Saving Social Security: Layman's Take

It’s that time again! We’re in the presidential election cycle and the topic of Social Security or rather its sustainability will surely be hotly debated again. This topic comes regularly with various levels of intensity and urgency and it never really goes away. It is mainly because the problems get talked about and nothing gets really done. Partly the politics of the issue and partly lack of real urgency. The fact that the SSA Trust Fund will run out of money in 15 or 20 years is far enough that most of the electorate is not focused on it now and the rest is mostly interested in the status quo being they’re current beneficiaries. It appears the conditions of clear and present danger are not quite met and hence unpopular changes are not being seriously considered. But all this is just stating the obvious.

To be sure I’m far from being an expert on the issue but since we are all affected by it in one way or another, we all have an implicit interest in resolving the issue in a politically and economically sensible fashion. And since there is endless material written on the subject by experts and non-experts alike I figure I’d contribute my five cents too.

Let’s take a step back and revisit briefly how social insurance programs began. It was Otto von Bismarck, 19th century German Chancellor, who first proposed old-age social insurance finally adopted in Germany in 1889. The participation was mandatory and contributions were collected from employees, employers and the government. The key component of that program was the initial retirement of 70 years old (it was lowered to 65 in 1916). Keep in mind that at-birth life expectancy in Germany at the end of 19th century was just about 50 years of age. This meant that vast majority of the contributors at that time would never become beneficiaries. In essence if one were unlucky enough to outlive all the friends and half the family, the government would help with some benefit payout. And probably not for long. With those conditions in place the program was likely economically sustainable (I’m purposely not getting into the size of contribution vs the size of benefit argument). A similar dynamic existed in 1935 here in the United States, the year Social Security Act was adopted. The life expectancy in the U.S. was 61 years and the retirement age was pegged at 65 years of age. And there were 37 workers per each beneficiary; a ratio that stands today at about 3 workers per beneficiary and it is bound to go lower.

This is really the crux of the issue. The changing demographics like the size of the contributing workforce and the ever expanding life expectancy of the beneficiaries are bound to break the system as designed today. In a pay-go system, the current contribution gets redistributed to current beneficiaries and any possible surplus would be managed by the trust fund to help smooth out expenditures at the time of deficits. Again, stating the obvious.

If the deficits persist over prolonged periods of time, adjustments have to be made (and some have been made over the years) to the size of contribution, size of benefit and retirement age among other factors. Most of these changes are politically very difficult and thus mostly avoided. But as someone smart said, “a good thing about things that can’t last is that they don’t”; these changes are coming whether we like it or not.

So in that spirit I thought about possible solutions and what struck me is that there can not be a rational discussion on this topic until the program is understood in a different light. My perspective goes to basics of incentives and motivations that drive the discourse.

In my opinion the number one problem that prevents a rational discussion and resolution is semantics and the way Social Security program (I will concentrate on the Old-Age and Survivors Insurance, OASI) is being sold and viewed. Most people think of SS program as some kind of retirement savings program administered by the government. One pays in to the program during working years and withdraws back in the form of a benefit during retirement. This is reinforced by the fact that the benefit payout is not need-based. Many beneficiaries in this country do not need the benefit (by their own admission) and yet they want it because they paid into the system. This goes directly to the issue of private property ownership (remember that the government is a only a custodian) and not necessarily greed or lack of compassion by the recipient. In this scenario, means testing and resulting cut in the size of the benefit would be viewed as a seizure of private property. This is a perfectly rational approach if we see the program as a savings platform. The savings program theme has been the norm for a long time. Do you remember the “Lock Box” from the election of 2000?

Assuming that SS is a savings program, the only way to persuade people who don’t need the benefit to give it up is through a moral argument. In other words if the promise of the government must be fulfilled then it will happen at the expense of the beneficiary’s children and grandchildren. I suppose some people would respond to this but most wouldn’t. Many also rightfully argue that they want to collect the benefit and donate it to the charity of their choice rather than have the government apparatus redistribute it. People want to be in control of their property. Bottom line: in this context changes are very difficult if at all possible.

But what if we don’t see Social Security program as a savings platform but rather as a taxation scheme? What if we acknowledge that there is no “lock box” and no savings account? But rather that there is simply a collection of taxes from current workers that gets redistributed to current beneficiaries. Once in this context, the program could be managed as a tax policy like many other government tax policies. The benefit of the program could then be means-tested. The spirit of the program would be that of an insurance policy: we all contribute (pay the premium) to the pool and the ones that are not successful may get assistance. The well off, the winners, would not. Nobody expects an insurance premium refund because their house didn't go up in smoke....

Sounds difficult to pull off? I’m sure it would be most difficult all else kept equal. Would taxpayers already burdened with highly progressive tax system be willing to add an additional layer of taxation? Perhaps those who stand to benefit and qualify for the assistance would but I suspect this would not be majority. So how can a taxpayer get incentivized to give up the benefit?

The answer lies in the tax code reform. Once the Social Security program gets rebranded as a tax program then it can be rolled into the larger reform that seems badly needed on its own. Remember the Simpson-Bowles proposal from 2011? It came unexpectedly even-keeled and took many by surprise given its comprehensive breadth and wisdom. Not ideal perhaps but clearly a giant step in the right direction. Sadly it never got off the ground and it was quickly shelved. But now there is a need and demand for a tax reform in the spirit of Simpson-Bowles. We all know how painful is the current tax code and how costly and time-consuming compliance with it is. I am convinced that taxpayers, especially in the middle and the upper part of the income spectrum, would be willing to give up the SS benefit they don't need if in return they get simpler and less progressive tax code. The total economic outcome could be in excess of forgone benefit. It just makes sense. And common sense is what needs to drive the change rather than a perceived sense of fairness.

In conclusion, rebranding Social Security program and combining its reform with the larger tax code overhaul will create incentive for the better-off tax payers to voluntarily give up the benefit or to agree to means testing cut-off in return for the overall economics and simplification of the tax code. In isolation, Social Security reform is not likely to succeed. But I think we will have an opportunity to properly revisit these issues once this election cycle is over. Good luck to all of us!