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Social Security Reform: Mechanisms for Achieving True Pre-Funding

17 Apr 2008
Posted by Andrew Samwick

Yesterday, the Treasury released its fourth in a series of issue briefs on reforming Social Security.  As the title indicates, this one was focused on making sure that Social Security surpluses are used to increase the ability of future generations of taxpayers to support the benefits claimed by future retirees.  It uses the LMS plan as an illustration and emphasizes the constructive role that personal accounts can play in safeguarding Social Security funds for Social Security benefits.

Here's an excerpt of the discussion about pre-funding future benefits, with my emphasis added:

Pre-funding is an effective financing strategy provided that the near-term surplus revenues are safeguarded in a way that allows them to be used to pay for future benefits. The present Social Security system has its surpluses accumulate in the trust fund. These surpluses will increase the government’s capacity to pay benefi ts in the future only to the extent that they result in smaller amounts of public debt issuance than would occur if there were no surpluses. This is because reducing near-term public debt issuance would increase the government’s capacity to issue debt in the future to help pay benefits when the bonds in the trust fund are redeemed.

Many analysts believe that Social Security surpluses under the present system do not increase the government’s capacity to pay future Social Security benefits. Under this view, Social Security surpluses are offset in the rest of the federal budget by some combination of higher non-Social Security spending and/or lower non-Social Security taxes. To the extent that this is true, Social Security’s surpluses do not increase the government’s capacity to pay future Social Security benefits. The future benefit payments that would have been financed with public debt issuance had Social Security surpluses truly been saved must instead be financed with lower non-Social Security spending and/or higher non-Social Security taxes. In this case, the existence of the near-term Social Security surplus causes the non-Social Security budget to be more profligate, and the future Social Security cash deficit will require future non-Social Security budgets to have either higher taxes or lower spending than would have been the case had today’s surpluses resulted in true pre-funding. Under this scenario, an attempt to make Social Security fair to future generations by accumulating near-term surpluses in the trust fund would be undone by a non-Social Security policy that is less fair to future generations. Rather than resulting in resources that provide future benefits, running a Social Security surplus today would instead lead to more debt outside the trust fund that must be paid off by future generations, leaving them with no net gain.

The part I've highlighted is the reason why I favor an explicit target for the on-budget deficit.  Read the whole thing.

One thing that was really

One thing that was really telling about the Treasury brief focusing on the LMS plan is the fact that it's about the only personal account plan that COULD be used, since it's about the only one without significant borrowing (Kolbe-Boyd is another). In other words, by far the biggest purpose for personal accounts is to spread burdens between generations, but if we're borrowing all the money to finance them then we can't be at all sure they're doing what they're supposed to be. Policy-wise, this tells me we've focused on only half the story. The account is like a wheelbarrow for shifting resources between generations. You still need to fill it with resources, though, and LMS is one of the few that actually does.

LMS Question?

What does the following phrase mean? a gradual increase in the payroll tax cap to 90 percent of earnings Are the earnings in question each individual's earnings, or is it a fixed cap at the 90 percentile mark of some population of earners?

90 Percent of Earnings

It is the latter. Increasing the Maximum Taxable Earnings to the point where 90% of total payroll is subject to the payroll tax. It has slipped below that level over the past couple of decades. That would have put the MTE at $171,600 in 2006 when the plan was scored by the Office of the Chief Actuary at SSA.

We can't save.

Social Security surpluses do not increase our capacity to pay future benefits because they cannot be saved anywhere. We are the biggest economy with the smallest retirement problem and other countries are saving here. There is no economy that we can save in and withdraw from later. Our country can only put money in our own economy, and that is not saving. Every penny to pay future benefits must be withdrawn from our own economy. The only thing our government can do is increase investment or reduce government consumption. The best way for government to invest money is to not tax money from private investors. The policy to have the biggest benefit to future generations is pro-growth policy that leads to the biggest future economy to withdraw from. To maximize growth we need a budget balanced between taxes, debt, and spending, such that changing the balance in any way will reduce growth.

The purpose of personal accounts?

"by far the biggest purpose for personal accounts is to spread burdens between generations"

Is that true? An increasing burden of SS is going to land on future generations one way or another by arithmetic. The main purpose of private accounts as I view them is to preserve the basic nature of SS as it is today, regardless.

