Social Security Reform -- 6/11/2005

The Wizard's News

June 11, 2005

From the Wizard..

Insights from The Wizard regarding the reform of social security.

A note from Bluejay: The Wizard has maintained a strict stance on keeping political discourse off of Wnternetradiomercedes.com. However, I've really pressed him for some time to discuss Social Security reform, as his expertise makes him exceptionally qualified to tackle this subject. He possesses not only in-depth knowledge but also a balanced, unbiased perspective, which I believe our audience would greatly value. Eventually, he agreed to share his insights on the topic, and I'm thrilled that we can provide you with a thoughtful analysis that you can trust. So, without further delay, Wizard, take it away!

NTraditionally, the Wizard of Odds operates as a nonpartisan platform. Personally, I advocate for the legalization of gambling, but I've refrained from diving into political matters until now. After eight years, I've decided to break the norm and express my views on an issue that isn't directly related to gambling.

Prior to my role as the Wizard of Odds, I worked as an actuary from 1992 to 2000 at the headquarters of the Social Security Administration in Baltimore. Actuaries in this field monitor the financial health of Social Security among other responsibilities. My focus was primarily on short-term projections, assessing the impacts of congressional changes on trust funds. Whenever Congress proposed modifications to Social Security, I often calculated their potential costs or savings over a span of five to ten years. I played a significant role during two major reforms in the 1990s: the rise in taxes on benefits for high-income earners and the gradual elimination of the earnings test for beneficiaries aged over 65.

I had a good rapport with the long-term actuaries and actively sought to transition to their department. There were discussions about hiring someone to focus on private accounts, and I expressed my desire to take on that role. Unfortunately, significant retirements within my own division meant I remained in my current position. Management was apprehensive about excessive turnover, and I can understand that decision. Stuck in my position, I felt unchallenged and dissatisfied, ultimately leading me to resign and dedicate myself to my website and gaming math consultation. Had circumstances shifted slightly back in 2000, I could have been known as the Wizard of private Social Security accounts rather than the Wizard of Odds.

Concisely addressing the complexities of Social Security's long-term financing and private accounts is a considerable challenge for me. In the past, I invested weeks drafting memos about rather niche issues that affected small beneficiary groups. As someone with strong opinions and qualifications on this issue, I feel compelled to discuss it with you, my engaged audience. Yet, summarizing a topic on which I could easily elaborate for over 100 pages is a daunting task.

First, let’s take a look at some relevant statistics from the 2004 Trustees Report , which are released annually by my colleagues in the actuarial field.

• Year when monthly payouts will surpass incoming tax revenues: 2018.
• Estimated year when trust funds will be depleted: 2042.
• Tax hike needed to guarantee solvency for a 75-year timeframe: 1.89% of taxable payroll.
• Projected shortfall over 75 years in 2004 dollars: $3.7 trillion.
• 2003 benefits paid: $479 billion
• 2003 tax revenue: $632 billion
• Average interest earned on trust funds in 2003: 6.0%.

  ( source )

Essentially, Social Security operates on a 'pay as you go' basis, where most incoming funds are immediately disbursed to current beneficiaries. Right now, we have a surplus of incoming funds compared to outgoing payouts. The excess is channeled into interest-earning government securities. While the current situation appears stable, a major long-term crisis looms. The aging baby boomer generation is approaching retirement, and life expectancy is increasing. Presently, there are 3.3 working individuals supporting each Social Security recipient, but this ratio is projected to drop to 2.0 by 2040 under moderate economic and demographic conditions, with a continued decline anticipated afterward.

It is indeed fortunate that we are currently collecting more funds than necessary to brace ourselves for the impending challenges ahead, but it won't be sufficient. As I mentioned earlier, a 1.89% increase in the Social Security tax is required to ensure solvency for 75 years. This predicament has been on the radar for years, yet meaningful action has not been taken since the Reagan administration. During his term, Reagan implemented tax increases and raised the retirement age, yet this did not resolve the underlying issues. Subsequent commissions during the Bush and Clinton administrations explored the topic, but progress was minimal. I do commend Clinton for finally abolishing the earnings test for beneficiaries aged 65 and older—an initiative I fully supported.

