Monday, August 04, 2008

What would FDR think of today's Social Security? 

Let's find out...

The commanding fact driving the unavoidable future reform of today's Social Security is the circa $15 trillion "backward transfer" made by the system to prior generations -- the amount by which benefits received by workers of the past exceeded the taxes they paid in -- which must be paid for somehow by workers of the future, in addition to paying for their own benefits.

Social Security is a "paygo" system in which total taxes equal total benefits, so if one group receives from it $X more than they pay in, everyone else in the system must receive back from it $X less than they pay in, by arithmetic. It's inescapable. Thus, workers of today and the future must take a loss from Social Security to the same extent that earlier generations received a gain -- $15 trillion.

When I say reform is unavoidable, I am including in the term "reform" the inevitable tax increases/benefit cuts for today's workers that will be forced even if the status quo system stays in place, to close its $14 trillion funding gap -- and which must worsen the loss to today's young by that much even beyond that specified in today's law (which calls for them to pay $1 trillion more in taxes over the benefits they will receive as it is).

Andrew Biggs has just posted an excellent explanation (with a nifty chart!) of this "backward transfer" and its effect on his blog. But if you are happy enough with expert testimony here's ...

The Treasury [.pdf] (2007 data):

"The fundamental reason Social Security must be reformed is that the benefits promised to the public have a present value that is $13.6 trillion greater than the present value of the revenues that the system is projected to receive....

"Why must the system increase net receipts by $13.6 trillion if it is already requiring current and future workers to pay in more than they will receive? The answer relates to the system’s generosity to early birth cohorts — generations of workers now either retired or deceased. Social Security paid these previous cohorts benefits that exceeded their lifetime contributions by more than $13.6 trillion."
The Trustees of the Social Security Administration:

"...Subtracting the current value of the trust fund (the accumulated value of past OASDI taxes less cost) gives a closed group (excluding all future participants) unfunded obligation of $15.2 trillion. This value represents the shortfall of lifetime contributions for all past and current participants relative to the lifetime costs associated with their generations."
Paul Krugman:.

"Social Security ... has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in.

"Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today's young may well get less than they put in)."
Paul Samuelson, writing back in 1967 during the Ponzi scheme's golden days:

"The beauty of social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in -- exceed his payments by more than ten times...!

"How is it possible? It stems from the fact that the national product is growing at a compound interest rate and can be expected to do so for as far ahead as the eye cannot see...

"Social Security is squarely based on what has been called the eight wonder of the world -- compound interest. A growing nation is the greatest Ponzi game ever contrived."
You can imagine what Milton Friedman had to say about this ... or look and see.

So the "backward transfer" is real enough -- and so is its cost to today's young. There is no possible way around it, it is a sunk cost, a done deal.

The key issues of reform resulting from this are:

[] Who should pay the loss? Should it be collected through workers' payroll taxes, dropping their return from their contributions ever lower, increasing their lifetime loss to Social Security? Or, perhaps, should a "reform" move this tax cost to income taxes, spreading it progressively over a much larger tax base of "the richer", enabling workers to get a healthy positive return on their contributions?

And, very related to the above...

[] How to preserve the political popularity of Social Security among the "loss generations" of the future? Ask yourself honestly: If the generations of your parents and grandparents had been made poorer by Social Security by $15 trillion, instead of richer by that much --- a $30 trillion swing for the worse -- would they have been as happy with it as they were? Would they have stood for that at all? That is the future of Social Security.

But I've discussed these reform options at some length previously, and am not going to re-hash that here.

The issue here is: What would Franklin D. Roosevelt think of all this, if he saw Social Security as it is today? Or: Are the righteous defenders of the status quo really defending "FDR's Social Security" as they so often claim?

Here are some historical facts:

The "Ponzi game" Social Security system described by Samuelson, Krugman and Friedman was very different from the Social Security program enacted by FDR.

To the contrary, "intergenerational equity" was a major concern of FDR himself and the other founders of Social Security, such as FDR's head of the Social Security Administration, Arthur Altmeyer, who also was one of Social Security's chief designers.

FDR famously insisted that Social Security be "self-supporting" and not drop a burden on future generations. What he'd think of a $14 trillion unfunded liability like today's being dropped on future workers we can tell from both his words and actions.

For instance, when his program was being legislated some working on it tried to slip in "paygo" provisions that would cause it to require funding in excess of payroll tax in the 1960s. To their surprise FDR actually read all the paperwork, found the provision, yanked it, made them re-write it without that unfunded liability, and delayed the legislative submission.

FDR's final program as enacted in the Social Security Act of 1935 was largely "funded" -- as opposed to "paygo" -- and projected to have a very large trust fund accumulation built up by the 1980s, sufficient to operate for decades more. It would have, too, had FDR's original law stayed in place. (Instead, Social Security went broke and had to be "saved" in 1983 with a reform that preserved benefits for the old with large tax hikes on and benefit cuts for the young -- the process of collecting from the young on the "backward transfer" had begun.)

