Montag, Oktober 05, 2009

Reality, Denial and The American Dream...

This is a rather nice piece, nice in the sense that the author, one James C. Capretta, does the math and draws the conclusions.

Read the whole thing.

The reality of the situation in the US is that promises have been made that, bluntly, cannot be kept. Basically, the case of Ida May Fuller, shows the impossibility of the situation: she was the very first social security recipient, paid around $27 into the system, and before she died at the age of 100, had received over $22 000 in benefits.

Today, 51 mn Americans receive $605 bn in benefits: that's $11 863 per beneficiary, on average.

Social security is a pay-as-you-go system: from 2017 onwards - in less than 8 years - income from taxes is expected to fail to cover expenditures. This is simple demographics as the retirement boom of the Baby Boomer Generation swells the number of retirees who believe that by paying into the system, they accrue benefits. Legally, they do: financially, all of their payments have gone to pay for retirees, many of whom paid only a small portion into social security in comparison to what they have and will receive.

It's the biggest generational transfer that the US has ever seen.

The difference from 2017 onwards between tax income and outlays is expected to be paid for by the Social Security Trust Fund, which has invested tax income surpluses over the decades since 1935 in special Treasury bonds. Good luck on that one, since this means that the US government must retire that debt in order to pay out benefits, which, given the current dire state of US government finances, is an interesting ... concept.

The reality of the situation is that social security, as a pay-as-you-go system, must either raise FICA taxes (which is the primary source of tax revenues for that purpose), decrease benefits, increase retirement age or hope that folks die at a faster rate without leaving beneficiaries behind (widows and children that qualify): these are the facts, and no amount of spin can remove the problem.

Of course, the body politic of the US is in denial about the problem: "fixing" Social Security, as President Bush found out, is one of the few Third Rails of US politics. Touch it and you are fried by everyone who has a vested interest in the status quo.

I'm not going to get involved in the fairly meaningless debates about whether Social Security is a Ponzi scheme, whether it is constitutional, etc., since these arguments are tangential at best to what I want to point out here.

Simply put, Social Security is part of the American Dream: you work your whole life, pay taxes, and when you retire you get your benefits, which while not paying for all costs, make a huge difference for retirees, especially lower-income ones. In fact, the higher your pre-retirement income was, the less sense Social Security makes, since beyond roughly $50k your actual actuarial benefits are negative, unless you live well beyond the average age.

This is now what is in danger: this is what all the beneficiaries of Social Security are in denial about.


Because Social Security as a pay-as-you-go system is unsustainable. Plain and simple. When, in 2017, income is outstripped by expenditures, the difference becomes a drag on federal finances (since federal debt must be retired in order to pay for retirement of US citizens), and this is where problems that we haven't even barely understood exist will raise their heads.

As Capretta says:

The paradox of our entitlement system is that although it is designed to mitigate risk at the individual level, it is now creating a massive ­economy-wide risk. For years, economists across the political spectrum have been warning that unconstrained federal borrowing will ultimately leave the country unable to issue debt at favorable and affordable rates of interest. When that point is reached, there will be little choice but to embark on a long period of painful fiscal contraction and austerity, with deep and immediate cuts in benefits and steep rises in taxes.

This is the reality of the situation, one that everyone in charge is in denial about, and which will, added to the massive increase in the debt burden caused by the federal debt, may well destroy the American Dream: of working hard, getting ahead, saving to buy a car and house, 2 kids, maybe the boat on the local lake, and when you're older you take off in your Winnebago for a couple of years before the health gives out.

In the brave new world of reality, you will work hard, see much of your income taxed, your savings income taxed, you can still finance a car and house, but only if you are in the upper income brackets, your kids will grow up in a smaller economy, your boat on the Lake has been outlawed because it pollutes and when you're old ... forget the Winnebago and your health care will be rationed.

Bluntly, the American Dream is unsustainable.

