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.

One Congressman, Paul Ryan (R-WI), who is the ranking Republican member of the House Budget Committee, has offered a detailed plan designed to put the United States on a fiscally sustainable path.  In so doing, he has drawn a big fat political bull’s eye on his own back, daring the Democrats to attack his ideas, which they and their allies have done with glee.  But without a plan of their own, Democrats should keep their mouths shut.  For courage alone, Ryan and his ideas deserve respectful consideration.

Congressman Ryan, in his “Road Map for America,” proposes nothing less than a radical transformation for the delivery of most government services.  Under Ryan’s plan, Medicare, Medicaid, and Social Security would dramatically change as would the way many Americans buy health insurance.  Ryan would also fundamentally reform corporate taxation by replacing corporate income taxes with corporate consumption taxes.   Ryan invites his fellow citizens to dig as deep they want into the details at his website.  The scope of what Ryan proposes is vast, so here is only a taste of his ideas.

For Social Security reform, Ryan refloats the long-held Republican position that workers should be able to put away or invest a portion of their payroll taxes for their own retirement.  Democrats love to demagogue this idea by accusing their opponents of wanting to “privatize” Social Security, as if the Social Security safety net would necessarily disappear under such a proposal.  Among other safeguards, Ryan would have the federal government guarantee a return equal to the rate of inflation. Opponents would like to categorize such “privatization” as radical, but it’s not. Over thirty countries from around the world allow workers to invest at least a portion of money they would otherwise pay in payroll taxes in private but regulated retirement accounts .   In Ryan’s plan, future Social Security benefits are cut for workers who are 55 or younger in 2011, but beginning in 2012 they will be entitled to invest some of their payroll taxes, which would almost certainly guarantee them much more money at retirement than under the current system.

Democrats, bashing Ryan’s plan like a piñata, claim that he wants to “abolish” Medicare and Medicaid.  While technically somewhat true, Ryan does not propose to leave the old and impoverished without healthcare insurance, out to forage in hospital dumpsters for discarded medical supplies, or to shout medical questions at passing doctors.  Rather, Ryan proposes to move to a model similar to the one offered by Democrat Ron Wyden, author of an innovative universal healthcare proposal that President Obama pretended did not exist during the course of this past year’s healthcare debate.  Under Ryan’s plan, all Americans are encouraged to buy their own insurance, with generous tax credits and vouchers for those who cannot afford insurance on their own.  Medicaid patients might have high deductible  plans with their health savings accounts (HSAs) funded by the government. The long-term care portion of Medicaid would remain intact.  Instead of Medicare, an elderly person would get, on average, $11,000 per year to buy insurance, a sum indexed annually to an inflation rate the falls between the overall rate of inflation and the current rate in healthcare cost increase. It is fair to question whether Ryan is offering  a big enough subsidy, or if his revenue assumption are too generous to balance the budget.   These are reasonable questions that Ryan would probably be happy to debate, but more often his ideas are pummeled by politically motivated cheap shots.  Those who attack Ryan should answer some questions of their own:

1)      How are we going to get our spending and debt under control?

2)      What are the most efficient means to provide the services we all want and need?

In the areas of medical-services delivery and social security, Ryan proposes consumer-centered  and market-driven models, as opposed to the big-government model we currently rely on but is going broke.  In everything we buy as consumers – from vegetables, to home electronics, to auto insurance – we rely on a market to deliver the best combination of quality and price.  Does medical insurance really have to be that different?  And no  individuals in their right minds would prefer to give money to the government to spend immediately, with only an IOU in return, rather than invest their own money, for their own retirement, securely stowed in their own account.

Both political parties need intellectually weighty, honest and articulate leadership to inspire the nation to address the immense and complex challenges of deficits and debt that truly threaten the America we know and love .  Conservative leaders, rising out of a populist tradition, have been insufficiently brainy and articulate.  Paul Ryan, should he assume leadership of the Republican Party, would completely reverse this trend.  President Obama, while possessing some impressive intellectual credentials, has been disappointingly dishonest on many issues, most notably those involving the true cost of his healthcare plan.

If Paul Ryan were to lead the Republicans in 2012, he would force a substantial debate about the issues that really matter – the nation’s debt and deficit, and the related public services on which we depend.  Ryan’s quick-mindedness would make Democratic dissembling more difficult and might bring out some of the nobleness of character that so many Americans thought they saw in candidate Barack Obama.

