Social Security is patronizing.  Implicitly, it assumes that individuals lack the discipline to save enough money out of current salaries to be financially comfortable when paychecks end with old age.  So, it forces us to save the same percentage of our earnings below a ceiling at present $106,800, regardless of our cash demands and the predictable trajectory of our salaries.  And then Social Security tells us that it will be in charge of those savings.  And then it spends them.  It spends our forced savings (see link to last week’s piece   ).  The kindest reaction to this behavior is to call it “ironic”.  But isn’t it really criminal?

Something has to change with Social Security.  To find good solutions, it’s best to start by trying to understand the goal the program professes to advance and then judging the adequacy or inadequacy of its means to this end.  This column is the second in a recent series on Social Security.  Click here to visit or revisit the first.

The structure of Social Security reinforces the idea that its mission is to force people to save while they’re earning money so that they won’t be poor after they retire.  How else can we justify funding the program through payroll taxes at all, much less zapping earnings only below a ceiling that, to be sure, is steadily rising — just like the debt ceiling.

The first problem with this structure is that, in pursuing the laudable objective of  reducing poverty in old age, it may be creating poverty in young and middle age.  Before the Earned income Tax Credit (EITC) was passed in 1975, payroll taxes were appallingly regressive: the lower class paid a higher percentage of their total income than the middle and upper classes.    Poorer people started work early, and all their income was taxed (they had no financial assets to speak of and therefore no interest or dividend income).  Richer people earned income well above the ceiling, and supplemented it with “unearned income”, none of which was taxed for Social Security.  The EITC fixed part of this problem by rebating payroll taxes to individuals and families whose income totals are below certain levels, but it doesn’t help people right above those levels.   And even some of the poorest families remain injured.  Social Security taxes both employers and employees.  Employers try to pass on some of these taxes to their employees by lowering their wages.  For example, if a boss lowered wages by $2 in response to higher taxes, workers would in effect be paying $2 of those taxes.  Worse yet, particularly in the case of minimum wages where business cannot shift the tax burden, low-skilled workers may be fired or never hired.  Their income goes down to or remains zero.

This regressivity of revenue is exacerbated by what happens on the benefits side.  Poorer people tend to live shorter lives than richer people; their benefits accordingly last longer on average.  They pay more, in percentage terms, to get less.

Another problem with Social Security is its lack of flexibility.  Most workers have jobs with a life cycle of earnings.  Their wages grow with age and experience,  on-the-job training.  And they tend to spend according to the “permanent income hypothesis”.  If they had their druthers, they’d save less in their youth and more as they age. Forced saving through payroll taxes makes it harder to smooth out consumption.  Doctors provide a good example here.  Many of them accumulate staggering levels of debt as they pay for their college and medical school expenses and then are paid modest wages during prolonged internships and residency.  The rewards are prestige, the satisfaction of doing good, and the high wages they’ll get finally fully credentialed.   Should physicians be taxed to “save” while their wages are low and already being reduced by debt payments?  Should they be taxed at all?  Should we really be worried about doctors being poor in old age?

Not only does Social Security act as if people must be forced to save for old age, it also dictates how those savings are invested — in special-issue bonds.  For decades, our savings have financed government deficits.  We’ve made it possible for the government to spend well beyond its means without increasing taxes.  Now, the only way to pay baby boomers their retirement promises will be to buy those special issues back.  The debt ceiling will have to be raised.  Why even bother with setting a debt ceiling when whenever it becomes a binding constraint it’s just raised?  Or maybe the government will just print money to redeem its debt to Social Security.  That’s easy, until inflation expectations adjust and interest on new debt rises significantly.

One alternative popularly suggested until the recent stock-market crash is having the government invest the savings (!!) in stocks and bonds.  This strategy is dangerous.  There are already too many conflicts of interest between Government and Big Business.  Imagine the favoritism, punishment, and insider trading that could result.

How about letting individuals invest their forced savings by picking their own combination of index funds, ETFs, and fixed income from a list prepared by Social Security, which would also require a  percentage in the fixed income category that rises with age?  Well, this approach is better than government investing directly, but it’s still fraught.  And people are still too wounded by recession to think logically about long-term returns.