Given the enormity of Social Security, its evaluation cannot be separated from the overall national economy. Despite the trust funds boasting $1.53 trillion at the end of 2003, one could argue that this capital may not genuinely exist. When it comes time to redeem those bonds and securities, the funds won't simply be available for distribution. Tax increases will be necessary, or we may have to curtail spending in other areas, or even borrow more. The primary concern is that the baby boomer generation is currently at the peak of their earning years while the number of Social Security recipients remains relatively low. As a nation, we should be strategically preparing for the future by reducing the national debt and amassing surplus funds for the time when there are only two workers for every beneficiary. Yet, what are we doing? We continue to overspend and accumulate debt at a time when we should be generating surplus revenues. While there was a surplus during several of Clinton’s years in office, that is no longer the case.

I commend President George W. Bush for daring to prioritize this crucial issue and taking a political risk. However, I do not agree with his proposition for private accounts, which he seems to favor being heavily invested in stocks. Allowing workers to divert a portion of their Social Security taxes into private accounts could create a funding shortfall for upholding existing benefits. As I've stated, we follow a pay-as-you-go framework. Another complication arises from the fact that Social Security was never designed to function solely as a ‘monetary value’ program. Its structure inherently favors low-income workers, granting them a more favorable rate of return compared to higher-income earners. If individuals were allowed to partially withdraw from the current system, it would largely benefit those who earn more money, resulting in yet another funding shortfall. To put it simply, in the realm of Social Security, the wealthier subsidize the less fortunate—typically, those with lower income receive more in benefits than what they contributed. If the affluent are permitted to exit the system partially, who will support those in need?

If we proceed with private accounts, it is likely that the government will need to impose tax increases or incur more debt to cover the anticipated shortfalls needed to sustain benefit payments to present recipients. While private accounts may offer comparatively higher returns for wealthy individuals than the standard system, the extra income would subsequently be funneled into higher taxes meant to support those without private accounts. Hence, those who opted for private accounts wouldn't genuinely have more money than what they currently receive from the existing system.

We should not idealize the stock market as the ultimate investment solution. Historical data indicates that stocks yielded just 7.8% from 1926 to 2001, excluding reinvested dividends. In contrast, Social Security trust funds are currently providing an impressive 6.0% return—an outcome that’s quite decent. Even if stocks were to outperform in the future, there will always be a finite amount of capital available. Increased competition for stock investments from private accounts could marginalize other investors. Ultimately, stock market profits will cap out, leaving us to decide whether those revenues will benefit one individual over another. If the federal government didn’t grapple with significant debt, I wouldn’t oppose the notion of placing some trust fund assets into stocks. Yet, given that the federal deficit requires financing from various sources, Social Security funds may end up getting borrowed from, rendering this scenario akin to borrowing to engage in stock trading—an approach that is ill-advised for individuals and should be considered unwise for an entire nation.

In the end, the nation’s wealth fundamentally hinges on the quantity of goods and services produced. Private accounts won't spur anyone to work more diligently or for longer periods. In fact, I predict that as a nation, we may end up working even less time as employees become preoccupied with monitoring stock market fluctuations, necessitating the creation of a vast new bureaucracy to oversee these accounts. The implementation of private accounts is likely to turn into a superficial exercise in redistributing resources. Consequently, it fails to address the looming long-term crisis as the average population age continues to rise.

There are no straightforward resolutions to the issues we face. We must find ways to either reduce benefits, hike taxes, or implement a combination of both strategies. The sooner we take action, the less severe the consequences will be. Personally, I advocate for a well-rounded approach involving a higher retirement age, smaller cost-of-living adjustments, and a modest tax increase. I believe this strategy would distribute the burdens fairly. There is no need to devise an entirely new framework; making some adjustments to the existing system could effectively resolve our challenges. It's time to take action instead of delaying the inevitable.