But not because it is fundamentally flawed: it is unsustainable because too much has been promised for too many without enough who actually do the work being able to pay the piper.

This is the collapse of the classic welfare state as we have it in the US.

Capretta lays out the story thus:

There is a mathematical limit to what any pay-as-you-go pension system can churn out in benefits, as the implied real rate of return for the average worker over the long run cannot exceed the sum of population growth and real productivity improvement in the economy. Put simply, what comes in must keep pace with what goes out. In practice, this means that what will be affordable in the future will depend entirely on the size of the future work force relative to the size of the retiree population, and on the capacity of that work force to produce marketable goods and services.

This is fundamental: it's not that the American Dream isn't sustainable, it's merely that the freebies, the government give-aways, have to be limited.

But even in comparatively fertile America, rapid increases in our retiree population combined with dwindling growth in the number of workers will put tremendous pressure on government finances and overall economic performance. Between 2010 and 2050, the number of Americans aged 65 and older is expected to more than double, growing from 40.5 million to 81.6 million. Meanwhile, the working-age population — those persons between the ages of 20 and 64 — will increase by only 37 million. The result is a large decrease in the all-important ­measure of pay-as-you-go pension viability: the ratio of workers to retirees. Between 2010 and 2050, it will decrease from about five workers for every retiree to about three.

This isn't scare tactics: this is simple math.

This demographic shift makes the mathematics of Social Security simply unsustainable. And the first serious problems are very near at hand. The program's trustees now project that the Social Security trust fund will run cash deficits (that is, will take less in through taxes than must be put out in benefits) every year after 2016. The outlook only gets worse over time: Social Security's projected unfunded liability is a whopping $5.3 trillion over the next 75 years.

You can't simply raise taxes: the tax increases here would be punitive to compensate for the demographic increases. This is, bluntly, an equation whose variables cannot be fudged to make things all right.

The fundamental problem?

The politics of middle-class entitlements has made it extremely difficult to change America's fiscal course, even as it has become increasingly clear that this course leads to ruin.

The only solution?

Reduce the middle-class entitlements to a sustainable level before the system goes bankrupt, becomes incapable of paying for itself, becomes sustainable.

The impulse to insulate the middle class from the cost consequences of their choices — an impulse that has defined our longstanding ­middle-class contract — has done great harm and stands to do far more. The remedy must be to redesign our entitlements so that the choices the middle class makes in terms of work, family, and health care will promote more productivity, efficiency, and wealth, rather than the shrinking of the labor force and the growth of government.

Denial only works for a short time before it becomes overwhelmed by reality.

By not dealing with reality, by continuing to be in denial, the American Dream is in jeopardy. Fool with it at your leisure, as the last several generations have done: the bill is coming due, driven by the inevitability of demographic developments.

Demography is indeed destiny. Perhaps it will take another Depression to get the American Dream back on course to sustainability: it also means robbing an entire generation of their illusions. There are so many of them...


Anonym hat gesagt…

I have enjoyed catching up on your most recent articles. However, I am curious what you mean by no one in government wants to touch social security for fear of being "fried by everyone who has a vested interest in the status quo." Are you referring to drawing attention to their retirement plan or is there other vested interests? Can you suggest any books or links that may shed light on the subject? Forgive me, for I am a bit naive at times when it comes to politics.


John F. Opie hat gesagt…

Hi Jeff -

Thanks for your comment.

What I mean is that it is social security is the Third Rail of American politics: touch it and die. Those who have a vested interest in the status quo are those who are getting the retirement benefits right now, as well as those who manage it: since they are the current customers of the system and those running the system, change has to come from outside, but those two groups are so powerful that even President Bush didn't get anywhere when he tried to address the problem.

The problem with social security is that benefits have outstripped the ability of the system to pay its way: you can imagine the wrath of social security recipients if someone were to venture to say that their benefits will have to be reduced. It's a structural thing.

Not much in the way of books or links, I fear.