A month ago, I wrote a list of ten topics I wanted to discuss.  At the top of that list was Social Security.

Social Security began in 1935 as a 1% tax on the first $1,400 of wages.  Today we pay 7.65% on the first $106,000 in income (when you include medicare). That is just the employee “contribution.”  Employers also must contribute 7.65%.  The original law made social security benefits non-taxable.  Today, the benefit is taxed on a sliding scale where up to 85% of the benefit payment can be taxable.   The basic idea was, and hopefully still is, to provide a baseline of retirement income.  Whether the idea was good or bad, whether the execution of the idea was good or bad, these things don’t matter.  What matters is that we have a system today that needs reform.  So let’s deal with it.  Leaders like Chris Christie and Scott Walker are dealing with it.

In a hypothetical case (using a Social Security Calculator from the SSA site) a Person who today earns $50,000 per year and who will retire at 66 next year will be paid a benefit of $1,324/month.  That is $15,888 per year or 31.8% of current salary.  Assume that payment is the result of the investment of 10% of all wages earned over the life of the retired person in our example (today it is 15.3% but it was 7.25% in 1964 when this person left High School and started working).  If that person first worked at the minimum wage ($1.00 in 1964), he would have earned $2080 that year.  If we assume 48 years of work before retirement and average the $50,000 income today with the $2,080 when he started, we have a total income of $1,249,920 earned.  With a 10% average contribution, that would mean $125,000 would have been put into the system.  That would pay $15,888 for just under 8 years.  This assumes the contributions earned no interest.  Again, to simplify, if we assume that all the contributions had earned an average of 5% you would have 48  years X 5% X $2,600/yr. avg. contribution, if compounded annually, you would have a fund of about $238,000.  That would make the $15,888 payouts last about 15 years (from age 66 until about age 81) or just past the life expectancy of the person in our example.  If the fund continued to earn 5% interest on the remaining balance, in 15 years, it would add about $95,000 to the fund (or 6 more years).

From this example, It would appear that the system works and is amply funded.  The example retiring person has a life expectancy of about age 81 just like the life of his fund if it earns no interest after he stops contributing.   So why do we hear that the Social Security Fund is almost bankrupt?  Fact: in 2010, the Social Security Administration paid out about $40 Billion more than it received in “contributions.”   As a business person, that means negative cash flow to me.  To gain this needed revenue, we either have to raise revenue (raise SS taxes or further tax the benefits) or cut expenditures (pay out less or start paying later).  What our politicians choose to do is to borrow more money – issue more IOUs.  In fact, since the Johnson Administration (1968) there really hasn’t been any real money in the Social Security Trust Fund.  It has all been Treasury notes (IOUs).  Those who tell you that there is enough money in the Trust Fund to pay all claims against it until about 2040 are dreaming.  They will tell you the Trust Funds have over $2.5 Trillion in assets.  If the Assets (IOUs) were cash money, that would be nearer the truth.  However, it is not cash, but instead, is made up almost entirely of non-marketable long-term Treasury Notes.  First, the only buyer of these securities is the U.S. Government (that’s the same government that is now spending over $1 Trillion more than it brings in each year – talk about negative cash flow!).  Second, those IOUs are interest bearing notes.  That means the worthless paper is being paid interest (in the form of still more worthless paper).  This means the U.S. Government is paying to the (U.S. Government) Social Security Trust Funds about $150 Billion interest on these restricted Treasury notes (IOUs) each year.  The assets of the Social Security Trust Funds show up in the Federal General Budget.  That makes it look like we have that $2.5 Trillion more in our budget than actually exists.  The Liability of the Treasury for these IOUs only shows up in what is called “off-budget” accounts, not seen in the general budget.   If this is not the definition of a scam, I want to see something better.  A very interesting article a couple of years ago describes this better than I can.

My conclusions are:  1.  If you are planning on Social Security to be a significant part of your income in retirement and you plan to retire more than 5 years from now, Change your Plan!;  2.  Congress could pass a law to remove Social Security from the General Fund account and create a true Trust Fund, sell back to the U.S. Treasury its IOUs ( likely at a big discount), take a one-time hit and replace the IOUs with cash or cash equivalents;  3.  Much like a Private Company must do to enter bankruptcy, Social Security could have a Court-approved plan which could require such bitter pills as increased contributions, moving the Retirement age up to 70 over the next 10 years, lowering the payout for those not now receiving benefits, etc.

Of course the real solution is some combination of these things.  All these austerity measures (I call them “Reality Measures”) would upset a lot of people. Without serious political leadership, these things are not likely to happen.  Leaders will have to convince a majority of citizens that we can solve this problem (and many like it) only with shared sacrifice.   In my view, lacking strong political leadership, Social Security (and its brother benefit Medicare) will be functionally bankrupt in our lifetime, not just technically bankrupt (and propped up with fiat money) like it is now.