Social Security and Fiscal Doomsday

2035.  That’s the optimistic date for Social Security’s impending doom, after which Social Security is expected to provide only 75-80% of expected benefits to retirees.  For the record, I turn 67 (full retirement age, for me) in 2047, so I, like many Americans, have been skeptical about the program for some time.

But perhaps it’s pertinent to note that when I began following this looming doomsday in earnest, it was projected at 2038.  It’s been creeping forward, with some estimates placing it as early as 2034.

But there’s an interesting thing that happens when people think about Social Security, just as that same interesting thing happens when people imagine the impending doom of municipal and state pension liabilities that are now crippling governments across the country with a roughly $5 trillion hole nationally.  Somehow, Americans think, the money is there if governments are capable of properly managing the inflows from workers, capitalizing upon the underlying investments, and just delivering the outflows to beneficiaries.

Each and every of those assumptions are wrong.

Let’s begin with municipal pensions. 

The inflows from workers in a city, for example, have a direct correlation to tax revenue raised by the populace.  This can vary wildly from decade to decade, city to city, as populations move for new opportunities due to business or governmental policy changes over time, but the municipal pension obligations do not typically change from the baseline optimistic assumptions employed by politicians and union representatives in setting them long ago.

For example, Detroit, once an American city gleaming upon the hill of unionized employment, has, since the 1960s, seen its “population decline by 60%.”

“Rather than reduce the size of government as its population shrank,” Alison Acosta Fraser and Rachel Grezler observe at Heritage, “Detroit sought higher levels of government spending. City leaders, following in the footsteps of automakers, acquiesced to the unions by increasing employee benefits, especially future pensions and retiree health care.”

Now apply this at a larger scale, to a state like California.  “By 2024,” writes Adam Ashton at the Sacramento Bee in an article, the likes of which are becoming increasingly commonplace, “cities anticipate that they will spend an average of 15.8% of their general funds on pensions, up from an average of 8.3% today.” 

This near-doubling of expected expenditures is exacerbated by reductions in returns in the investment forecast of the underlying pension funds.  In the past, you see, pension funds have enjoyed actuarial assumptions based upon more optimistic returns on the funds’ fixed positions, i.e., bond holdings.  Rates of return on those investments have fallen sharply over the past decades, and there is little to suggest a return to “normalcy” in the bond market, so actuaries have rightfully downgraded expected returns.

All of this is to say that, on top of lower interest returns on fixed investments, local and state pension funds are exposed to what retirement planners call the risk of a “sequence-of-returns” risk

If there is a market downturn, and particularly, a long-standing market downturn like we saw in the tech crash of 2000, being forced to liquidate investments to pay obligations will deplete the funds faster than if the funds were able to hold those investments as a typical investor would. 

The average American investor might understand this, in principle.  For example, if you had an IRA (Individual Retirement Account) in 2008, it may have lost 30% or more due to the market crash of the Great Recession.  The government requires that, if you are over the age of 70-and-a-half, that you must begin liquidating money from your tax-sheltered accounts in order for the government to collect the revenue from your doing so.  Congress declared, uniquely in the scope of United States’ tax history, that in 2009 those Americans were not required to take their “required minimum distribution” in that year, thereby not forcing retirees to sell their investments at a dramatic loss, because doing so might be detrimental to the longevity of their retirement accounts.

Pension funds do not have that luxury.  They must liquidate the investments to pay ongoing obligations.

That alone causes myriad problems.  Social Security, however, is a horse of a different color.

Social Security has no underlying investments, as local and state pension funds do.  The “trust fund” for the Social Security Administration simply does not exist. 

The misunderstanding of this principle has led to the fallacies which you’ve undoubtedly heard, or may even believe.  Perhaps you believe, for example, that the Social Security trust fund has been “raided” by politicians over the years.  In truth, Social Security has run at a surplus until 2010, and the Social Security Administration has taken more in revenue than has been necessary to pay its obligations year-to-year until that time.  Excess revenue had, up to that point, only one place to go, by law -- to the federal government, and with that money, the federal government issued bonds back to the Social Security Administration with the promise of the repayment of the principal and interest.

What did the federal government do with that excess capital over the years?  They spent it.  It’s now part of the $20+ trillion debt that the federal government owns.

Now, here’s the really important part.

When you hear about the “reserves” of the Social Security trust funds that are meant to keep Social Security afloat until 2035, they’re talking about the repayment of this money by the federal government, and the interest involved.  But the money was never “invested.”  It was given to the government to spend.  And spend that money, the government did.

So, the “reserves” for Social Security now represent nothing more than red on the ledger for the federal government.  To pay for the growing deficit in Social Security revenues versus obligations, the government must take on more debt.

Heritage provides a chart showing the level of these new expenditures relative to government spending:

This is a key component of increasing government spending.  Demographics have hammered the Social Security Administration the same way that they’ve hammered pensions across the country.  The back end of the Baby-Boomer generation is massive.  They will be retiring in even greater numbers in the coming years, further straining these shortsighted redistributive systems to an extent not seen before.

I do not claim to have the political answers to solve the problems that socialistic policies set in place long before I was born.  But I would suggest that addressing the question of entitlement spending, this massive Damocles’ blade hanging above our collective heads, would, at least, be prudent.

Yet no one is clamoring to do so, you’ll notice.

It’s not easy for politicians to encroach the touchstones of socialism which have been embedded in our nation.  I get that.  But if we cannot make practical changes to modestly maintain those foolhardy programs’ sustainability, with working and collecting voters in consideration, we run the risk of running headlong into a million-mile-thick brick wall which may make the American experiment little more than a memory.

William Sullivan can be followed at Political Palaver and can be followed on Twitter.