Social Security has already raised the age of retirement with full benefits and will continue to do so.  The rationale, that people live longer than they used to, would be more compelling if the rules weren’t being changed in midstream.  At least the adjustments are being announced well in advance.

Still, if the real issue is poverty — and it should be,  isn’t it better to treat this problem directly?  As a cohort, seniors actually have more assets than younger groups.  Indeed, the boomers are not only the largest, but also the best educated and wealthiest in American history.  Why should tomorrow’s workers be supporting them as they retire, on average about 7000 a day for more than a decade?  For many seniors, Social Security benefits are simply not necessary.  Medicare and Medicaid are already addressing issues of declining health and rising medical bills (although they’re both statistically bankrupt, too).  And yet, we tinker with economic efficiency to get seniors the defined benefits of their “saving”, driving a wedge between the benefits and the costs of employment.   Better education and mentoring are the best tools to help youth emerge from poverty.  But for the rest of us, shouldn’t the same safety-net solutions be appropriate for all adults who are in hard times, regardless of our ages?

Social Security should be phased out.  It costs more than it’s worth, and it cannot be fixed in a way that reverses this inequality.  Our government has been proved untrustworthy with our savings, and we should make it harder, not easier, for politicians to meddle with personal decisions.  Education and a negative income tax are probably the most cost effective, and respectful, way to address and ameliorate the problems of poverty without discriminating on the basis of age.

This set of facts could be the death of a prosperous and competitive America unless we start acting to avert disaster right now.  Next week, we’ll talk about solutions.  But we’ll start today by outlining some of the reasons for this apocalyptic prognostication regarding Social Security and the history that got us where we are today.

First, our public pension program is statistically bankrupt and therefore reduces the national confidence and power necessary to remain the world’s economic and political leader. Current deficits retard our recovery from recession as the rules keep changing and businesses cautiously await clarity before increasing hiring and investing.  But today’s problems pale in comparison to what will happen in the future unless we reform Social Security.  Benefits began to be paid out as soon as the program began — that is, before contributions could be saved to fund them.  The system accordingly quickly became a “pay as you go” affair. Benefits have also been raised and widened throughout the years.  The result is a “defined benefits” retirement program that, until recently, has redefined benefits only in an upward direction and is financed off the backs of current workers. Individual benefits have precious little connection to individual contributions.

Aggravating the problem are demographics.  In 1945, there were 50 workers for every one retiree on Social Security.  In 1950, the ratio had fallen to 17.  In ten years, it fell to 8.6, and by 2025, it is expect to drop to 2.27, with a further decline to 2.1 in 2031.   Even with “full” employment, senior boomers are going to be supported by a smaller and smaller relative work force.  Something has to change.

But that something should not be raising payroll taxes again. These taxes already put us at a competitive disadvantage internationally and make it harder to reduce unemployment domestically through job creation. Raising the rates again is not a good solution for future insolvency because doing so increases the cost of labor even more without concomitant improvements in productivity.  What it really raises is unemployment.  Perhaps it takes a sustained global recession with many nations trying to solve their unemployment problems by enhancing exports to highlight these unintended consequences.  No crisis should fail to be exploited.  Let’s just hope this one doesn’t accelerate into an international trade war with battling currencies as well as quotas and tariffs.

Additionally, in all the years when revenues exceeded benefits, our government didn’t save Social Security surpluses for a future that could well be predicted to need them for boomer retirement years.  Rather, it spent these extra billions of dollars, using noxious payroll taxes to fund other government programs.  Social Security supported $99 billion of other government spending in 2009.    What did it get in exchange?  “Special issues” from the US Treasury, with both principle and interest backed thereby.  Safe?  Not necessarily, at least for individuals who have already contributed through payroll taxes and rightly should own their own shares of retirement “savings”.   The rules of eligibility and tax bases are already changing. At least the average annual interest return in 2009 was 4.860%.  That would be a nice return on private savings.  And those savings could have been secured in private nest eggs.  Many Congressional Democrats consider “privatizing social security” criminal.  That’s what we should instead call  keeping forced savings “public” and then spending them on other programs.