Two things made SS exceedingly popular in the past: everybody received more from it in than they put into it, while the tax cost to the politicians was very low (at least until '83). What wasn't going to be popular about that?

But in the future both these conditions go into reverse.

Future generations must get less back from SS than they put in (discounted by the bond rate) in an amount that matches the extra that prior generations received over what they put it. And would past generations have loved SS so much if it had paid them $11 trillion less than they contributed to it, rather than $11 trillion more??

Also, to pay even these benefits, income taxes are going to have to be increased by 2 points of GDP to cover the operation of the trust fund by the 2030s. For perspective, this is 10 times the size of the tax increase of the 1983 SS Ammendments that traumatized Congress, and 3x the size of the 1993 Clinton tax increase that passed a Democratic Congress by one vote and preceeded the Democrats losing the House for the first time in 40 years. And it will be simultaneous with tax increases at least twice as large needed for Medicare etc.

It is inconceivable to me that SS's design as we know it will survive this period. How many people are going to vote for a tax increase this large, simultaneous with other even larger tax increases, to support a program that will make them poorer on a lifetime basis? Even many retirees will do better off by voting "no" on a big tax increase on their taxable retirement income (pensions, IRAs, etc).

The political incentives seem instead to point powerfully to another reform "compromise" repeating that of 1983 but on a larger scale: Most current and soon-to-retirees keep their benefits ... the young get benefits reduced by various means ... the rich get means-tested further (this time "out" for many -- how many liberals are going to support big tax increases on workers to secure benefits for Bill Gates?) ... and increased taxes are dropped on the young.

The effect of all which will be to destroy SS as we know it for the then-young, who will receive a return from it so clearly negative, while being means-tested out of if it if they are a success in life, as to make SS politically unsupportable. SS becomes a rich-pay-for poor welfare program.

OTOH, if SS private accounts to hold the surplus in real economic investments had been adopted back in '83 or when proposed after the '94 Advisory Commission, then there'd be no extra 2% of GDP tax cost to fund the trust fund in the 2030s, and the private investments would still be giving all particiapants a positive return on net.

The conditions that made SS politically popular would still be met instead of being reversed, and SS could continue happily on its way.

Of course it would have been best to fund such private accounts with reduced general budget spending -- but even if borrowing had been needed, increasing borrowing in the 1990s and 2000s, when cheap, to reduce borrowing and spending in the 2030s and 2040s, when it figures to be very dear, would have been a good deal.

Alas it seems to late to go this route to save the structure of SS now. And I'm afraid that any reform plan that counts on incurring the 2-pt of GDP income tax cost of the 2030s, by counting the value of the Trust fund bonds towards of the "actuarial balance" of SS, will fail to avoid hitting the political minefield ahead.


A Capitalist's Social Security, 401(k), and Retirement Plan Refo

What if there was an easy way to implement a whole new approach to retirement funding, pension planning, and Social Security? Would the politicians be interested? Let's find out.

What if the new plan actually reduced payroll taxes, cut prices, created jobs, increased salaries, raised shareholder dividends, partially funded decreased healthcare costs, and was available to everyone?

Sound too good to be true, but it's actually doable. The reasons for the present system's failure are mostly political; the solutions are clear, practical, and non-partisan. What we want is a less expensive system for assuring that everyone is able to retire with an adequate income, higher than that provided now by Social Security.

What we need is a simple program, part mandatory and part voluntary, using experienced trustees who operate within the strictures of the prudent-man rule--- a risk-minimizing legal doctrine that restricts investments to those that seek reasonable income and preservation of invested capital--- SIBORAP Tier One investments.

The 2007-2008 stock market correction and credit crisis laid bare the weaknesses of all self-directed retirement accounts. First of all, they are not (and never were) pension plan equivalents. They were cheap-to-provide replacements for fully funded defined benefit pension plans--- supplemental programs at best.

Next, inexperienced investors were provided with an array of far-too-speculative investment options, and little if any training in basic QDI (Quality, Diversification, and Income) investment principles. The mutual fund industry was allowed to monopolize the self-directed plan market place.