Image courtesy the Heritage Foundation.

2035.  That’s the optimistic date for Social Security’s impending doom, after which Social Security is expected to provide only 75-80% of expected benefits to retirees.  For the record, I turn 67 (full retirement age, for me) in 2047, so I, like many Americans, have been skeptical about the program for some time.

But perhaps it’s pertinent to note that when I began following this looming doomsday in earnest, it was projected at 2038.  It’s been creeping forward, with some estimates placing it as early as 2034.

But there’s an interesting thing that happens when people think about Social Security, just as that same interesting thing happens when people imagine the impending doom of municipal and state pension liabilities that are now crippling governments across the country with a roughly $5 trillion hole nationally.  Somehow, Americans think, the money is there if governments are capable of properly managing the inflows from workers, capitalizing upon the underlying investments, and just delivering the outflows to beneficiaries.

Each and every of those assumptions are wrong.

Let’s begin with municipal pensions. 

The inflows from workers in a city, for example, have a direct correlation to tax revenue raised by the populace.  This can vary wildly from decade to decade, city to city, as populations move for new opportunities due to business or governmental policy changes over time, but the municipal pension obligations do not typically change from the baseline optimistic assumptions employed by politicians and union representatives in setting them long ago.

For example, Detroit, once an American city gleaming upon the hill of unionized employment, has, since the 1960s, seen its “population decline by 60%.”

“Rather than reduce the size of government as its population shrank,” Alison Acosta Fraser and Rachel Grezler observe at Heritage, “Detroit sought higher levels of government spending. City leaders, following in the footsteps of automakers, acquiesced to the unions by increasing employee benefits, especially future pensions and retiree health care.”

Now apply this at a larger scale, to a state like California.  “By 2024,” writes Adam Ashton at the Sacramento Bee in an article, the likes of which are becoming increasingly commonplace, “cities anticipate that they will spend an average of 15.8% of their general funds on pensions, up from an average of 8.3% today.” 

This near-doubling of expected expenditures is exacerbated by reductions in returns in the investment forecast of the underlying pension funds.  In the past, you see, pension funds have enjoyed actuarial assumptions based upon more optimistic returns on the funds’ fixed positions, i.e., bond holdings.  Rates of return on those investments have fallen sharply over the past decades, and there is little to suggest a return to “normalcy” in the bond market, so actuaries have rightfully downgraded expected returns.

All of this is to say that, on top of lower interest returns on fixed investments, local and state pension funds are exposed to what retirement planners call the risk of a “sequence-of-returns” risk

If there is a market downturn, and particularly, a long-standing market downturn like we saw in the tech crash of 2000, being forced to liquidate investments to pay obligations will deplete the funds faster than if the funds were able to hold those investments as a typical investor would. 

The average American investor might understand this, in principle.  For example, if you had an IRA (Individual Retirement Account) in 2008, it may have lost 30% or more due to the market crash of the Great Recession.  The government requires that, if you are over the age of 70-and-a-half, that you must begin liquidating money from your tax-sheltered accounts in order for the government to collect the revenue from your doing so.  Congress declared, uniquely in the scope of United States’ tax history, that in 2009 those Americans were not required to take their “required minimum distribution” in that year, thereby not forcing retirees to sell their investments at a dramatic loss, because doing so might be detrimental to the longevity of their retirement accounts.

Pension funds do not have that luxury.  They must liquidate the investments to pay ongoing obligations.

That alone causes myriad problems.  Social Security, however, is a horse of a different color.

Social Security has no underlying investments, as local and state pension funds do.  The “trust fund” for the Social Security Administration simply does not exist. 

The misunderstanding of this principle has led to the fallacies which you’ve undoubtedly heard, or may even believe.  Perhaps you believe, for example, that the Social Security trust fund has been “raided” by politicians over the years.  In truth, Social Security has run at a surplus until 2010, and the Social Security Administration has taken more in revenue than has been necessary to pay its obligations year-to-year until that time.  Excess revenue had, up to that point, only one place to go, by law -- to the federal government, and with that money, the federal government issued bonds back to the Social Security Administration with the promise of the repayment of the principal and interest.

What did the federal government do with that excess capital over the years?  They spent it.  It’s now part of the $20+ trillion debt that the federal government owns.

Now, here’s the really important part.

When you hear about the “reserves” of the Social Security trust funds that are meant to keep Social Security afloat until 2035, they’re talking about the repayment of this money by the federal government, and the interest involved.  But the money was never “invested.”  It was given to the government to spend.  And spend that money, the government did.

So, the “reserves” for Social Security now represent nothing more than red on the ledger for the federal government.  To pay for the growing deficit in Social Security revenues versus obligations, the government must take on more debt.

Heritage provides a chart showing the level of these new expenditures relative to government spending:

This is a key component of increasing government spending.  Demographics have hammered the Social Security Administration the same way that they’ve hammered pensions across the country.  The back end of the Baby-Boomer generation is massive.  They will be retiring in even greater numbers in the coming years, further straining these shortsighted redistributive systems to an extent not seen before.

I do not claim to have the political answers to solve the problems that socialistic policies set in place long before I was born.  But I would suggest that addressing the question of entitlement spending, this massive Damocles’ blade hanging above our collective heads, would, at least, be prudent.

Yet no one is clamoring to do so, you’ll notice.

It’s not easy for politicians to encroach the touchstones of socialism which have been embedded in our nation.  I get that.  But if we cannot make practical changes to modestly maintain those foolhardy programs’ sustainability, with working and collecting voters in consideration, we run the risk of running headlong into a million-mile-thick brick wall which may make the American experiment little more than a memory.

William Sullivan can be followed at Political Palaver and can be followed on Twitter.

Image courtesy the Heritage Foundation.