An American Actuarial Tragedy

The article below spells out in the minds of American Academy of Actuaries what our options are in reforming Social Security. If you carefully read this analysis you will want to sit down and cry. These "experts" conclude "any way you look at it, the results will be higher taxes and less benefits".

Of course they were not evaluating our plan. They dismissed personal accounts because the timid partial carve-out promoted by our President did nothing to extinguish our unfunded liabilities. Of course our Rise Up plan rids us of those promises and their financial implications with the stroke of a pen.

As my regular readers know, my Rise Up Economic Theory appled to the reform of Social Security, Disability and Medicare dramatically increases benefits and repeals all payroll taxes while paying off all the unfunded liabilities these "experts" are trying to negotiate around.

Politicians are backing many of these suggestions so they will be easy pickings for a plan as robust as mine. In these "experts" last option they dismiss "personal accounts" for among other reasons because they have no idea that financing the transition can be so easy.

Actuaries' Checklist for Social Security Reform

The Democracy Project
January 19, 2007

The January 2007, “Social Security Reform Options,” monograph by the American Academy of Actuaries presents as good, or better, list as any of the alternatives’ economics.

The monograph states that the reforms will change Social Security’s design “characteristics”:

(1) benefits are based on a balance between “individual equity” and “social adequacy;” (2) financing from, or on behalf of, participants makes the program “self supporting” and gives participants an “earned right” to benefits without a “means test;” and (3) participation is mandatory.

These “characteristics” have already eroded. The weight of premiums falls more heavily upon the more productive and are benefits are usually inadequate for the least productive. The program is not self-supporting, at least soon won’t be, and there is no contractual obligation to pay promised benefits, while there is already reduced net benefits for the middle class and above relative to contributions and to current income. Thus, the mandatory participation is seen by many not as a personal selling point, and may be seen negatively by more.

The question is how much further along these paths we will go. The related question is how much further along these paths we can go without undermining the program’s objectives, public support, or the economy.

The primary rationale presented by the actuaries is better sooner than later: “Enacting such changes soon is desirable, because doing so would provide significant advance notice to those affected, allowing future recipients to plan accordingly.”

This is probably so. But, at the same time, there will be current effects of each alternative, to individuals, to incentives to earn, and to the economy. Therefore, choices must be made based upon both the premises of the Social Security program’s continuation itself and upon alternatives’ current and longer-term effects.

The nominal and time-adjusted dollars of the deficits in funding the current program are huge, and confusing relative to the actuarial impact of the alternatives. The actuaries provide, instead, percentage calculations.

Over the next 75-years, the deficit from payroll taxes compared to present obligations is 2.02% of taxable payroll.

In other words, if action were taken this year, long-range actuarial balance could be achieved if the combined employee-employer payroll-tax rate, currently 12.40 percent, were increased immediately by 2.02 percentage points to 14.42 percent. Long-range actuarial balance could also be achieved with an across-the-board benefit cut of about 13 percent for all current and future recipients.

Neither of those two methods, however, would keep Social Security in actuarial balance permanently….In all years after 2080, projected expenses will significantly exceed projected income….[Therefore] in addition to a positive actuarial balance over the projection period, [it is required] that the trust fund balance, as a percentage of annual expenses, be stable or rising at the end of this period.

The confidence that one may have in actuarial projections is reduced by the result of the last such financing adjustments, and further indicates why higher adjustments may be needed now for the future: “The 2006 trustees’ report projects the trust funds [will be] drawn down to zero in 2040, about a decade and a half earlier than projected in 1983.”

The list below shows the percentage of the financial needs that may be met by some of the various alternatives. Any way you look at it, the results will be higher taxes and less benefits.

* Increase Limit on Taxable Earnings: Presently, $97,500 (and indexed to increase) is about 85% of total covered employment earnings. If raised 25% to $121,875 (90% of all earnings), about 25% of Social Security’s deficit would be eliminated.

