social Security trustees report, the cash flow projections for 2009 and 2010 have shrunk by almost 80%, to $19 billion and $18 billion, respectively. How did $138 billion of projected cash go missing in just one year? Stephen Goss, Social Security's chief actuary, says the major reason is that the recession has cost millions of jobs, reducing Social Security's tax income below projections.
But $18 billion is still a surplus. Why do I say Social Security could go cash-negative this year? Because unemployment is far worse than Social Security projected. It assumed that unemployment would rise gradually this year and peak at 9% in 2010. Now, of course, the rate is 9.5% and rising -- and we're still in 2009.
I'd love to be able to give you a report on Social Security's cash flow so far this year, which is more than half over. However, it's impossible to get interim numbers. So I don't know where we stand, and we probably won't find out before next spring, when the 2010 trustees report comes out.
Social Security's having negative cash flow this year would be a relatively minor economic event -- what's a few more billion when the government's already borrowing more than $1 trillion? -- but I think it would be a really important psychological, political, and journalistic event.
OMB's Peter Orszag -- remember, he's a Social Security maven -- pooh-poohed my thinking when I met with him. He says I'm wrong to harp on Social Security's near-term cash flow -- a term, by the way, that he won't use. "I think the real question of Social Security is how we bring long-term revenues in line with long-term expenses," he said, "not whether the primary surplus within Social Security turns negative within the next few years." I guess we'll see.
When you look back at numbers from previous years, as I did while reporting this article, you suddenly realize that Social Security's finances have been deteriorating for a long time. As the "2009 cash-flow projections" chart, above and to the right, shows, Social Security's cash flow (and thus its trust fund balances) has fallen well below earlier projections. Seven years ago, the projected 2009 cash flow was $115 billion, which as we've seen had fallen to $87 billion by last year and is now $19 billion. Ten years ago the trust fund was projected to be $3 trillion at the end of this year, rather than the currently projected $2.56 trillion.
In 1983 the system was projected to be "solvent" until the 2050s. This year it's only until 2036.
Social Security's Steve Goss says the major reason is that over the past two decades the wages on which Social Security collects taxes have grown more slowly than projected. He said Social Security projected them to grow at 1.5% above inflation, but they've been growing at only 1.1%. While this reduces future obligations because benefits are based on salaries, for now the below-projected salaries cut sharply into cash-flow projections.
The scariest thing, at least to me, is that even as its financials erode, Social Security is as important as ever -- maybe more so.
Let me elaborate on what I said earlier, about how older people depend heavily on Social Security. It accounts for more than half the income of 52% of married couples over 65, and 72% of that of 65-and-up singles, according to the Social Security Administration. For 20% of such couples and 41% of singles, it's more than 90% of their income.
What's more, this dependence -- which Goss says isn't projected to change -- comes despite 30 years of broadly popular self-directed retirement accounts such as 401(k)s, IRAs, 403(b)s, and such.
Why haven't those reduced dependence on Social Security? Part of the reason is that it takes a lot of money to generate serious retirement income: about $170,000 for a $1,000-a-month lifetime annuity. Inflation protection, if you can find it, is ultra-expensive. Vanguard, which offers a lifetime inflation-adjusted annuity in conjunction with -- shudder! -- an AIG insurance company called American General, quoted me a staggering price for an annuity mimicking my wife's and my Social Security benefit. Would you believe ... $774,895? Yes, that was the number.
Another problem is that the stock market has been stinko, the post-March rally notwithstanding. Stocks are below their level of April 2000, when the great bull market (August 1982 to March 2000) ended. It's hard to make money in stocks when they've been down for nine years. The Employee Benefit Research Institute estimates that the average retirement account balance of people 65 to 74 was about $266,000 in 2007 but had fallen to about $217,000 as of mid-June.
Then there's the problem of lost home equity. According to a study conducted for Fortune by the Center for Economic and Policy Research, people in the lower-income to upper-middle-income ranges have lost a far greater proportion of their net worth as a result of the housing bust than the most wealthy people have.
The bottom line is that many older people who felt reasonably well-fixed for retirement a few years ago now need Social Security more than ever. That makes it even more important to come up with a way to sustain it and to show our children a realistic plan to give them benefits, rather than to rely on the trust fund and the supposed political clout of the geezer and the approaching-geezerhood classes to keep benefits flowing when cash flow goes negative.
So how do we fix these problems? Let me divide it into three categories: what to do, what to change, and -- this is crucial -- what not to do.
