CPI & Economic Growth Provide Solution To Social Security Funding Problem

"Your estimated benefits are based on current law. Congress has made changes to the law in the past and can do so at any time. The law governing benefit amounts may change because, by 2034, the payroll taxes collected will be enough to pay only about 77 percent of scheduled benefits." – from page 2 of sample statement on Social Security Administration website.  I have never met one person @ my FairTax seminars or anyone who has participated in radio or TV programs I have been on that was aware of this warning that plainly says that Social Security benefits will be reduced by 23% in the not too distant future unless changes are made to the Social Security entitlement program.

 

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The above graphic shows the country's financial condition we are all familiar with in general terms – namely, that sometime between 2030 & 2040 Social Security, Medicare, Medicaid, & net interest on the national debt will exceed government revenues.  The above excerpt from the Social Security website personalizes this general problem – an individual receiving the average Social Security benefit of $1,404 per month in 2018 will see the benefit abruptly cut to $1,081 (in 2018 dollars) when the deceitfully named Social Security Trust Fund runs out of IOUs & the payroll taxes collected are not enough to pay scheduled benefits – this is currently estimated to happen in 2034.

 

In addition, the above graphic shows the portion of government revenue available for Discretionary programs will be crowded out if no corrective action occurs.

 

This post will examine why Social Security is out of control - cascading toward the type of abrupt cuts for current recipients described above - & what can be done to solve the problem.  The next post will cover Medicare problems & solutions.

 

The problem with Social Security is that liabilities are growing faster than inflation or real GDP.  The declining ratio of workers to retirees (see table & graphic below) means that Social Security payments to beneficiaries won't be able to keep up with the future liabilities of the entitlement program which in turn will overwhelm the economy as shown on the above graphic.  For instance, when three 2015 workers retire they will receive benefits based on two workers funding the system in 2035 – this is unsustainable.

 

 

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Social Security was originally a pay as you go system meaning that benefits were provided by then current payroll taxes.  In the 1980s & 1990s the baby boom generation's payroll taxes exceeded the annual amount of benefits paid & the surplus was used to create a Social Security Trust Fund – money Congress used to fund other programs that were accounted for by issuing IOUs that now make up the contents of the trust fund: i.e., there is no real money in the Social Security Trust Fund, just IOUs.  The reduction in benefits, currently estimated to be 23%, will occur when the last IOU is redeemed using money from the general treasury.  Social Security has been paying out more in benefits than it collects in taxes since 2010 thereby reducing the number of IOUs in the trust fund.

 

The solution to the above described Social Security funding problem centers around the determination of a person's initial Social Security benefit – the monthly benefit when a recipient begins getting checks.  This initial benefit is based on the average real wage growth of a person's earnings over their working lifetime.  Real wage earnings growth is greater than inflation measures such as the Consumer Price Index (CPI) so in essence the government is guaranteeing a real positive return on everyone's financial participation in the Social Security program – a guarantee no other investor including the federal government has.  In addition, to fund current Social Security benefit promises it will require a 50% increase in payroll taxes meaning we will sooner or later run out of our own money let alone other people's.  Just reducing this initial benefit so that it is calculated based on the CPI rate instead of the wage rate solves the Social Security funding problem – Source Susan Lee column in the WSJ dated November 23, 2004 entitled All You Need To Know About Social Security. 

 

I have promoted, on RTE, the above solution to the Social Security funding problem several times since I first read about it in 2004.  I know it will take a mindset change in our country but I bring it up again because we may have the perfect opportunity to implement it if we don't squander the potential increase in economic growth & the prosperity that comes with it that results from the recent tax legislation.

 

The Tax Cuts & Jobs Act of 2017 includes many features that potentially will increase economic growth.

 

Economic growth is determined by how many people are working, & how productive they are.  Population growth drives economic growth because a larger population means more workers to produce & more consumers to buy things.

 

The new tax legislation that went into effect on January 1 will take care of the productivity part of economic growth as documented in several posts the past two months.  Check archives on RTE.

