Last week, while the media covered North Korea and political extremist groups, President Trump sent out a series of tweets about government spending, and our national debt. It was kind of an exciting moment – politicians don’t like to talk about the debt, or out of control spending – it’s not a popular subject. Lawmakers have till September 29th to raise the debt ceiling, or else we will default. As a businessman, you would expect President Trump would understand the need to cut spending; his tweets suggest otherwise.
When it comes federal spending, social security programs made up almost half of all federal spending in 2014, and it’s set to increase dramatically over the next decade. In 2003 entitlement spending accounted for 44% of federal spending, in 2014 entitlement programs accounted for 49% of all spending. Government spending is set to increase by 66% (from 2014-2024). 85% of the projected growth in spending can be attributed to entitlement spending, and interest on the national debt. To give you an idea of how bloated the social security budget is; in 2014 social security programs cost $845 billion dollars, in 2024 it’s projected that those programs will cost north of $1 trillion dollars a year.
As of 2015, 163 million American’s paid into Social Security, while 59 million collect monthly benefits. With costs on the rise, the “Social Security Trust Fund” is set to run out in about 17 years. Unfortunately, politicians are unlikely to make any meaningful change to the programs.
History of Social Security
While public entitlement programs didn’t become prominent in America till the great depression, they all have their basis in the English “Poor Laws” which were first enacted in 1601. These laws were the first acts passed in Europe to outline the state’s duty to provide relief to the poor.
The idea of entitlement programs – specifically programs to the elderly, poor, and disabled – in this country has its roots in a pamphlet published by Founding Father Thomas Paine. In his last pamphlet, “Agrarian Justice,” published in 17 in 1795, called for a 10% inheritance tax. This tax would be used to pay a pension to the elderly, and a universal basic income for everyone over 21 years old.
In modern times, President FDR signed the “Social Security Act” in August 1935 as part of his “New Deal.” The act was passed at a time when a lot of people had lost their life’s savings during the great depression, and was meant to provide relief to retirees. This pension was created by the “Federal Insurance Contribution Act” (FICA), which created the “payroll tax” that funds social security. The fund is made available to retirees, but when you were born determines when you’re eligible to receive benefits. For example, if you’re 62 in 2017, you’re eligible for benefits at 66 and 2 months.
Why is Social Security Such a Mess?
This week, former Republican Senator Alan Simpson appeared on CNBC to discuss one of the ways to reduce spending on social security ; increasing the retirement age from 66, to 68.
Raising the retirement age was a key component of the “Bowles-Simpson Plan,” a plan that was designed by Simpson and Erskine Bowles in 2010, to tackle the national debt by cutting expenditures and raising taxes. One of the options presented in Bowles-Simpson, was referred to as “The Zero Plan.” This plan called for devoting $80 billion annually to eliminating the debt. The “Tax Policy Center” laid out the 3 main components of “The Zero Plan”:
- Eliminate all tax expenditures—for both income and payroll taxes—except the EITC, the child credit, foreign tax credits, and a few less common preferences.
- Eliminate tax expenditures only for income taxes, not for payroll taxes.
- Eliminate tax expenditures only for income taxes—not for payroll taxes—but cap and restructure the tax benefits for mortgage interest, employer-sponsored health insurance, and retirement saving instead of eliminating them.
As with all plans determined to “fix” social security, Bowles-Simpson revolves around raising taxes and cutting benefits. Both options are universally unpopular.
Most plans would gradually increase the “payroll tax” to reduce the spending gap. The payroll tax, created by the “Federal Insurance Contribution Act” (FICA) is a flat tax withheld from your paycheck by your employer to fund social security programs. The tax is assessed at a rate of 12.4%. The median household income in the United States is $56,000. That means the average household is paying $6,944 in payroll taxes, on top of income tax, property tax, sales tax, etc.
Michael Tanner, of the Cato Institute, outlined the follies involved with trying to “fix” social security, and how these “fixes” hurt minorities and women.
