Sunday, November 29, 2009

Social Security Solutions, Part 1: The social contract

Back in the mid-1980s I visited an elderly cousin of mine. She would have been in her mid to late 70s at the time and she had a number of health problems. Nothing major but her vision was very poor and she was generally weak. They - whoever “they” were at the time - were talking about reducing Social Security, possibly across the board, possibly through means testing. My cousin had a pension from her husband and money in the bank - she and her husband had worked hard to make sure she had both - but her Social Security money was something she had counted on when planning for retirement. When we discussed the possibility of her Social Security being reduced she was almost in tears. “They can’t take that money away from me,” she said. “I have no way to make more.”

I went home and wrote a letter to Bill Bradley, one of my Senators at the time, saying that I realized Social Security was unsustainable but that I thought it would be criminal to suddenly cut Social Security for people already over 65 or for those close to 65. Instead, I said, we should start telling younger people that their Social Security would be means-tested. Perhaps, I suggested, we could say that for everyone over 55, Social Security would not be means-tested. For everyone under 55 Social Security would be means-tested when they were old enough to qualify but the reductions would be phased in. For example, let’s say you were between 50 and 55 when the new rules went into effect. When you started receiving Social Security, means-testing would be done to see if your Social Security should be reduced. However, if the means-testing said your Social Security should be cut by $100, it would only actually be cut by $25. For someone 45-50 when the new rules went into effect, the cut would be $50; 40-45, the cut would be $75; and for those under 40 the cut would be in full effect. Knowing head of time that Social Security would be means-tested would give those younger people a chance to save more of their own money for their retirement while not unfairly taking money away from those who were counting on Social Security and no longer had the time or the ability to earn and save more.

Needless to say, nothing like this happened (I got a very nice form letter from one of Senator Bradley’s aides) and here we are twenty years later. Unfortunately the great bulge of baby boomers who would have been subject to means-testing if we’d done this twenty years ago are now so old that we can’t give them advance warning of means-testing. That means we can’t cut their Social Security without great unfairness. How would suddenly beginning to means-test Social Security be unfair to the well-off elderly who would lose money as a result of it? Well, here’s how Megan McArdle puts it when talking about a different entitlement, higher education in California (emphasis mine):

... shutting down prior entitlements suddenly is a very bad thing, even if you're the kind of heartless conservative who hates entitlements ...

People plan their lives around public programs. Allowing an unsustainable program to run until it comes to a screeching halt is often worse than having no program. The UC system is very good, and I am in no way suggesting that we would be better off if it didn't exist. But many, many California students, and their parents, planned their lives around a reasonable expectation of what in-state tuition would be. The protests are childish, but the rage underneath them is understandable: if you suddenly have to leave school because legislators have broken your implied social contract, you're probably going to be pretty mad.

And that, of course, is the problem with a change to Social Security that involves cutting benefits for those already receiving them or for those on the verge of being eligible for them. It’s all very well and good to say that well-off old people shouldn’t be getting money from less well-off younger people but those well-off old people made plans based on those Social Security payments. When they decided what job to take, how much money to save for retirement, what to buy and what to forego so they could have the kind of retirement they wanted, the money from Social Security was always in their calculations. To see how this works, let’s take a look at two hypothetical couples.

Ann and Bob have worked hard their whole lives. They married right out of college and bought a three-bedroom ranch house in a nice enough subdivision; both sets of parents helped them out with the down payment. They lived close to the bone - no dinners out, modest Christmas presents, no getting away on vacation - until they paid back those loans. Once they were making a little more money they had a couple of children but they still watched their pennies. Vacations were driving trips, often to visit relatives; they shopped at discount stores for clothes and food; Christmas and birthday presents were still modest and always included a little extra cash tucked away in their kids’ college accounts. And they always, always put away as much as they could for their retirement. They figured they’d have the house paid off and the kids through college by the time they retired and they calculated that with the $2000 per month - $1000 for each - that they’d get from Social Security plus the $2000 per month they planned to have from their own retirement investments, they’d have enough money to do all the traveling and wining and dining they weren’t doing now.