Social Security probably had to be run in the red at first.  After all, it was created during the Great Depression in response to the severe and unexpected suffering of seniors who’d already retired from work and lost most of their carefully built-up nest eggs because of Black Tuesday’s 12% drop in the stock market and continued declines for more than a decade thereafter.  It’s not as if retirees could rejoin the work force in response to destroyed savings:  unemployment rates were as high as 25% and didn’t fall below 14.3% until 1941.  Actual unemployment was probably even worse – much worse.  The elderly, if not yet disabled, were likely to be in that invisible pile, “discouraged workers”, who didn’t make it into the unemployment statistics because they’d given up trying to find jobs – any jobs. And we think today’s bad…

While we can approve of — and even applaud — running Social Security in the red during its early years, in no way can we honestly justify plundering Social Security surpluses to finance other government programs in later years.  With all their equity and efficiency issues (see an earlier centermovement.org post), payroll taxes are an acceptable source of revenue if and only if it’s appropriate to force individuals in the work force to save a significant percentage of their earnings for a future when they’re too old to work.  Is this kind of mandate appropriate?  Is it even Constitutional?  State challenges to Obamacare’s requirement that all individuals carry health insurance make one wonder.

In any event, the irony here is that our government forced working individuals to save, and then spent rather than saved their savings.  Until recently, economists have bemoaned how low the national rate of saving has been. More saving typically means more investment, which raises productivity and therefore growth and general prosperity.  National savings are likely as a whole to have actually decreased under this opaque system of  Social Security funds and their raidability.  It’s likely that voluntary participation in company pension plans and  contributions to 401(k)’s declined with forced participation in Social Security.

Sunk costs are sunk; the past is past – although it does inform the present.  The questions we should now be asking are how to reform Social Security or eliminate it as a public program altogether.   Perhaps there’s a better way to prevent poverty in old age.  Regardless of what the changes will be, it’s also important to figure out how to make the transitions from old to new as smoothly and equitably as possible.

One fact we should already know: the sooner the rule changes are announced and the more gradually they occur, the better off for all concerned.  We’re then given time to adjust to the new framework with whatever variables we control and decisions we can make.

Three lessons we must learn from Social Security’s history so far and keep in mind before architecting improvements.  First, perfection is beyond our reach – and even our definition. Wishing so won’t make it so. Second, the law of unintended consequences is fierce and ubiquitous.   How will behaviors change as we alter the rules of the game?  Will they offset or advance our objectives? And third, it’s not enough to have a problem in the private sector to justify involving the government.   At least Social Security has taught us this: we must first try to insure that the government has the resources, incentives and information to ameliorate the situation.

Unless we learn these lessons and have the political and personal courage to fix Social Security, and fix it soon, our whole society will join seniors in facing profound insecurity on all levels – including national defense.   A broke and broken nation cannot successfully defend itself.  And Social Security is just a baby of a problem compared to Medicare and Medicaid.  We need to cut our bipartisan teeth fixing the Social Security mess before we can address these pressing health-care problems with an American First attitude.  All sorts of issues will come to a head with upcoming debt-limit debates and decisions.  Unless this ceiling is raised, the government is likely to run out of funds by March 31.  One thing’s for sure: our government can no longer avoid tough decisions about spending cuts or tax increases by raiding Social Security surpluses.  Why?  Because the surpluses are vanishing.  There will soon be nothing left to raid.  Rather, the debt ceiling will be raised yet again, this time in part so that seniors can continue to receive their monthly checks.

Next week’s post will outline some of the ways to make Social Security secure.  They’ll range from the modest to the extreme.  Please come back, read the piece, and add your own thoughts and suggestions.  We need all the help we can get.

MINIMUM WAGES
In May of 2007, during the Bush 43 Administration, Congress passed legislation that raised America’s hourly minimum wage in three stages from $5.15 to $7.25 – an increase of 41% in slightly over two years. The stated purpose of minimum-wage requirements is laudable: it’s to give every worker a living wage.

“How nice,” good-hearted readers may respond; “it’s hard enough to get by on $7.25 an hour, but making due with $5.15 is nearly impossible these days.  And imagine trying to feed yourself, much less clothe and shelter yourself, if some fat-cat boss could get away with paying you even less!”  They’re right.  And low-skilled individuals who keep their jobs are decidedly better off with the higher minimum wages.

