In a previous post, I argued that Social Security is a terrible investment for workers. Simply, workers would do a lot better by purchasing 30-year Treasury bonds throughout the course of their careers to attain more value than what they derive from Social Security. My original intent was to have this next post contain proposals for fixing the system. However, I wanted to elaborate on the additional problems confronting Social Security. Next time I'll throw out some solutions, I promise.
Social Security is a program facing enormous systemic problems: not only does it produce poor returns, but the future entails negative returns for many workers; it is a wealth redistribution system that actually transfers money from the poor to middle class and even affluent people; and bankruptcy looms for right around the time today's children are going to their mailboxes looking for a check.
And those are just the major issues.
Before identifying possible solutions, it is worth looking at how Social Security actually works. Importantly, Social Security is a type of program called "pay-as-you-go." In other words, taxes that are collected today are used to pay benefits tomorrow. Today's workers are paying for today's retirees. Bernie Madoff went to jail for a similar business model.
Fewer Workers, More Retirees
Still, pay-as-you-go was not necessarily a problem when Social Security was created. In fact, it made a lot of sense: in 1950, there were 16 workers for every retiree. Also, the retirement age was 65 and the life expectancy for someone born in 1930 was 60. Not only were there more workers to support the system, but also retirees were unlikely to receive benefits for more than a handful of years (if ever).
But then the Greatest Generation decided to have babies. And boy did they have a lot of them. This baby boom would not in itself cause a problem if the Boomers had maintained a similar birth rate as their parents, but they did not. Fewer babies meant fewer workers. By 1960, the worker-to-retiree ratio had fallen to 5:1. Today the ratio is 3.3:1. By 2050, that ratio will have fallen to 2:1.
Think about that for a second: each married couple will essentially have the responsibility for providing for most of the retirement income of an elderly Baby Boomer because Boomers have been horribly irresponsible at saving for retirement.
Higher Taxes or Lower Benefits?
Even the folks at Social Security acknowledge that either taxes will have to go up or benefits will have to go down. Right now, the Social Security Administration is planning on benefits going down. As the Trustees report states, benefits for future retirees will only be about 70% of what they are today. They say this like it's a good thing and we should be grateful that there will be anything left at all.
Of course, this reduction in benefits just makes a bad deal worse, kind of like when Darth Vader threatens Lando in The Empire Strikes Back:
Negative Returns (or how I lost money in Social Security)
Remember Bob? Bob was our fairly typical worker. He has a bachelor's degree and worked from age 25 to age 65. When Bob could expect to receive 100% of his benefit, his ROI for his Social Security taxes was 2.5%.
However, according to the Social Security Trustees, those benefits are going to have to be slashed to 70% of what they are today. Let's re-run the ROI calculator with those new numbers:
Average Salary: $52,500
Years Worked: 40
Taxes Contributed: $6,510 (annually -- includes both employee & employer contributions)
Monthly Benefit: $1,526
Value of Annuity: $288,150
New ROI: 0.525%
That's right. If benefits are slashed to 70% of what they are currently, then Bob will be earning the equivalent of about one-half of one percent on his taxes. Of course, since inflation is expected to dramatically increase in coming years, this means his real rate of return will be negative. What a system!
Punishing Minority Working Couples (or How I transferred wealth from black workers to white stay-at-home moms)
Social Security is very effective at transferring wealth -- from young black men to old white women. There are two primary reasons: life expectancy and the so-called "two-earner bias."
Life Expectancy
A black male born today has a life expectancy of 70 years. A white female has a life expectancy of 81 years. A black male, therefore, is less likely to receive benefits for more than a handful of years after retiring. A white female, however, can quite easily receive benefits for more than 20 years.
As a study by the Urban Institute found, when one accounts for mortality rates and other factors, black males have a real internal rate of return of 1.99%; white females, by contrast, have a rate of return of 3.2%.
That might not sound like much, but let's consider what that means in real numbers. Say a black male and a white female both invested $50,000 for 40 years at their different rates of return. At the end of 40 years, the black male has $110,000; the white female has $176,000. These rates of return really do matter.
Two-Earner Bias
This benefits disparity is complicated by differences in earnings and whether or not both individuals in a family are working. As Washington & Lee Law School professor Dorothy A. Brown explains it in a truly fantastic paper ("Social Security and Marriage in Black and White"):
"Social security benefits will generally be lower for a two-earner couple than a single-earner couple with the same total household income. In addition, for two-earner couples, the greater the wife's contribution to household income, the less she receives in spousal and survivor benefits."
The reasons for the benefits disparity are complex, and for the details I recommend you read Prof. Brown's excellent analysis, but the 30-second version is that Social Security treats spouses differently depending on whether they have worked or not.
For example, say both Couple A and Couple B earn $60,000 total household income. Couple A is a single-earner, and therefore the wife receives a benefit calculated on his income. Couple B is a two-earner family, and each person earns $30,000. The wife receives a benefit based on each individual's lower earnings (compared to the single-earner), and her own benefit is limited because of what is known as the "dual entitlement limitation."
Prof. Brown cites a quote from the Social Security Administration itself on the impact this has on two-earner families: "In some cases, a two-earner couple can receive total benefits that are one-third less than an otherwise identical one-earner couple's benefits."
What a system!
Don't Worry -- It Won't Be Around Too Much Longer Anyway
This section does not require a whole lot of elaboration. Even though Social Security is running a surplus right now, that won't last. According to the Trustees, the Trust Fund will become insolvent (that is, start paying out more than it is taking in) by 2040.
By 2084, it will be broke. I will most likely be dead by then, so it won't matter a whole lot for my personal finances. But it does mean that anyone born in 1990 or later would watch the funds run out unless we dramatically revamp the program.
What a system!
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