Carol and Dave have also worked hard their whole lives. They, too, married right out of college and bought a three-bedroom ranch in a nice enough subdivision with the help of their parents. They, too, scrimped and saved to pay back their parents. After that, though, they saw no need to continue to be frugal. They never ran up a lot of debt but except for saving for their kids’ college they spent every penny of their income on trips and clothes and restaurants and just plain stuff. As soon as they got halfway decent equity in their ranch house they traded up to a McMansion. There was no way they could save for retirement after that but they figured that the $2000 - $1000 for each of them - that they would get from Social Security would be plenty: they’d be so old when they retired that they wouldn’t want to do much of anything anyhow.

Now both couples are retiring. Ann and Bob will get $24,000 a year from Social Security plus $24,000 a year from their own retirement investments; their house is long since paid off. Carol and Dave will get $24,000 a year from Social Security but they have no retirement savings and not only is their house not paid off, the lousy real estate market means the value of the house is just barely enough to cover the outstanding mortgage.

The government decides to means-test Social Security. What’s going to happen? Why, Ann and Bob are going to lose their Social Security because they’re financially secure without it. Carol and Dave are going to keep theirs because that’s all they’ve got. And that’s not fair.

So are there ways to keep Social Security solvent without unfairly penalizing those who counted on their Social Security benefit when they planned for retirement? Yes and I’m going to discuss three of them: the three-month solution; the 10% solution; and the Lifetime Endowment. As always, I’ve created a new category to group together the posts in this discussion.


Anonymous said...

This is why I like private contracts better than government programs. I negotiate for a private deal and expect to be able to enforce it legally. If it's a good enough deal, I pay into it voluntarily with my own money. Social Security was a deal that not many workers would have opted for. Of course it's unfair to accept their contributions throughout their working lives and then suddenly decide they don't deserve the benefits -- but it was even more unfair to force them to contribute to the system in the first place. They could have been contributing that money into a retirement program with a private, reliable, and honorable counterparty. The problem was, of course, that the system couldn't have competed on a voluntary basis; it had to be mandatory to survive at all.

What's more, it had to be mandatory in order to force people to contribute to it who otherwise simply would not make adequate provision for their own retirement, and who would then present themselves to the public as an intolerable problem when they were too old to continue working but too poor to support themselves in a decent retirement. We see the same problem with medical care: we can't bear to turn improvident patients away from the emergency room, so we have to think about ways to force them to buy insurance. Wouldn't it be better if we acknowledged that we're forced to cover some emergencies for people who can't or won't ever pay society back? That way, we could decide how much we're willing to contribute, and quit fantasizing about how we'll be able to control the recipients of our charity enough to force them either to pay us back or to act in safer ways so they won't need so much of our help.

-- Texan99

Figment and Reality said...

The problem that any solution will have is that if you do not force everyone pay something into the system, there are some that will not save anything, inadequately save, or never earn enough to save appropriately for retirement.

It is the same basic problem facing heath care funding. If the young invinsible group does not join any plan, the remaining people will end up paying significantly higher premiums to cover the remainder. When an invincible gets injured, the people that paid into the system from day one still end up paying for his injury, if he is a lower paid person without savings.

In the case of funnelling our SS funds into private savings by opting out, we are faced with what ahppens if it gets put in the wrong fund and we are unable to finance our own retirement. Government ends up picking up the tab anyway. Whether it is right or wrong, it is what will happen with any system where we can't just let people starve or die in the cold in old age.

I will be interested in how you analyze the SS Solutions contract. It follows similar path to the health care situation. Like the "wheat and chessboard problem" everything looks fine until it is too late to do anything but something drastic to solve the problem.

Means testing may end up being part of the solution but pushing the age limits out by several years will also have to be part of the solution, without other drastic changes. It is the cost of our better living standards.