The problem is the unintended consequences.  Not everyone gets to keep his or her job when the rules change.  Because the government cannot force private enterprises to hire new workers or continue employing existing labor when the cost of doing so goes up, raising the minimum wage prices people with unexceptional skills out of the market.  For all their good intentions, minimum wages accordingly create more unemployment and more poverty for society as a whole.

The third increase in the minimal wage, the one that raised the rate from $6.55 to $7.25, took effect in July of 2009.  The timing was terrible.  In the midst of high and rising unemployment, and halfway through a year where cost-of-living indices actually declined, we made old jobs and new hires even less affordable to companies that were already losing sales and cutting back their workforces.

It’s much harder to get by with $0.00 an hour than with a market-determined wage.  But the consequences for the future may be even worse than the poverty of the present. When the starting wage gets too high, not only do some workers get laid off, but others can’t even join the workforce in the first place.  Their entry-level job skills simply aren’t worth $7.25/hour.  Educating one’s way out of poverty occurs just as much in the office as it does in the classroom.  When people fail to find employment, they don’t just lose wage income today, they also lose the on-the-job training that makes future advancement to better jobs possible – all this on top of the destructive effect unemployment has on existing skills and attitude.

This problem is particularly acute for individuals seeking their first jobs. The Wall Street Journal’s lead editorial on March 5 is entitled “The Lost Wages of Youth” and has some stern and startling unemployment statistics for teenagers in general and teenagers of color in particular. The situation is so bad that the Journal condemns in no uncertain terms going through with last summer’s last step in 2007’s three-stage wage legislation:

To raise the cost of unskilled labor precisely when the jobless rate is heading towards 10% is an act of almost willful economic stupidity.  A Congress that has spent $862 billion to create jobs thus managed to harm tens of thousands of entry-level job seekers.  And it did so in the name of “compassion” and a “living wage.”

The WSJ could have said much more.  Because it’s a national standard, the wage floor is even more destructive for teenagers in parts of the country with low costs of living than the averages indicate for the United States as a whole.  Teenagers living in rural Mississippi, for example, have a much harder time finding employment when the starting wage is $7.25 than their counterparts in Anchorage, Alaska, where the cost of living is so high that the minimum wage may be below market rates and therefore irrelevant.  Mississippi itself suffers even more than loss of employment and associated production.  It also loses some of the competitive advantage it would otherwise gain from lower labor costs.  In a sense, minimum-wage legislation is a subsidy to the pricier states and cities in our nation.

PAYROLL TAXES
The Wall Street Journal also could have, and should have, extended its critique to payroll taxes and the disincentives they add to an already ugly picture of market distortion and unintended consequences.  The omission is surprising for a newspaper of its conservative nature and caliber.  Each of the five taxes has a raison  d’etre, but none of the benefits at this time is worth the associated costs.

All wages up to a ceiling of $106,800 are taxed to “fund” Social Security and Medicare.  The idea is to “smooth” consumption and make people “save” for the days when they’re too old or too sick to work.  But the revenues are not in fact saved, and they aggravate unemployment and poverty issues.

Employers pay half these payroll taxes themselves and withhold the other half from the checks they cut for their employees’ take-home pay.  When markets set wages, it’s highly likely that companies shift some of their payroll-tax burden to their employees by reducing their pre-tax wages.  When workers are paid minimum wage, none of this shifting is possible.  While shifting at first glance seems morally opprobrious, it’s a heckuva lot less heinous than firing.

Social Security payroll tax rates are currently 6.2% for both employer and employee, and Medicare adds another 1.45% to both sides.  The $106,800 ceiling is irrelevant for minimum-wage workers, and there’s no exemption for low incomes.  The result is to increase employers’ hourly-wage cost for each of their lowest-skilled workers to more than $7.80, while reducing take-home pay initially to less than $6.70.

