Tuesday, September 5, 1995

FISCAL FITNESS: Social (in)Securities

VERY FEW PUBLIC POLICY ISSUES affect more people than Social Security. Almost every wage earner pays Social Security taxes, and most people expect to receive benefits some day or are already receiving them. Social Security is a different kind of pension plan, and that's a big part of the reason why its future is so much in doubt.

To appreciate the dilemma, it helps to compare Social Security with private pension plans or even the plan for state employees. Any pension plan is designed to provide a future flow of income for the participants. You can think of that aspect as the pension plan's liability.

Virtually every pension plan except Social Security has assets to correspond to its liabilities. Over time, a portion of an employee's compensation is set aside and invested, usually in stocks and bonds, and over time, those assets increase in value. A corollary of the funds being set aside is that it provides a pool of capital that fosters economic growth. The future retirees are effectively building the generator of their future flow of income.

Social Security, on the other hand, incorporates no such investment account, at least not in any meaningful sense. It is essentially a hand-to-mouth process. Revenue used to pay current retirees comes primarily from current taxpayers, not from a pool of investments.

When there are assets available to cover your retirement needs, the adequacy of your retirement income depends on how much has been invested, and on the performance of the investments. In the case of Social Security, however, there is no such pool of assets. Consequently, the level of your retirement income depends on the willingness and ability of future taxpayers to tax themselves. Demographics becomes a major concern in a system designed like Social Security. So far the system has benefited from the relatively small population of retirees in relation to those who are still working. That, however, will change drastically as the baby boomers reach retirement ages.

What kinds of solutions to this dilemma can we expect to see in the future? One partial solution is already in place, and that is an increase in the eligible retirement age. Those born after 1938 will not receive a full Social Security benefit at age 65. I was born in 1941 so I won't get full benefits until age 65 years and 8 months. If you were born after 1959 you will not be eligible for full benefits until you are 67.

Don't be surprised to see these ages pushed back even more. Increased life expectancy has been a major contributor to the costs of Social Security. When the system started in 1935, relatively few people lived past age 65. In fact, average longevity at the time was only about 60. Today it is over 75. (If you want there to be enough money for you, encourage your friends to smoke.)

The least painful solution for our Social Security bind is increased economic growth. Greater wealth and income in the future will make it easier for future taxpayers to afford the large population of retirees.

Unfortunately, the very structure of the Social Security system retards economic growth. Workers save less money when they expect Social Security will provide for their retirement. Reduced rates of saving decrease the amount of funds available for investment, which is a major ingredient of economic growth and progress. Furthermore, the Social Security payroll taxes reduce our ability to provide for our own retirement. Social Security taxes are now at 15 percent of a person's compensation. How would you like to have that 15 percent to invest for yourself?

The payroll taxes you see coming out of your paycheck are "only" 7.65 percent of your compensation. There is an additional 7.65 percent that is supposedly being paid by your employer. Basic economic analysis strongly indicates that the employee actually pays both parts of the tax. Splitting the tax arbitrarily into two halves is nothing more than a political shell game having nothing whatever to do with reality.

When Social Security commenced in 1935 the total tax was 2 percent of a worker's first $3,000 of compensation. The rate has multiplied over sevenfold and the base twentyfold. That's a dramatic example of how much the system has changed from its original conception.

We will see further tax increases or the system will have to reduce its unfunded promises. Eventually we will discover where the taxpayers' breaking point is.

In the meantime, you would be well advised to fund your own retirement plan.

A former professor of economics, Ron Ross is a financial planner with Premiere Financial Group, Eureka.


FISCAL FITNESS: Social (in)Securities - NOrth Coast Journal September 1995

Ron Ross Ph.D. is a former economics professor and author of The Unbeatable Market. Ron resides in Arcata, California and is a founder of Premier Financial Group, a wealth management firm located in Eureka, California. He is a native of Tulsa, Oklahoma and can be reached at rossecon@gmail.com.

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