Ryan sits on the President’s deficit commission, which is all well and fine; we hope they can find a bipartisan solution behind their closed doors.  But Democrats should man-up (or woman-up in the case of Speaker Pellosi), by standing and delivering their own deficit and debt reduction program.  They should engage the passionate young conservative reformer, Congressman Paul Ryan.   It is time for bright and honest people to make the hard choices.

It is certainly a strange time not to have a federal budget.  Budget resolutions are non-binding, but like a family budget, they do provide a framework for controlling spending.  The federal debt is scheduled to rise to over 90% of GNP in five to ten years, leading to a Greece-style economic collapse. But unlike Greece, there is no one out there to bail us out.  A fiscal 911 is on its way, except it won’t be a surprise. When will we act to stop it?

Before the Democrats took office  the national debt was $56,000 per household.  Now it’s $72,000 per household.  These figures do not count the $379,000 per household in unfunded liabilities for Social Security and Medicare.

Some have said for a long time that we need a lockbox for Social Security and Medicare.  But through their inactions our politicians have always responded, “We don’t need no stinking lockbox!”  They have spent all of those payroll taxes, including those paid by some of America’s lowest-wage workers. Nothing is there but an IOU.  Demographics have turned a reasonable program into a pyramid scheme worthy of Bernie Madoff while Congress, term after term, has buried its head in the sand.  Re-elections are, after all, more fun than hard choices.

And now, in times of increasingly harder choices and oncoming fiscal calamity, Congress is not even planning to restrain spending through the use of a tool as routine as a budget.

Forget terrorism, global warming or any social problem that might come to mind.  In the United States and in Europe, debt is the crisis of our time, and our “leaders” – President Obama, House Speaker Pelosi, and Senate Majority Leader Reid – are willfully looking the other way.  Moreover, they have made the situation much worse through the creation a new entitlement – an attempt at universal healthcare insurance – without first reforming the old entitlements.  Indeed, like the bandits in The Treasure of the Sierra Madre,  they robbed to get what they  wanted: they stole from Medicare, a program already going broke.

The Democrats poured in $125.9 billion so far to bail out Fannie Mae and Freddie Mac (institutions Democrats refused to reform years ago), with no effort to change the programs partially responsible for the financial collapse.  Fannie and Freddie need no stinking badges either, just taxpayer cash.  Now they want $19 billion more to save private profit at public expense.  At least bailed-out corporations in wholly private industry, from Goldman Sachs to GM, are paying back owed taxpayer money.  If you want to know why Fannie and Freddie are not being reformed, just look at who they are paying off with campaign donations.

Certainly not all of this debt is the Democrats’ fault.  Congressional Republican majorities have not lifted a finger to reform entitlements either.  President George W. Bush added a Medicare drug benefit without paying for it, and launched the war in Iraq, which was wrong for a lot reasons, including its massive expense.  But Bush, to his credit, tried to reform Social Security.   Congress said no.

Unless something changes, Obama, Pelosi and Reid will be remembered as the Neville Chamberlains of the Great American Fiscal Collapse. Politicians don’t seem to appreciate the extent to which the American people demand action on spending and the debt.

Concern – or fury – over federal spending and the growth of the national debt is at the heart of the Tea Party movement.   The Left likes to pretend that the Tea Party consists of racists and other nitwits without any legitimate arguments to make about the direction of the country, but demonizing the Tea Party won’t work.  Most Centrists and Independents, and even many Democrats, though they do not watch Glenn Beck or believe that Sarah Palin is presidential timber, share Tea Party concerns about out-of-control federal spending.  They will vote to purge any politician, Democrat or Republican, who appears to put a political career above the fiscal stability of the country.  Tuesday’s results and recent elections in Virginia, New Jersey and Massachusetts offer ample evidence of this.

Congressional leaders obviously lack the courage to pass a budget.  They don’t want to showcase their fiscal irresponsibility, call for higher taxes or cut spending, so they refrain from passing a budget and hope no one notices.   But citizens are paying attention.  Here’s betting that the American people won’t sit by and watch the United States destroyed from within by irresponsible politicians who care more about their ideologies and political careers than they do about the long-term good of the country.   Politicians who don’t bother to write a budget to live by in these fiscally perilous times betray the public trust and are unworthy of the offices they hold.

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.