Fortunately, low-paid employees with a certain savvy can file an Earned Income Credit (EIC) form with the IRS and, depending on their income and number of dependents, restore part, if not most, all or even more than all, of their gross earned income.  (Sometimes they can even get more money from the government than was withheld from their paychecks.)  Unfortunately, there’s no such program to reduce taxes on the employers’ side, where heightened labor costs continue to cause layoffs and deter job creation.

Add to this business burden Workmen’s Comp taxes, paid by employers, with rates based on how many previously employed workers have filed for injury claims. Keep going with Federal and State Unemployment Tax Acts (FUTA and SUTA).  FUTA levies another 6.2% employer tax on the first $7000 each employee earned. Although much of this “unemployment insurance funding” can be offset by a refund if paid in a timely fashion, it still remains regressive because of the salary ceilings. And isn’t it ironic in all times, but particularly these, that companies creating  and maintaining employment are also penalized through payroll taxes that make them fund unemployment programs?

Could there be more obvious deterrents to new hires in precarious economic times than the chaotic array of legislation we’ve now discussed?  Actually, yes: continuing to make health insurance a required, regressive, and tax-subsidized perk of employment for businesses over a certain size.  But that’s step three in addressing economic reforms to reduce unemployment, deficits and debt, and the purview of another piece.

CONCLUSION
Minimum-wage legislation is an abomination for society as a whole.  While it benefits some low-skilled workers, it does so at the expense of the even more vulnerable, whose poverty it only deepens.  Minimum wages should be abolished.

Five different payroll taxes add to the damage.  They further discourage employment, and for some workers they also take away sizeable chunks of incomes that are already perilously low.  The good-hearted readers who – at least initially – applauded the concept of the “living wage” as achieved through minimum-wage legislation should now rise up in outrage over policies that take money back from those who keep their jobs but either don’t qualify for full refunds through EIC or don’t know enough to file.  Payroll taxes should be suspended for both sides, at all wage levels, at least while unemployment rates are so high.

The goals for all six of these wage and tax policies are admirable.  But the best of intentions often create the worst of programs.  They do so because of unintended consequences.  They do so because we cannot overturn the laws of economics, we can only work with them.

The best way to help poor people is to help them help themselves.  We should reform formal education so that everyone can read, write, and think.  We should encourage employment not only for the earned income but for the on-the-job education that leads to better jobs.  And we should ease the transition to a living wage.  For those of us who believe in the ability of poor people to make decisions on their own and to learn from their mistakes, the best transitional tool is the negative income tax.  For those of us who prefer to protect them and guide their choices,  vouchers are the way to go.  Minimum wages and payroll taxes are getting in the way for both sides.

The problem that holds back reform is that we must also work with the laws of politics.  Unions, for example, love minimum wages: they keep some nonunion labor competition at bay.  And the majority of politicians in power today – the Democrats — are deeply indebted to unions.  How else to explain the government bailout-takeovers of Chrysler and General Motors?

If there is ever a time when we can overcome the political power of vested interests and eliminate minimum-wage laws and suspend payroll taxes, that time is now. Rates of unemployment that all of us find ethically and economically unacceptable demand solutions, and alternative approaches are not working well. A lot of the “stimulus” programs have yet to be implemented, well over a year into recession.  For those that have, it looks as if each job “saved” has cost six-figure sums of added deficits.  These results are appalling at all times, but particularly when soaring deficits and debt undermine confidence and credit ratings.

Eliminating minimum-wage laws is fast and free.  Suspending payroll taxes is a quicker, more equitable, and arguably much cheaper approach to reducing unemployment than the government spending the Administration has endorsed and pursued so far.  And let’s be clear: EIC has already nullified, reduced or reversed half of the biggest payroll taxes — those associated with Social Security and Medicare — for many with low income.  Let’s give the same break to businesses for all of the payroll taxes they pay.  Suspension would have to be fairly long term to generate results, and it also provides an opening wedge to eliminating these highly regressive taxes altogether.

For a man who admires speed, pledges fiscal sobriety, and talks the populist line as much as President Obama now does, the obstacles to these suggested reform are political, not economic. Each government program, whether it be taxing, spending or regulating, creates its own protective constituency. If our President can bring to Washington the change we once believed in, we can emerge from recession in better – stronger, more equitable – shape than ever before.  The time to act, Mr. President, is now.

