Social Security rules are complicated and change often. For the most recent “Ask Larry” columns, check out maximizemysocialsecurity.com/ask-larry.
Larry Kotlikoff’s Social Security original 34 “secrets”, his additional secrets, his Social Security “mistakes” and his Social Security gotchas have prompted so many of you to write in that we now feature “Ask Larry” every Monday. Find a complete list of his columns here. We are determined to continue it until the queries stop or we run through the particular problems of all 78 million Baby Boomers, whichever comes first. Let us know your Social Security questions. Kotlikoff’s state-of-the-art retirement software is available here, for free, in its “basic” version.
Kotlikoff is a professor of economics at Boston University and director of the Tax Analysis Center.
The Social Security system gives social insurance a bad name and needs to be replaced, root and branch. I’m a strong supporter of compulsory saving and social insurance. But Social Security, as currently constituted, is a disgrace. It’s insolvent, grossly unfair within and across generations, and a user’s nightmare.
It’s in Worse Shape than Detroit’s Pension Systems
According to table IVB6 of its 2013 Trustees Report, the Social Security system is 32 percent underfunded. To be precise, its infinite horizon fiscal gap — the present value difference between all future projected expenditures less the sum of all future projected taxes, plus the system’s trust fund — is $23 trillion, or 32 percent of the present value of future projected Social Security taxes.
Resolving Social Security’s insolvency requires either an immediate and permanent 32 percent increase in payroll taxes or an immediate and permanent 22 percent cut in all Social Security benefits. Detroit, in contrast, needs to cut pension benefits by roughly 16 percent on a system-wide basis.
Social Security won’t be broke in 10 or 20 years; it’s broke now, as I’ve detailed before on this page. Like Detroit, there are no reasonable scenarios under which its projected receipts cover its projected expenditures. And waiting to address the system’s finances will make them even worse.
Social Security’s 32 percent present-value fiscal gap ($23 trillion in absolute dollars) is calculated over the infinite horizon, not over a finite horizon like 75 years. Over 1,000 economists, including 16 Nobel Laureates, have endorsed infinite-horizon fiscal gap accounting not just for Social Security, but for the federal government as a whole.
This reflects the profession’s realization that finite-horizon fiscal gap measures aren’t well-defined fiscal measures. Instead, they are linguistic constructs reflecting how the government labels its receipts and payments. Were one to label all of the next 75 years of Social Security contributions as “borrowing” rather than “taxes” and label the future benefits those contributions trigger as “repayment of principal plus interest” on this borrowing, the 75-year fiscal gap would be vastly larger (since there would be no taxes to discount for the next 75 years) than is now the case. Only the infinite-horizon fiscal gap is invariant to such economically irrelevant changes in fiscal language.
Yes, valuing uncertain future flows is difficult. But economists are developing better risk-adjustment techniques for doing so. This research suggests that Social Security’s risk-adjusted fiscal gap may be substantially larger than reported in table IVB6. Why? Because Social Security’s projected benefits are more likely to be paid than its projected taxes are to be collected. And risk adjusting means discounting (as in making less of) more heavily future payments and receipts that are less certain.
Social Security Is Generationally Inequitable
Social Security, like the federal government as a whole (which is 57 percent underfunded), has been run on a take-as-you-go basis. Each generation of retirees (rich, middle class and poor) takes from the contemporaneous young, promising the young that their turn will come when they’re old, at generational expropriation.
This Ponzi scheme is an ongoing moral outrage. Current and near-term retirees (rich, middle class, and poor) are being asked to pay not a penny of the system’s $23 trillion unfunded liability. This bill will, apparently, be dumped entirely in our children’s laps requiring of them, not 37 percent, but 50 percent or higher lifetime FICA tax payments in exchange for no extra benefits.
Social Security Is Unfair Within Generations
Social Security’s provision of free spousal and survivor benefits leads to egregious inequalities. Husbands (or wives) that contribute not a penny to Social Security their entire lives, but who are married to high earners, can receive hundreds of thousands of dollars in free benefits over their lifetimes based on their spouses’ earnings records. Yet these workers aren’t asked to contribute a penny more to help pay for those auxiliary benefits.
Divorced spouses who were married for 10 or more years can potentially collect hundreds of thousands of dollars in spousal and survivor benefits on their exes’ earnings record. But those who call it quits nine years and 364 days into their marriages receive nothing whatsoever in such benefits.
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Surviving spouses who remarry at 60 or older can collect on their deceased partners’ records, but not those who remarry even a day before.
Households that time their benefit collection just right can collect tens of thousands in additional benefits. Those who don’t understand deeming, excess spousal benefits and other esoteric provisions are left out of these freebies.
A Retirement System that No One Can Understand
Social Security has 2,728 rules in its handbook and tens of thousands of rules about these rules in its program operating manual. The rules are so complex and written in such an opaque manner that it’s virtually impossible for anyone to understand his or her retirement finances. The formulas for determining benefits are so complex, who knows how many households are undersaving because they think Social Security will deliver more benefits than is the case.
Freeze the Current System, Pay Off Accrued Liabilities and Start from Scratch
President Franklin Roosevelt would be appalled at what politicians and bureaucrats have done to his signature social program. But there is a way to reform the system from scratch to let it fulfill its real mission. It’s called The Purple Social Security Plan. It transforms the retirement portion of Social Security into a personal security account system with compulsory, shared (between spouses) and progressively matched (by the government) contributions made to personal accounts and invested by a computer (i.e., not Wall Street) in a global, market-weighted index of stocks, bonds and real estate. The government would guarantee a zero cumulative real return on the portfolio and gradually sell each participant’s account balance, converting them into inflation-indexed pensions (again, with no involvement by Wall Street).
You can’t make a silk purse out of a sow’s ear. Social Security’s time is past. It needs to be retired and replaced for everyone’s sake, especially our children’s.