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Friday, October 2, 2009

Social Security in a nut shell: Part III

This is Ida May Fuller, the first person ever to get a Social Security check. She paid in to Social Security a total of $24.75 in 1937-39. Her first check was for $22.54. She lived to be 100 and collected a total of $22,888.92. She hit the superfecta and did not even buy a ticket. I don't begrudge her this or any of our other proud senior citizens that fought the Depression and won World War II. What I am terribly troubled by, however, is the future projection of benefits and that is problem #3.

Problem: Ever rising real, inflation-adjusted benefits. Today, the average person at 65 gets about $14,000 per year in Social Security benefits. In 2050, the promised average benefits are $20,000 per year in 2009 dollars. Every generation gets higher and higher promised real, inflation-adjusted benefits. So what has been promised to today's 20 year olds is 40% higher than what people get today. This comes from legislation passed under Carter that indexes initial benefits to wages and not prices. The result is ever rising real benefits. Sorry folks but that is not sustainable either.

Solution: From the mortality tables and wage histories, actuarially, we can figure out within $1.32 how much is needed in the years to come to pay promised benefits. The Social Security trust fund runs out around 2042, although it could be sooner if economic growth takes a hit in the decades to come. It is estimated that after 2042, there will be taxes sufficient to cover 70% of promised benefits. Whamo! I propose to tell the American people that after 2042, you will receive 70% of what has been unrealistically promised. You now have 33 years to make adjustments to your retirement cash flow. In addition, there was talk of a "blended" indexation formula that made a great deal of sense to me. That is probably why it has not been spoken of again. This would change the indexing formula as follows: instead of indexing initial benefits to wages only, the bottom 1/3 of all recipients would continue to have their benefits indexed to wages, the middle 1/3 would have their initial benefits indexed by a 50-50 blend of wages and the Consumer Price Index, and the top 1/3 would have their initial benefits indexed to the CPI only. This would go a long way to correcting this pie-in-the-sky future promised benefits Candyland.

Remember, when all is said and done, we could have higher benefits with a stable worker-to-retiree ratio and economic growth...OR...we could have a declining worker-to-retiree ratio with stable real promised future benefits...BUT... we can not have a declining worker-to-retiree ratio with higher real promised future benefits. And of course, that is what we have right now.

As the late great Herbert Stein famously said, "something that can't go on forever...won't". And it won't.


Glaucon said...

Simple question: when you write "top," "middle" and "bottom" recipients, are you referring to an age relationship or what?

Thank you for your time.

A student of yours.

Randall Parker said...

No, here I mean the 1-33%, 34-66%, and 67-100% of the income distribution percentiles.