Radical Reform of Social Security requires starting at the root, and that root is its real purpose and goals today, in 2010.  What are we really trying to accomplish with this program?  What are the basic problems for which we should supply social safety nets, and how do we best supply and sustain them?

2010 is more like the 1935 of Social Security’s birth during the Great Depression than any other time in American history so far.  It is a time of Great Recession, when macroeconomic events have created new poverty and exacerbated old.  Unemployment has destroyed wage income, and plummeting stock markets have devastated savings from earlier and other incomes.  Nonetheless, asking this root question of purpose yields distinctly different appropriate approaches from those we’ve been following, only slightly tweaked, for almost 75 years.

In 1935, FDR was responding to the ruination of nest eggs through collapse of the stock market.  He was particularly interested in the suffering of people who were too old to replace these losses through years of extra work and saving.  They had become poor too late to help themselves, and Society stepped in to provide this help.

Today, even as FDR’s Social Security system approaches bankruptcy, it does only a mediocre job providing financial ease in old age.  Even worse, the very structure of social security causes harmful effects to the economy in general and the working poor in particular.

According to the Social Security Administration, Social Security checks only provide 39% of a retiree’s income.  American workers must not only pay their Social Security taxes, but put money away at the same time if they want to avoid poverty in old age.  Needless to say, there is not much “security” in such a system.  Most people will not be able to survive on $1100 or  $1200 per month.  The current Social Security System does not successfully protect against poverty in old age.

Furthermore, Social Security has a number of negative indirect effects. The program may actually make a substantial number of people poorer in many of the years before retirement. “Contributory financing” is attractive to Americans who like to think that other people have paid for what they’re getting from the government.  But in the case of Social Security, this translates into the practice of early forced “saving” through payroll taxes to replace earned income for the elderly after retirement.  The result is more poverty, less employment, and higher underemployment in hopes of less poverty tomorrow — a tomorrow far, far away for many and never reached for those who die early.

Payroll taxes are a noxious form of taxation at all times, but particularly when high rates of unemployment are a national concern, as they are today.  These taxes discourage employment by creating a wedge between what businesses have to pay to hire or keep workers and what workers get to keep.  From 1937 to 1948, this difference was relatively small.  To finance Social Security benefits, employers and employees were each taxed 1.0% of the wages they paid out or took home. Medicare had yet to be invented, so its payroll taxes didn’t add to the total.  Social Security now taxes all workers at a rate of 6.2% of all their earned income up to $106,800, and employers have to match withholding with another 6.2% of their own. (Medicare adds another 1.45% to each side, for a total burden of 15.3%.)

The poor, it is often said, don’t pay income taxes.  The Earned Income Tax Credit has certainly made this true for some.  But the income ceilings for eligibility are pretty low, and everyone with a job paying above that level sends at least 7.65% of his or her earned income to the government.  “At least” because “writing the check” is different from “paying in a true economic sense.”  If businesses can get away with lowering wages in response to payroll taxes, they will.  Their total costs (wages plus their share of taxes) then go up by less than the taxes, and labor’s income (wages minus their share of taxes) go down by more. Business has then shifted some of the tax burden to Labor.  For workers earning minimum wage, the results can be even more draconian.  Employers can’t shift any of the burden to these employees, but they may lower their wage to zero, firing or never hiring people whose productivity is regarded as less than the total of minimum wages plus payroll taxes.

The situation gets even more deplorable.  Social Security may be part of what traps the poor in an even deeper sense.  The payroll tax not only causes poor people to lose income today by reducing employment and after-tax income.  It also causes losses in future income.  Entry-level jobs don’t just provide current income. Part of their rewards are hidden and deferred — on-the-job training, investment in human capital that can lead to better jobs and entry into the middle class.  Investing in human capital doesn’t just occur through formal education.  And it’s every bit as important a source of economic growth and prosperity as investing in machinery.

Growing the economy requires getting out of this Great Recession and increasing investment in equipment as well as in people.  Investment in extra capital tends to increase labor productivity even when the new equipment is just like the old.  The effect is even more positive when new capital embodies new technology.  Unfortunately, Social Security is probably holding back recovery and holding back growth.

