Footing the bill

Leaving aside the merits of the current health care legislation being debated in Congress I thought it would be interesting to focus on how it will be paid for. A lot of attention has been given to a plan circulating in the House that would implement an income surtax of between 1 to 5.4 percent. But will that be enough to pay for it all?

While no one can say for sure, an examination of the taxes that are devoted to Medicare and Social Security do not give cause for optimism. Since its inception in 1965 Medicare has been funded by a 2.9 percent payroll tax evenly split between the worker and employer at 1.45 percent each. Until the end of 1993, however, the amount of income subject to the tax was capped, while beginning Jan. 1, 1994 that limit was repealed -- a massive tax increase.

It's a similar story with Social Security, where both the amount of income subject to the tax as well as the tax rate itself -- paid by both workers and employers -- has been on a steady upward trajectory. Here are a couple of graphs that I made based on this data provided by the Social Security Administration:

From 1937 to 1990 the tax rate increased from 1 percent to 7.65 percent.

Using constant 2006 dollars the amount subject to the tax has more than doubled from $41,730 to $94,200.

The trend is unmistakable. If taxes to pay for health care reform prove sufficient to pay for the program without any increase it would be unprecedented.

The state of Social Security

Upon being re-elected in 2004 President George W. Bush vowed to spend some of his accumulated political capital on reforming Social Security, claiming that without profound changes that it was headed for bankruptcy. Part of the proposal involved allowing citizens under a certain age to invest part of their social security taxes in the stock market.

Democrats pronounced the idea foolish and said that worries about social security's fiscal future were a product of Bush's imagination. Even years later some are still congratulating themselves on defeating Bush's plan.

I thought about that when I read this in today's Washington Post:

The U.S. recession is wreaking havoc on yet another front: the Social Security trust fund.

With unemployment rising, the payroll tax revenue that finances Social Security benefits for nearly 51 million retirees and other recipients is falling, according to a report from the Congressional Budget Office. As a result, the trust fund's annual surplus is forecast to all but vanish next year -- nearly a decade ahead of schedule -- and deprive the government of billions of dollars it had been counting on to help balance the nation's books.

While the new numbers will not affect payments to current Social Security recipients, experts say, the disappearing surplus could have considerable implications for the government's already grim financial situation.

The Treasury Department has for decades borrowed money from the Social Security trust fund to finance government operations. If it is no longer able to do so, it could be forced to borrow an additional $700 billion over the next decade from China, Japan and other investors. And at some point, perhaps as early as 2017, according to the CBO, the Treasury would have to start repaying the billions it has borrowed from the trust fund over the past 25 years, driving the nation further into debt or forcing Congress to raise taxes.

The coffers are running dry. Something has got to give.

Update: The author of this liberal blog says (in the comments section) that Social Security is "one of the most successful government programs of all time." If so, that's a pretty damning indictment of government.

Email to Andrew Sullivan

Just sent the following to Andrew Sullivan (I suggest you read this first in order to better make sense of what I wrote):

Andrew,

A couple of points regarding the 57 year old that wrote to you in defense of the social security system:

• If he experienced drastic reductions in earnings over the course of the "past couple of years" then why has he been forced to rely on savings for daily living for a total of the "last 6 years"?
• Furthermore, if he truly had "a fairly reasonable nest egg some years back" then why was he able to deplete it so quickly? How is it that a fund that was supposed to last him literally the rest of his life has run dry in the matter of a few years even while he claims to be working 6 days a week?

This doesn't add up at all. Either he has some terrible spending habits or his nest egg was thoroughly inadequate. I suspect it is some combination thereof. I am tempted to further point out that if he hadn't had social security deducted all of these years that he would have a much better financial cushion at this point, but based on his letter he probably would have blown through that too.

Lastly, how does this amount to an argument against opting out of social security? Why should his incompetence mean that the rest of us shouldn't be given this option? The best I can figure it, it's only an argument against such an option in that if those of us who actually know how to handle our money left the system then those who would rather outsource their financial management to the government would be left truly high and dry.

But then again, maybe it isn't my job to make up for their incompetence or lack of discipline.

Regards,

Colin

Schemes

The Washington Post today has an article about a family that lost hundreds of thousands of dollars in the Ponzi scheme perpetrated by Bernard Madoff. Without that money their retirement just became a lot more problematic. It's a sad story and you can't help but feel sorry for them.

It got me thinking, however, about a Ponzi scheme that all of us are forced to participate in -- social security. For those who aren't familiar with such schemes, wikipedia offers the following definition:

A Ponzi scheme is a fraudulent investment operation that pays returns to investors from their own money or money paid by subsequent investors rather than from profit. The term "Ponzi scheme" is used primarily in the United States, while other English-speaking countries do not distinguish colloquially between this scheme and other pyramid schemes.

Social security operates in a similar fashion. You pay money into the system and then receive returns at a future date from money paid by future contributors. Essentially, the money that you put in is not the money that you get back. Your money is not set aside in some account to await withdrawal upon your retirement. Rather, your money goes to pay people currently receiving benefits while your own benefits will be paid by people working and paying social security taxes at the time you retire.


Think about that: while Madoff is vilified -- justifiably -- for his scheme, this isn't too far removed from the way in which the government's retirement program that we are all forced to participate in operates.

Now, in recent years there has been discussion about whether social security should be privatized or undergo some other reform due to a shift in demographics (too few workers contributing money for too many retirees) that affects revenue projections. Advocates for such a move argue that privatization would let workers get a better return on their money by investing it in the stock market, while opponents counter that it would leave retirees vulnerable to downswings such as the current one.

Leaving aside which approach makes more sense from a purely financial perspective, what about the morality of the program? I find it offensive that I am forced to participate in such a program rather than being allowed to determine for myself how I would like to invest and save for retirement.

Rather than forcing people into social security, why don't we simply expand freedom and allow people to opt out of the program? Those that want to stay in should be able to do so while those who would rather fund their own retirements should have that right.

I suspect that most politicians would never go for this in part because it would allow people a de facto vote on social security that would demonstrate their lack of confidence in the system.