“The current Social Security system contains a host of inequities, many of which disadvantage minorities and women. For example, because lifetime Social Security benefits are closely linked to longevity, people with shorter life expectancies can expect to receive less in retirement benefits. At every age and every income level, African Americans have shorter life expectancies than do whites. As a result, an African American who has the same lifetime earnings and pays the same payroll taxes as a white person can expect to receive a lower rate of return. This problem is exacerbated by the facts that African Americans are more likely to begin working earlier than whites and that African-American marriages are more likely to end in divorce in less than 10 years. Indeed, no group may be as poorly treated by Social Security as African Americans. None of the proposals advanced by opponents of privatization would change this unfair situation—and many would make it worse. For example, African Americans, who on average earn lower wages, would be disproportionately affected by proposed increases in the payroll tax. Even worse would be increases in the retirement age supported by Aaron and other foes of privatization. The current system also penalizes many women, especially women who work outside Even under assumptions vastly more optimistic than can be expected, Social Security remains insolvent. If add-on accounts are funded by mandatory contributions, they become simply another tax increase. For instance, under Social Security’s “dual entitlement rule” for spousal benefits, the spouse with lower lifetime earnings, nearly always the wife, is eligible to receive either a benefit based on her own earnings or one-half of her spouse’s benefits, but not both. Effectively, this means that many women pay Social Security taxes but receive no additional benefits for those taxes. Moreover, the current spousal system may set up situations in which a two-earner couple may actually receive less in benefits than a single-earner couple with the same lifetime earnings.”
Should We Privatize Social Security?
One option in the ongoing entitlement debate is privatizing social security. There are generally 3 main arguments for privatizing social security:
- it can lift the rate of return workers obtain on their retirement contributions;
- it can boost national saving and future economic growth;
- it has practical political advantages in comparison with a Social Security rescue plan based on higher payroll taxes and a bigger accumulation of Social Security reserves.
In practice, privatization has shown some promising results. Chile privatized social security in the 1970’s, Jose Pinera, Chile’s former Secretary of Labor and Social Security wrote:
“Some 93% of Chilean workers chose the new system. They trust the private sector and prefer market risk to political risk. If you invest money in the market, it could go up or down. Over a 40-year period, though, a diversified portfolio will have very low risk and provide a positive rate of real return. But when the government runs the pension system, it can slash benefits at any time.”
“Today, all workers in Chile are capitalists, because their money is invested in the stock market. And they also understand that if government tomorrow were to create the conditions for inflation, they would be damaged because some of the money is also invested in bonds — around 60%. So the whole working population of Chile has a vested interest in sound economic policies and a pro-market, pro-private-enterprise environment.
There have been enormous external benefits: the savings rate of Chile was 10% of gross national product traditionally. It has gone up to 27% of GNP. The payroll tax in Chile is zero. Of course we have an estate tax and an income tax, but not a payroll tax. With full employment and a 27% savings rate, the rate of growth of the Chilean economy has doubled.”
Despite the benefits, privatization faces stiff opposition, primarily from Democrats, most Republicans, and the AARP.
It’s easy to understand why Democrats distrust the private sector, most of them get elected on platforms that mistrust the free market. Some have gone so far as to propose allowing the government to invest in the stock market. This idea would politicize the economy and undermine free market ideals.
It’s also easy to understand the AARP’s position; raising the retirement age, cutting benefits, or any change at all would hurt their business model. The AARP really cares about keeping the status quo, they have spent $4.6 million on lobbying efforts in 2017, and in 2005 the group spent upwards of $36 million on lobbying efforts.
The Republicans, in theory at least, should be pushing social security reform as often as possible, the party is supposed to stand for less government. In practice politicians just want to get re-elected, and the elderly make up a large portion of the voting block, disenfranchising them could cost you an election.
The economy is important. By kicking the can down the road, and increasing entitlement spending, all we’re doing is putting our financial future at risk. Until we start talking about serious entitlement reform, starting with social security, we cannot hope to stabilize our economy.