Anonymous said...

FIgment & Reality is making a point similar to mine, but with this difference: He/she doesn't consider the possibility that we should decide how much we're willing to GIVE to solve the problems of people who won't help themselves -- and then we should quit trying to figuring out ways to force them to pay us back, or to control them so they won't ever need our help in the first place.

It's not charity if you demand payback or control. It's just squeamishness about facing misery.

-- Texan99

Elise said...

What do you mean by "give"? If you're talking about private charity then what happens if private charity isn't sufficient? Do we let old people who either didn't save or lost their savings beg in the streets?

If you're talking about giving via government programs that's not really giving because the taxes are mandatory. So it's not charity - it's just a different kind of entitlement. And I would argue that such an entitlement encourages not saving for retirement.

A government system which allows an opt-out would be great but that only works if you're willing to let people suffer the consequences. I don't see any indication that we as a society are willing to do that. Yes, there are people like you, Texan99, who would opt out, save, do your best to invest wisely, and take your lumps quietly if you didn't have enough money to live on when you got too old to work. But there are also people who wouldn't take their lumps quietly if their plans didn't work out and there are people who would opt out and never save - they would just want the money now and let tomorrow go. Unless we're willing to let those people suffer, an opt out isn't realistic.

This is kind of the problem with the country as a whole and something I wrote about here in the context of health care. We've gotten ourselves into the worst of both worlds: we want to avoid government directing our behavior but we also want government to save us if we foul things up. We have to pick: no government direction but we suffer if we fail OR government saves us when we need it but we accept that means government pushes us around. We've got people who honestly want the first option and are willing to live by it but we've also got people who pick the first option then holler for help when they get in trouble. And we're always willing to help them. Which is why I've come to the conclusion that the best we can hope for is to accept but attempt to minimize the government safety net with its concomitant coercion.

Or do stuff on a state-by-state basis which is very difficult for retirement plans - people move too much. Or split the country. I've had a post called "Splitsville" started for about two months now.

Figment and Reality said...

The original intent of SS, was to ensure a threshold subsistence level below which any worker who had paid into the program cannot fall. Now it is part of every reasonable person's financial plan.

I totally agree with Firebrand that we are in a catch-22 scenario. Whether we like it or not, we force one groups desires on another group with our form of government, and it is not charity if I have no choice. People that pay their bills and save appropriately are penalized for saving.

I contribute to charities, but only as long as they use my money wisely. We aren't given a choice with SS, but it is our system.

To me, it seems that the only way around the problem is to force the surplus outside the current budget starting today. Where the funds get put is part of the problem but you have to start by committing to quit spending the money coming in as if it never was going to be needed. The magnitude of governmental cuts will hurt in benefits we have come to appreciate (parks, regional airports, healthy investment in research for health and other sciences). It will hit defense spending (base closures, fewer new weapons systems?) too since it is such a large part of the budget. You have to cut where the money resides.

Next you have to change the indexed retirement age. The lengthening lifespan has contributed to the payout problem, so it must be dealt with. It might not be fair to people in every job but it is equitable to the vast majority.

Do we have to change the top income level subject to taxation? I hope not but I expect it is coming.

Finally, the system needs some additional help to combat fraud by persons receiving benefits illegitimately and others not paying in at all. I know of people that receive SS benefits for complete disability, yet build houses in their spare time. Often, contractors/housekeepers/restauranteurs prefer cash payment so they avoid paying into SS or to pay any form of taxes. Neither of these is equitable, yet it is common.

As Steven Levitt points out in his book Freakonomics, we should encourage more audits, not less. His book contains an interesting discussion on the logic and mathematics of IRS auditing and who get caught.

If the real intent is to provide a minimal safety net and some basic systemwide equity, we must collect all taxes owed and only pay out to those that legitimately should receive a benefit. We must simultaneously change the system so it works since it is highly unlikely that the basic system can be changed.

The challenges abound in this highly controversial topic.