Postscript

I composed the earlier commentary on March 15. I certainly didn't anticipate that by June 11 we still would not have issued our next newsletter. (My apologies, Bad Bluejay!) Since writing that commentary, Bush has introduced a proposal aimed at addressing the long-term fiscal shortfall of Social Security. His solution involves slowing the growth of the initial benefit (known as the Primary Insurance Amount), which essentially translates to a reduction in benefits. This adjustment will alter how benefits accrue from this point forward; however, all previously established benefit increases will remain calculated using the old methodology.

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The Wizard's perspective on reforming social security.

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I first heard of 32 Red was when Casinomeister Introduction from Bluejay: Despite the Wizard's long-standing policy of keeping political topics separate on Wnternetradiomercedes.com, I've persistently urged him to address the issue of Social Security reform. His expertise and impartial approach make him particularly well-suited for this discussion, as he doesn't lean towards any political party. I felt that our audience would greatly benefit from his insights, and after much discussion, he finally consented. I'm thrilled that we can now present you with an analysis that is both credible and enlightening. So without further delay, I hand it over to the Wizard!

Typically, the Wizard of Odds maintains a neutral stance on political matters. While I personally support the legalization of gambling, this has been the extent of my site's political engagement. However, after eight years, I am ready to set aside tradition and express my views on a topic not directly related to gambling.

Before I became known as the Wizard of Odds, I worked as an actuary at the Social Security Administration in Baltimore from 1992 to 2000. Actuaries there play a crucial role in estimating when the Social Security funds will become depleted, among other responsibilities. My focus was primarily on short-term projections, especially analyzing how legislation would affect trust fund balances. Whenever changes to Social Security were proposed in Congress, I was likely the one calculating their financial implications over a span of five to ten years. I was deeply involved in two significant reforms during the 1990s, which included increasing taxes on benefits for high earners and eliminating the earnings test for individuals over 65.

Discussing the entire complex issue of Social Security financing and the debate over private accounts succinctly is quite challenging for me. I used to devote weeks to drafting internal reports on matters affecting very limited groups of beneficiaries. I have strong opinions on this subject and feel adequately prepared to discuss it, with a captive audience like you. However, it’s tough to cover a topic I could easily elaborate on in 100 pages in such a short format.

First, let’s examine some key statistics from the

From Michael Bluejay.. Greetings

year when the monthly benefits will outstrip tax income: 2018.

• Expected date of depletion for trust funds: 2042.
• Necessary tax increase to ensure solvency over a 75-year horizon: 1.89% of taxable payroll.
• Projected revenue shortfall over 75 years: $3.7 trillion in 2004 dollars.

Average interest accrued on trust funds in 2003: 6.0%.

In essence, Social Security operates on a 'pay as you go' model. The majority of funds received are immediately distributed to beneficiaries. At present, there is a surplus of funds coming in compared to those being paid out, with the excess being invested in interest-bearing government securities. Although the current situation seems stable, a significant long-term crisis looms. As the baby boomer generation approaches retirement, and life expectancy increases, the pressure will mount. Currently, there are approximately 3.3 workers for every Social Security recipient, but this ratio is predicted to drop to 2.0 by 2040 based on standard economic and demographic forecasts, and it will likely continue to decline.

It's fortunate that we're currently generating a surplus to prepare for the challenges we know lie ahead, but it won't suffice. As noted earlier, we would need to raise the Social Security tax by 1.89% today to maintain solvency over the next 75 years. We've been aware of this issue for a long time, yet no significant action has been taken since Reagan's administration. During his tenure, tax increases were gradually implemented and the retirement age was raised, but that alone wasn’t adequate. Subsequent commissions during the first Bush and Clinton presidencies have merely studied the issue without any meaningful solutions. I do commend Clinton for finally abolishing the earnings test for beneficiaries aged 65 and above, an issue I passionately supported. GIGSE convention Given the immense scale of Social Security, it cannot be analyzed without considering the wider economy. While there was $1.53 trillion in trust funds at the close of 2003, one could argue that this money is somewhat illusory. When the time comes to redeem those bonds and securities, the funds may not be readily available for distribution. The government may need to raise taxes, reduce spending on other services, or increase borrowing. The overarching concern is that at this moment, the baby boomer generation is at their peak earning capacity, and the number of beneficiaries remains relatively low. As a nation, we ought to be strategically preparing for the inevitable changes by tackling the national debt and creating a surplus for when the ratio of workers to beneficiaries narrows to two to one. Yet instead, we continue to overspend and accumulate debt during a time when we should be achieving a surplus. Although there were surpluses during many years of the Clinton administration, that period has unfortunately passed.