What to do
Many of the old standbys: raising the "covered wage" limit, but not to outrageous levels; tweaking the benefit formulas so that high-end people like me get a little less bang for the buck; modifying cost-of-living increases for us high-end types; and most important, raising the retirement age to 70, with a special "disability" earlier-retirement provision for manual laborers, who can't be expected to work that long.
What to change
The law requiring 75-year solvency. It's hard to predict what will happen 75 days from now, let alone 75 years from now. But the obsession with 75-year solvency and the status of the trust fund has obscured what's really going on in Social Security.
This requirement forces Social Security's actuaries --who are among the best and smartest public servants I know -- to make all sorts of impossible projections, such as the one we show, above and to the right, about how many beneficiaries we'll have per worker decades from now.
As we've seen, even one faulty projection -- such as overestimating wage growth -- can cause substantial problems. Would you bet your life on the beneficiary-to-worker ratio, given the rising pressures for people to work longer? I sure wouldn't.
The trust fund. Before the Greenspan Commission-related changes in 1983, the trust fund was a checking account. The workings of Social Security post-1983 have turned it into something it was never intended to be: an investment account. Let's gradually draw down the trust fund by having the Treasury redeem $100 billion or so annually (less than the current interest the fund earns) by giving the fund cash rather than Treasury IOUs, gradually increasing the redemptions. That will let the fund buy assets that will be useful when serious cash-flow deficits hit -- things like high-grade mortgage securities and high-grade bonds.
That way we'll be bailing out Social Security a bit at a time, which is realistic, rather than in huge chunks, which isn't. Combine that with the lower costs and higher revenues we've mentioned, and today's kids could see there really is a way they'll get benefits when they attain geezerhood. They'll be looking at what will have become a pay-as-you-go system with a checking-account-size trust fund. That would give any numerate person more confidence in Social Security's future than the current system does.
What not to do
Depend on taxing "the rich." One of the solutions you hear in Washington is restoring "covered wage" levels to the good old Greenspan Commission days, when 90% of wages were subject to Social Security tax, compared with 83% now. Sounds simple and fair, doesn't it? However, that would increase the Social Security wage base to about $170,000 from the current $106,800, according to Andrew Biggs of the American Enterprise Institute -- at 12.4%, a huge new tax to middle-class workers. (And yes, that's middle-class income, not rich-person income, in large parts of the country, including much of the East and West coasts.)
During the presidential campaign, President Obama proposed (and then dropped) a plan to leave the Social Security wage cap where it is but to apply the 12.4% Social Security tax to all wages above $250,000. That -- like the 90%-level-of-income idea -- would be an enormous new tax that would greatly weaken support for Social Security among higher-income people. I'm not saying "rich people," because truly rich people generally have huge amounts of investment income, which isn't subject to Social Security tax.
Don't means-test benefits. It's already being done. We'd be making a terrible mistake to means-test Social Security by saying that people above a certain income level can't get it. That would violate the current social compact that everyone pays Social Security taxes and everyone gets something. It would turn Social Security from an earned benefit into a flat-out welfare program. Remember what happened to welfare when Bill Clinton was in office? Imagine what would happen to a welfare Social Security program the next time we have a conservative administration and a conservative Congress.
Besides, Social Security is already means-tested, indirectly. That's because if you have enough non-Social Security income -- about $23,000 a year in my case -- you pay federal income tax on 85% of your benefit.
Given the three pensions I stand to collect from previous employers, I'm reasonably sure to hit that level. So, for the final time, let's go through the numbers on me. If my wife and I are in the 28% federal tax bracket when we start collecting benefits, we'll be giving almost a quarter of our benefit right back to Social Security (0.28 x 0.85).
It would also mean that the $600,000 benefit I talked about earlier would cost Social Security only about $450,000 -- just 55% or so of the $800,000-plus value of our taxes.
I don't mind that big haircut -- but I'd be furious if the government decided to just confiscate all the money my wife and I put into Social Security over the decades by saying we were "rich" and had no right to any benefits. And I wouldn't be alone.
Given the way health care has bogged down, Social Security may not make it onto the agenda until next year. But it's going to show up sooner or later, probably sooner, because the numbers are so bad that something's going to have to be done. As I hope I've shown you, we're going to have to bail out Social Security or else risk hurting a lot of low-income older people or putting the whole program's future at risk by gouging and alienating upper-income Social Security sympathizers like me.
So let's fix this, already. By the numbers. And by the right numbers, not fantasy ones.