 

So let's analyze the number of people working – although the U-3 headline unemployment rate is very low the January unemployment report released on Friday by the Labor Department shows there still are 451,000 people in U-6 who are too discouraged to look for work because they believe there is no work for them in America & five million more who want full time jobs but can only find part time work – in fact U-6 ticked up in January from 8.1% to 8.2%.  Likewise, with some overlap, there are thousands in the 25 to 54 age group who are still not employed @ the prerecession level – twelve year later.  I know some of these people – they are more interested in playing Pokémon Go & contemplating living off the inheritance their mother leaves them than thinking about a career in engineering that will help America grow – this mindset must change or the future of these people will be composed of only wealth spend down which will leave them penniless sooner than they think.  In total there are over 95-million people in America that are not in the labor force – with regard to those of working age:  Phil Gramm once told President Reagan that people will leave their wheelchairs when the economy grows.  Legal immigration is also important in that we must bring in people who can immediately contribute to the economy's growth.  See referenced post below for more examples of where workers will be found.

 

President Trump's budget released last May called for 2.3% real economic growth in calendar year 2017 – so he was right on target – it was 2.3% in 2017.  It was 1.5% in 2016 so the stage is set for improvement from BO's years with the first three full quarters of Trump's presidency producing GDP growth of 3.1%, 3.2%, & 2.6%.  Trump's budget calls for 2.5% growth in 2018 & 2.8% in 2019 with 3.0% thereafter.

 

But economic growth in & of itself will not solve the Social Security funding problem – it needs another element or influence like the change to the CPI basis for determination of the initial benefit, because as the economy grows so do real wages meaning the Social Security liability grows right along with it in lockstep under the current wage growth benefit formula. 

 

What solid economic growth contributes to solving the Social Security funding problem is providing a sense of prosperity that makes a national pension system not seem so necessary – or @ least not one that went from 222,488 primary worker beneficiaries in 1940 to one that by December 2015 had Social Security beneficiaries totaling 40 million retired workers, 2.3 million spouses & children of retired workers, 6.1 million surviving children & spouses of deceased workers, & 10.8 million disabled workers & their eligible dependents.  Source – Center On Budget & Policy Priorities.

 

If improved prosperity is realized as a result of greater economic growth, than has been experienced in the U.S. in a long time, the timing is right to switch the Social Security benefits basis to the CPI & do away with the wage indexing formula.  The phase in to the new system would not affect anyone age 55 or older.  Anyone age 54 or younger would retain their wage base work years in the formula but would switch to the CPI basis immediately – so everyone would retain the portion of the existing system methodology up until the change in benefit basis from wage to CPI.

 

True, benefits eight years after the change in benefit basis, will start to be lower for those age 54 when the system change is made, - but the revised system would be on sound footing for everyone, especially younger workers, unlike the current system based on the wage indexing formula – where the choices in the near future are to raise payroll taxes 50% on younger workers (& all others) as indicated above, borrow hundreds of billions of dollars, or abruptly slash benefits 23% on current benefit recipients as the Social Security website indicates is a certainty under current law. 

 

Do your own calculation to see how much effect the change to the CPI formula would have on your personal Social Security benefits.  Those age 55 & older – none.  Those age 54 & younger would follow a sliding scale with people in their 50s receiving appreciably more than those just entering the workforce who would receive about 77% of the amount based on the wage index formula – a good verification of the Social Security Administration's calculation of the current cut to be expected after all of the IOUs in the trust fund are redeemed.

 

Under the CPI based system Social Security would become financially sound – able to pay all benefits with no need for financial gimmicks – & if the needed mindset change produced enough courage the long debated change to privatizing @ least a portion of the Social Security taxes would be an additional benefit providing the chance to return benefits to a higher level while giving current workers a property right to the returns on the taxes they pay toward retirement.

 

The above explanation of the Social Security funding problem shows the obvious predictable suffering & distress that will be realized by unsuspecting people in the not too distant future.  Too bad that the selfishness of politicians & recipients of current benefits as well as those close to receiving benefits precludes working on a solution unless people of substance, who understand the problem that is so obvious, cry out in outrage for a solution like the one described above.

 

Reference Post:  How Trump's Budget Enhances Economic Growth & Prosperity