To hire new workers, employers have to be very optimistic about economic recovery and not too concerned about future tax increases and other changes in the rules.  Reverse Keynesianism may actually be taking hold today. Deficit spending may actually be holding back private spending. Businesses may be cutting back as all that “job creation spending” previously known as “stimulus spending” raises anxiety about exploding deficits and debt and how they’ll be financed. Social Security plays a negative role here, too. Not only does it require current taxes that discourage employment, it has future unfounded liabilities that reduce entrepreneurial confidence and optimism as we all anticipate future tax hikes.

Few, if any, of these negatives are offset by the salutary effect of all the forced “saving” driven by payroll taxes. More saving, absent recession, means more investment, and more investment means more growth.  But none of that payroll revenue has actually been saved.   Our government is saving nothing for the elderly. It has never saved anything for the elderly.

What we have is a pay-as-we-go program, with a pledge to support today’s and tomorrow’s elderly by imposing payroll taxes on today’s and tomorrow’s workers.  Demographic change has put us on a frightening trajectory of massive and accelerating unfounded liabilities.  In 1950, 16.5 workers supported each retiree. Because of the baby-boomer bulge and increased life expectancy, this number has fallen to 3.1 today, and within 20 years it’s expected to drop to a mere 2.1.

The horror story of unfunded promises has received a lot of publicity of late. Less acknowledged is what has happened to earlier surpluses in the system: they were diverted to the payment of other government programs.  In 2008 alone, the Social Security surplus was $180 million, with a cumulative total of $2.4 trillion.  No wonder Mark Brandly urges us to “[t]hink of it as an exponentially larger version of Bernie Madoff’s Ponzi scheme.”  (See  “The Social Security Scam”.)Trillions of dollars of regressive payroll taxes can’t even be justified as “contributory financing”.  This is shameful diversion and warrants more exposure from the press.

While Social Security has done nothing directly to increase savings, the program has at least two indirect consequences for private savings.  On the one hand, people with jobs and therefore mandatory contributions to Social Security are likely to save less because this program “guarantees” defined benefits for their retirement years.  On the other hand, they may not believe this guarantee and increase savings not just because Social Security is insolvent but also because most efforts to improve its balance sheet are likely to include increased income taxes.  Small solace, this, because the extra savings will go ultimately to debt and deficit reduction, not to new ideas and the equipment that embodies them.

Poverty at all ages is our real problem, and the Social Security program as it exists today should accordingly itself be retired.   It’s certainly old enough, it’s not properly structured, and its goals are insufficiently wide.  Created in a crisis, it’s worsening today’s crisis.  Even in times of prosperity, it has created  poverty in efforts to avoid poverty.  Well intentioned, Social Security deserves a proper memorial service, but buried it definitely should be.

The next column will discuss alternatives to the current social security system.

Government deficits and debt have reached alarming levels today, and the unfunded liabilities of tomorrow are even more staggering.  The key to attaining fiscal sobriety is entitlement reform, and Social Security is as good a place to start as any.

Established in 1935, in the midst of the Great Depression, Social Security was FDR’s strong response to the difficulties experienced by the elderly, who saw most of their nest eggs disappear with Black Tuesday’s precipitous 12% drop in the stock market and continued declines for more than a decade thereafter.  Already retired from work, what could they do to restore their savings, the assets on which they’d counted to fund their golden years?  Nothing besides hoping for economic recovery.  So FDR thought the Government should help, and it did.

The program was, and remains, one based on “contributory financing”.  Payroll taxes force today’s workers to “save” some of their earned income, with the promise that when they reach the age of 62 they become eligible for monthly checks from the Government.  It’s a laudable goal, to insure that some wages be set aside for those days, and years, when retirement ends earned income and retirees must live off their savings.  But three major factors have rendered the American Social Security System untenable.

First, the Government hasn’t put this forced saving into a savings account for citizens. Rather, the program is run on a “pay as you go” basis.  One reason, itself not unreasonable, is that benefits started flowing so soon after participants started earning credits that current workers have basically been supporting current retirees rather than saving through the Government for their own futures.  The first beneficiary of the program, for example, was Cleveland motorman Ernest Ackerman, from whose paycheck 5 cents was withheld the first day Social Security was up and going, and who retired the next day with a lump-sum payment of 17 cents from the program.