Third, most participants thought of their programs (401(k)s, IRAs, ROTHs, SEPs, SIMPLEs, etc.) in guaranteed pension plan terms. They were encouraged to do so purposely by mutual fund distributors and inadvertently by uninvestment-educated employee benefit representatives.

If good news ever becomes an actual news story again, people would realize that both defined benefit pension plan and guaranteed fixed annuity contract payments were maintained throughout, and in spite of, this terrible financial environment. Why not deal with Social Security in the same manner?

A Social Security Retirement Income Annuity, or SSRIA, invested 70% or more in government guaranteed securities, could be phased in quickly as a mandatory replacement for the existing Social Security program. The personally owned SSRIA would also become a voluntary investment option for all self-directed programs and a guaranteed safe savings vehicle for after tax discretionary dollars.

These are the bare bones parameters of the new program:

SSRIA contracts will be provided by newly formed subsidiaries of established insurance companies. They are deferred, fixed-income-only annuities with no commissions or fees paid by participants or employers. All companies would provide identical products, insurances, and maturity options. A minimum of 150,000 new jobs could be created.

The contracts would include $10,000 of term life insurance, provide for retirement at age 60 or above with just two immediate annuity options: life and joint life. No variable account features, or withdrawals, would ever be allowed, and all SSRIA retirement payments would be absolutely income-tax-exempt at every political level.

SSRIA providors would receive an investment management fee of .85% of the Working Capital under management, emphasizing the importance of both income generation and preservation of capital. Participant account statements would reflect ever-increasing cash balances, growing at annually adjusted, contractually guaranteed rates

Providor operating profits would be distributed 70% to parent company shareholders and 30% to fund a trust for retiree health care benefits. An associated tort reform bill would cap jury awards and attorney fees for personal injury lawsuits against all health care providors.

SSRIA mandated contributions would be capped at 3% of pre tax total employment compensation; an additional 2% of pre tax earnings could be contributed voluntarily. Voluntary contributions to an employee's SSRIA would be a required investment option of all self-directed employee benefit programs.

There would be no employer contribution to individual SSRIAs. Employers would be required to use their savings in any combination of these options: increase non-executive salaries, hire additional workers, reduce consumer prices, and increase shareholder dividends.

Employees earning total compensation in excess of $1,000,000 would pay 10% of the excess directly to the retiree health care trust. All special compensation arrangements, including stock option plans would be banned. Bonus payments in excess of 20% of base pay would be pooled, and divided among all employees and shareholders, dollar for dollar.

Employees would be assigned randomly to qualifying SSRIA providors, one contract per person. Self-employed persons, dependent spouses and children, would be eligible for SSRIAs, and would be assigned to a providor by the Social Security Administration.

The Social Security Administration would oversee the operations, pricing, and investment practices of SSRIA providors, qualify companies wanting to become providors, and implement the transition from the existing program to the new. The process could take up to five years, unless peace breaks out in the Middle East.

The transition to the SSRIA program would commence immediately, starting with employees under age thirty. Existing Social Security accounts would be frozen. Balances would be applied 50% in cash as an SSRIA deposit, 20% to the retiree health care fund, and 30% as a Federal Income Tax credit. Older employees would have proportionately larger direct credits to their start up SSRIA accounts.

One other thought: All active government employees at all levels, elected, appointed, or hired, would be transitioned into the new SSRIA system.

OK, there it is, a viable first step change plan that most of us would go for. Call your representatives, newspapers, and favorite radio talk shows. Hey, it's our money; let's keep it that way.

Steve Selengut
http://www.sancoservices.com/
http://www.kiawahgolfinvestmentseminars.com
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"


A Capitalist's Social Security, 401(k), and Retirement Plan Refo

What if there was an easy way to implement a whole new approach to retirement funding, pension planning, and Social Security? Would the politicians be interested? Let's find out.

What if the new plan actually reduced payroll taxes, cut prices, created jobs, increased salaries, raised shareholder dividends, partially funded decreased healthcare costs, and was available to everyone?

Sound too good to be true, but it's actually doable. The reasons for the present system's failure are mostly political; the solutions are clear, practical, and non-partisan. What we want is a less expensive system for assuring that everyone is able to retire with an adequate income, higher than that provided now by Social Security.