* Increase Taxation of Benefits: “Because the dollar thresholds are not indexed, 85 percent of most participants’ benefits will ultimately be subject to income tax under current law. The revenue that could be raised through additional benefit taxation is relatively modest.” In other words, almost all beneficiaries are presently or will be taxed, having their net benefits reduced. Similar taxation of private pensions, to subsidize Social Security, would reduce Social Security deficits by about 17%, reducing additional peoples’ retirement income.

* Expand Coverage: “If all of the non-covered groups [working for religious organizations or state and local governments] could be covered, the effect would be to eliminate about one-tenth of the long-range deficit.”

* Reduce Benefits Across the Board: A 13% immediate reduction would eliminate the deficit for the next 75-years, but not get the deficits past the 75-year projection period.

* Raise the Normal Retirement Age: “Raising the NRA would reduce Social Security’s long-range actuarial deficit by about one-third to two-thirds, depending on how soon and how fast it is increased.”

* Change the Benefit Formula: Would “reduce the program’s adequacy [percent of income replaced], especially for lower earners and their families….Reducing the PIA formula by 1.1 percent each year [results in] the replacement ratio of low-income workers would be roughly cut in half in 62 years….Alternatively” just reducing the replacement ratio of mid and upper-income workers “would increase the progressiveness of the formula” (i.e., further lower the relative benefit from contributions) to where “by 2089…workers with larger wages would have larger payroll taxes, but would get the same benefit amount as lower wage workers.” This “proposal would eliminate about three-quarters of Social Security’s deficit.”

* Change the Benefit Formula to Price-indexing Instead of Wage-Indexing: Results in lower benefits, as wages rise usually faster than prices. “Such changes would have the greatest effect on high-paid workers, but over time…even low-paid workers would incur severe benefit cuts.” No percent impact provided.

* Change Initial Benefit Formula: Increase the income averaging from the present 35 years to 38 or 40 years. “This change would reduce projected future benefits for individuals with shorter work histories. For example, the 40-year proposal would reduce benefits an average of 3 percent and would eliminate about a quarter of the 75-year long-range actuarial deficit.”

* Reduce Cost-of-Living Adjustments: A more restrained calculation of the Consumer Price Index, adjusting for behavioral substitutions, would “lower the annual increase in CPI by an estimated 0.22 percent. This proposal would reduce Social Security’s deficit by about 20 percent.” On the other hand, a CPI focused on retiree needs, would be higher by about 0.3 percent per year than the one presently used.

* Double-Deck Benefit Formula: First deck provides all with a flat dollar amount, the second deck a specified percentage of average earnings. The actuaries do not provide financial impact estimates, but consider that proportionate benefits to contributions is DOA. So much for such individual equity.

* Change Auxiliary Benefits: Non-working widows, and survivors, would either receive lesser benefits, or working spouses higher. The actuaries do not provide financial program impacts. The permutations are mostly about the relative spread of the benefits of non-working and working spouses, which currently favor the non-working spouses.

* Invest Trust Fund In Equities: Although seemingly a greater risk, over the long run and compared to the paper received now from the Treasury, not really. With 40% of the trust fund in equities, at an average 6.5% real return (meaning, above inflation), 40% of the deficit could be reduced.

* Means Testing: Reduce benefits to those with income or assets above a certain amount. For example, a mid-1990’s proposal would phase out benefits at $40,000 of other income, eliminating benefits at $120,000. A percentage reduction of the deficit isn’t given, but the reaction and erosion of support for Social security from the middle and upper classes would be considered overwhelming, so the less obvious or sneakier routes of taxing benefits or fiddling with the complex benefit formulas are favored.

* General Revenue Financing: “{T]his form of financing would be more progressive than the current payroll tax…General revenue financing would require significantly higher income tax collections and/or government borrowing.”

* Individual Accounts: “Like add-on accounts, the carve-out approach does nothing by itself to ameliorate Social Security’s financial problems. However, most carve-out plans reduce trust fund expenses through a decrease in the current program benefit…However, individual accounts exacerbate the problem of funding current program benefits. This is because they divert payroll tax income away from the trust funds immediately, while resulting decreases in current program benefits occur much later.”