Second, expanding Social Security benefits has worsened the real balance sheet.  In 1939, the program include survivor benefits for spouses and dependent children, and in 1956 it added disability benefits recognizing that wages were lost by injury as well as by aging.  These additions increased program outlays more than the tax base and rates that would fund them.

Third, changes in demographics also altered the balance between future benefits and revenues.   In 1935, no one forecast the Baby Boomer dynamic, an enormous bulge in the population due to unusually high births from 1946 to 1964.  This cohort vastly outnumbers the group working to support them. Additionally, life expectancy and therefore benefit claims have risen significantly from the early days of the program.  In 1930, life expectancy was only 58 for men and 62 for women.  At first glance, then, the program looks rather sinister.  Was FDR going to force people to save for a future they’d never reach?  No.  The figures reflect appalling rates of infant mortality.  By 1940, 53.9% of men and 60.6% of women who reached the age of 21 lived until 65, the original starting point for benefits eligibility.  Those men and women who reached 65 could be expected to live an additional 12.7 and 14.7 years, respectively.  By 2005, these numbers had increased to 17.2 and 20.

The unfortunate result of these three factors is an estimated unfounded liability for Social Security of  $17.5 trillion, swelling the already disheartening official national debt figure of $12.3 trillion by 142%. The good news is that reforming Social Security is not rocket science, although it does require strong political will.   Here are 5 reform steps that could put Social Security on the road to solvency.

1.We should raise the age of eligibility for Social Security benefits. Doing so violates expectations, but so does altering regulations and tax codes, something our Government does quite often. 65 may not be the new 55, but irritating and expensive as it may be, healthcare can now promise us a high probability of longer and healthier lives.  We can and should work longer to reduce the unfounded liabilities of a program designed to help people who cannot or should not work due to truly advanced age or disability.

To give people some time to adjust to the new rules, a schedule should be announced as soon as possible, and it should phase in the increases.  Advance notice reduces “fairness” concerns, but no change can truly eliminate them.

2. We should make all Social Security benefits part of taxable income. We’ve already started in this direction; let’s keep going.

3. Cost of Living Adjustments (COLAs) should operate in both directions. Raising real Social Security benefits by keeping nominal payments constant in last year’s period of falling prices was appalling even before each senior received an extra $250 through Obama’s special handout. COLAs were designed to protect beneficiaries from inflation, not reward them for deflation.  The cumulative effect of this asymmetry aggravates the inequity and fiscal irresponsibility of this approach to changing price levels.

4. We should modify the way Social Security is funded. One quick possibility is continuing to raise the Social Security ceiling for taxable earned income. Another is to raise the rate at which this income is taxed.  A third is to introduce progressive rates for this payroll taxation.

5. We should radically change the way Social Security is funded. Our current context of battling high levels of both unemployment and debt highlights just how unattractive payroll taxes really are. They raise revenue by making employment more expensive for employers and less attractive for employees. No tax is worse in its employment consequences than the payroll tax. None.

But even when we exit the recession, Americans should remain uncomfortably aware that Social Security’s payroll taxes are regressive.  Poorer people tend to enter the workforce early, while the more advantaged are still getting advanced degrees.  The less advantaged not only start paying for their benefits early, they also are likely to stop receiving these benefits early, because of lower life expectancies (a problem mitigated but not eliminated by survivor rights).  Further, almost all of the income of the working class will be taxed to raise revenue for today’s Social Security recipients because it’s almost entirely wage income below the tax ceiling of $106,800.  Meantime, the upper classes will be taxed on only some of their wages and none of their interest and dividends. Surely, there’s a better way to run this program.

The third column in this series on Government Debt will accordingly explore different approaches to providing socially secured incomes for people who have left the workforce because of age or disability.  The suggestions are radical, and they should be.  Social Security finances are on a terrifying trajectory.  The program had laudable objectives in 1935, and they remain worthy today.  In the 74 ½ years since FDR signed the Social Security Act, however, the old means to these ends are no longer the best means to these ends.