What we need is a simple program, part mandatory and part voluntary, using experienced trustees who operate within the strictures of the prudent-man rule--- a risk-minimizing legal doctrine that restricts investments to those that seek reasonable income and preservation of invested capital--- SIBORAP Tier One investments.

The 2007-2008 stock market correction and credit crisis laid bare the weaknesses of all self-directed retirement accounts. First of all, they are not (and never were) pension plan equivalents. They were cheap-to-provide replacements for fully funded defined benefit pension plans--- supplemental programs at best.

Next, inexperienced investors were provided with an array of far-too-speculative investment options, and little if any training in basic QDI (Quality, Diversification, and Income) investment principles. The mutual fund industry was allowed to monopolize the self-directed plan market place.

Third, most participants thought of their programs (401(k)s, IRAs, ROTHs, SEPs, SIMPLEs, etc.) in guaranteed pension plan terms. They were encouraged to do so purposely by mutual fund distributors and inadvertently by uninvestment-educated employee benefit representatives.

If good news ever becomes an actual news story again, people would realize that both defined benefit pension plan and guaranteed fixed annuity contract payments were maintained throughout, and in spite of, this terrible financial environment. Why not deal with Social Security in the same manner?

A Social Security Retirement Income Annuity, or SSRIA, invested 70% or more in government guaranteed securities, could be phased in quickly as a mandatory replacement for the existing Social Security program. The personally owned SSRIA would also become a voluntary investment option for all self-directed programs and a guaranteed safe savings vehicle for after tax discretionary dollars.

These are the bare bones parameters of the new program:

SSRIA contracts will be provided by newly formed subsidiaries of established insurance companies. They are deferred, fixed-income-only annuities with no commissions or fees paid by participants or employers. All companies would provide identical products, insurances, and maturity options. A minimum of 150,000 new jobs could be created.

The contracts would include $10,000 of term life insurance, provide for retirement at age 60 or above with just two immediate annuity options: life and joint life. No variable account features, or withdrawals, would ever be allowed, and all SSRIA retirement payments would be absolutely income-tax-exempt at every political level.

SSRIA providors would receive an investment management fee of .85% of the Working Capital under management, emphasizing the importance of both income generation and preservation of capital. Participant account statements would reflect ever-increasing cash balances, growing at annually adjusted, contractually guaranteed rates

Providor operating profits would be distributed 70% to parent company shareholders and 30% to fund a trust for retiree health care benefits. An associated tort reform bill would cap jury awards and attorney fees for personal injury lawsuits against all health care providors.

SSRIA mandated contributions would be capped at 3% of pre tax total employment compensation; an additional 2% of pre tax earnings could be contributed voluntarily. Voluntary contributions to an employee's SSRIA would be a required investment option of all self-directed employee benefit programs.

There would be no employer contribution to individual SSRIAs. Employers would be required to use their savings in any combination of these options: increase non-executive salaries, hire additional workers, reduce consumer prices, and increase shareholder dividends.

Employees earning total compensation in excess of $1,000,000 would pay 10% of the excess directly to the retiree health care trust. All special compensation arrangements, including stock option plans would be banned. Bonus payments in excess of 20% of base pay would be pooled, and divided among all employees and shareholders, dollar for dollar.

Employees would be assigned randomly to qualifying SSRIA providors, one contract per person. Self-employed persons, dependent spouses and children, would be eligible for SSRIAs, and would be assigned to a providor by the Social Security Administration.

The Social Security Administration would oversee the operations, pricing, and investment practices of SSRIA providors, qualify companies wanting to become providors, and implement the transition from the existing program to the new. The process could take up to five years, unless peace breaks out in the Middle East.

The transition to the SSRIA program would commence immediately, starting with employees under age thirty. Existing Social Security accounts would be frozen. Balances would be applied 50% in cash as an SSRIA deposit, 20% to the retiree health care fund, and 30% as a Federal Income Tax credit. Older employees would have proportionately larger direct credits to their start up SSRIA accounts.

One other thought: All active government employees at all levels, elected, appointed, or hired, would be transitioned into the new SSRIA system.

OK, there it is, a viable first step change plan that most of us would go for. Call your representatives, newspapers, and favorite radio talk shows. Hey, it's our money; let's keep it that way.

Steve Selengut
http://www.sancoservices.com/
http://www.kiawahgolfinvestmentseminars.com
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"




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