I commend President George W. Bush for taking the substantial political gamble of making Social Security reform a priority. However, I disagree with his proposal to introduce private accounts, primarily invested in the stock market, as a solution. If we allow individuals to redirect portions of their Social Security taxes into private accounts, this would create a gap in funding for current beneficiaries. As mentioned, we have a pay-as-you-go system. Another significant concern is that Social Security was never designed to function solely as a 'money's worth' program. The system is structured in a way that offers much better returns for low-income workers compared to high-income workers. If high earners are permitted to partially exit the system, it would exacerbate the funding shortfall. Essentially, the financial contributions of wealthier individuals help sustain the benefits received by those with lower incomes. If higher earners are allowed to partially withdraw, who will ensure the subsidies for low-income individuals?

If we allow for private accounts, it's likely the government will have to either raise taxes or borrow more money to compensate for the funding deficits required to support current beneficiaries. In the end, while higher earners might see better returns from these private accounts compared to the existing system, much of that additional income would ultimately be redirected toward higher taxes to subsidize those without private accounts, meaning they wouldn’t necessarily gain more money than what they currently receive.

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• We should also refrain from viewing the stock market as a foolproof investment solution. Historical data indicates that stocks yielded only a 7.8% return from 1926 to 2001 without reinvesting dividends. Meanwhile, the Social Security trust funds are already yielding a respectable 6.0%. Even if stocks were demonstrably more lucrative, there is limited availability for investment. As the demand for stocks increases due to private accounts, it may drive other investors out of the market. Ultimately, stocks have a cap on potential gains or losses; the question is merely about whether the benefits go to Peter or Paul. If the government wasn’t grappling with significant debt, I would entertain the idea of diversifying some of the trust funds into stocks. However, because the federal government needs to fund its deficit, it might as well borrow from Social Security, as investing in the stock market would be akin to taking on debt for speculative reasons, which is unadvisable for individuals and should be for the nation as well.

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In essence, the nation's wealth largely depends on the volume of goods and services produced. The establishment of private accounts won’t inherently motivate individuals to work harder or longer. In fact, I foresee a scenario where productivity decreases as workers spend more time monitoring market performance, leading to the creation of yet another bureaucratic entity to manage these accounts. Private accounts would merely shuffle funds around without addressing the underlying long-term challenges posed by an aging population.

• Addressing this dilemma isn't straightforward. We must either cut benefits, raise taxes, or consider a combination of both solutions. The sooner we implement measures, the less painful the adjustment will be. Personally, I advocate for a balanced strategy, including raising the retirement age, reducing cost-of-living adjustments, and implementing moderate tax increases. I believe this approach can fairly distribute the burden. A complete overhaul isn’t necessary; simply adjusting certain factors within the current framework is sufficient to resolve the issue. Let's act now instead of deferring this challenge further. I composed the preceding commentary on March 15. At that time, I couldn’t have fathomed that we would still be without a newsletter as of June 11. (Apologies from Bluejay!) Since my initial writing, President Bush has introduced a plan to address Social Security's long-term funding challenges. His proposal entails slowing the growth of the initial benefit amount (known as the Primary Insurance Amount), which is essentially a method of reducing benefits. This adjustment would affect the manner in which benefits are calculated going forward while preserving the previous calculation method for any benefits that have already been established.
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Written by: Michael Shackleford