FDR and Altmeyer repeatedly insisted that Social Security would have "insurance-basis funding" providing a "fair return" favorably comparable to that from an annuity bought from an insurance company (which very few people could obtain on their own in the 1930s).

As Altmeyer promised the public in 1936:
"Moreover, every worker eligible ...will receive a monthly retirement benefit upon reaching the age of 65 larger than he could purchase from any private insurance company with the taxes he will have paid."
This basically resolved to a return at the Treasury bond interest rate -- a return that was stable across generations and sustainable indefinitely into the future.

Look at the actual benefit schedule of the FDR's Social Security Act of 1935. With the payroll tax rapidly rising to 6%, no benefits payable until five years after tax collection started, and benefits then only very slowly rising to their maximum, and always directly dependent on the amount of tax each individual had already paid -- at the same rate across generations, FDR's funded program was designed to provide a steady rate-of-return that could have lasted indefinitely.

But what happened instead? As soon as the payroll taxes started coming in Congress's Left side said: "Don't save them, don't wait, spend those taxes right now!" And it's Right side said: "The left is just going to squander all the tax money -- stop them by cutting the tax!"

So they made a deal: use all the tax money coming in on faster and bigger benefits right away while stopping the future tax hikes. More spending, less taxes! What politician doesn't like that?? (That's when the trust fund was really wiped out.)

Of course, the arithmetical effect of that was to greatly increase the return on contributions to early participants, while reducing that to later participants who would have to pay taxes larger than originally planned to cover the funding shortfall created in the future -- creating exactly the kind of "burden on the future" that FDR loathed.

FDR vetoed the changes for exactly those reasons. During the legislative fight over the changes he sent his SSA Chief, Altmeyer, to Congress to urge it to preserve Social Security as FDR had created it. Here's some of what Altmeyer said:

"It is a mathematical certainty that the longer the present day payroll tax remains in effect, the higher the future payroll tax must be if the system is to remain financed by payroll taxes.

"This will eventually necessitate raising employee's contributions rate later to a point where future beneficiaries will be obliged to pay more for their benefits than they would if they obtained this same insurance from a private insurance company.

"I say it is inequitable to compel them to pay under this system more than they would have to pay to a private insurance company, and I think Congress would be confronted with that embarrassing situation..."...


"If we should let a situation develop whereby it eventually becomes necessary to charge future beneficiaries rates in excess of the actuarial cost of the protection afforded them, we would be guilty of gross inequity and gross financial mismanagement, bound to imperil our social insurance system...." []
Congress ignored Altmeyer, overrode FDR's veto, kept the tax rate down, raised the benefits, turned Social Security "paygo", and created the "Ponzi scheme that works" that Samuelson praised for the early generations of participants.

And by Altmeyer's "mathematical certainty" it also assured that workers born 30 years later would get retirement benefits worth less than they paid for them, taking an outright loss of $15 trillion -- which sure as heck is a "rate in excess of the actuarial cost of the protection afforded them", eh?

The result is exactly what Altmeyer predicted -- today people who will receive from Social Security a net $30 trillion less than did prior generations are showing signs of, well, being not happy about it ... with the result "bound to imperil our social insurance system". Altmeyer was right.

Political finance is interesting. "Intergenerational equity" was a major concern of FDR, Altmeyer, et. al., at the founding of Social Security. Then it was totally forgotten, wiped from memory, during the easy-money "everybody wins with 'the Ponzi scheme that works'" era. Clearly, it is still wiped from memory among today's left. Then, as the Ponzi game approached its back end during the 1990s, it was discovered as a "new" approach to analyzing Social Security by economists such as Laurence Kotlikoff. But it wasn't new, it was only being rediscovered as the future losses to the young entered plain sight on the horizon.

So ... to everybody who self-righteously thinks, "I'm defending FDR's Social Security from those who want to destroy it" -- get a grip: you're not. That $15 trillion loss being dropped on the workers of today and the future is no part of anything FDR ever had to do with Social Security.

"I say it is inequitable ... we would be guilty of gross inequity and gross financial mismanagement, bound to imperil our social insurance system...."

Here we are living it -- he was right on all counts. (It seems you don't have to be Hari Seldon to see the future in politics.)

That tells us very well what Arthur Altmeyer would think of today's Social Security. And Altmeyer was FDR's guy on everything Social Security ... so you can decide for yourself what you'd imagine FDR would think.

Personally I suspect that all the knee-jerk defenders of the Social Security status quo, and of the $15 trillion loss it drops on the young, who proclaim to be fighting to "Save Franklin Roosevelt's Social Security!", have him burning rubber popping wheelies in his chair, wherever he may be.