President Obama is expected to announce today a $3.8 trillion budget with a $1.2 trillion deficit for FY2011.  Here’s the context within which he will reveal his plan.  For decades now, the federal debt acquired through years and years of deficit spending has been the “elephant in the room” – the huge presence nobody talks about but everyone knows is there.  In last week’s State of the Union address, however, debt joined unemployment as the two most urgent issues facing America as Obama enters his second year as our President.

Last year, the White House and Congress went “Keynesian” in a big way as the real-estate bubble popped and started to pull Wall Street and Main Street down with it.  In crisis mode, they quickly passed stimulus bills designed to unfreeze credit and prevent the rate of unemployment from reaching double-digit percentages through a combination of renewed lending and “shovel ready” government spending to increase overall demand.

Last fiscal year, our federal deficit reached a record $1.4 trillion, and it’s projected to total $1.7 trillion this fiscal year, the first quarter of which has already seen spending exceed revenue by $389 billion, a 17% increase over the same period a year before. But as we enter February, unemployment resists declining below 10%, and debt as normally configured has reached almost $12,300,000,000  – or roughly $40,000 for every man, woman and child in America.

On January 12, the Obama Administration announced that its Council of Economic Advisers determined that the $787 billion stimulus program “saved” or “created” between 1.5 and 2 million jobs during 2009. Using the upper bound, that’s $393,500 per job. The “what if” ‘s of history cannot be proved, they can only be stated.  But even if we accept the upper bound as a true of the extra unemployment we’d have suffered if the Administration’s policies had not been implemented, it’s hard to conclude that our money has been well spent.  At best, each job has cost us $393,500, while none is regarded as permanent and the average compensation for comparable work is surely less than $75,000 on an annual basis.

<em>Pace</em> John Maynard Keynes and his new followers, it looks as if new government spending programs and the concomitant deficits are hurting, not helping recovery. Consumers, savers, and businesspeople alike worry about which taxes are going to increase and by how much to avoid continued debt explosion.  We also worry about what’s going to happen to interest rates and their effect on private borrowing expenses and the carrying costs of the national debt.

How, then, should we analyze the debt and its effect on the economy?

First of all, it’s ridiculous and misleading to compare today’s $12 trillion with, say,1950’s  $357 billion because of the cumulative effect of inflation over the last 60 years.   And we should also correct for growth in the economy.  After all, whether a $200,000 private mortgage is extravagant and foolhardy or modest and frugal depends upon the income of the borrower.  The following graph basically makes both of these corrections.

As is the case with most statistics, the tone of the story depends on its starting point.  Begin in 1945 if you want to relax, in 1980 if you’re okay with having your blood pressure soar.

Either way, two other adjustments are also appropriate. We should rework the numbers for automatic stabilizers, and we should separate government spending into consumption and investment categories, just as we do for private spending.

The Beltway doesn’t have to change anything to get some Keynesian stimulus spending going.  As unemployment increases, welfare payments will rise and tax revenues will fall, increasing or creating deficits.  If there’s any validity to Keynesian Economics, these quick developments are appropriate, and fair assessment of deficits should reconfigure the sums with these formulaic changes in mind.  We should find out, in other words, what the difference between spending and taxing would be at a level of employment considered “full”.

Our evaluation of debt should also depend in part on whether it’s being acquired through consumption or investment spending. We should be less concerned about deficit spending that finances investments than we are about deficits fueled by transfer payments properly categorized as consumption. Just as the probity of taking on a $200,000 mortgage depends on income (and its security), so is it sometimes okay and even good to take on some debt when acquiring an asset like a home, but not so good to finance a shopping bender in the Mall of America or a new car (which loses half its value right off the lot).

Unfortunately,“investment” is a malleable term that politicians will use to their advantage and not to ours.  Is the War in Iraq an investment in our future (which includes national security, itself dependent on reliable supplies of oil)?  Is Obama’s likely proposal of a huge increase in spending on education an investment in our youth, the individuals whose payroll taxes will be funding our Social Security checks?  Or, absent reform, is it more like income redistribution and consumption?

The issue of Social Security demands more scrutiny.  It also requires grit.  While insight is gained, the comfort our graph of debt/GDP can provide if we start with the Truman years is trashed.  The US could reduce national debt as a fraction of national income after World War II fairly easily because budgets weren’t encumbered by entitlement programs as they are today.  The value of these programs is not in question.  The problem is their cost, both in dollars and in flexibility and control. Baby-boomer demographics were not in play during the  1940s.

The unfounded future liabilities in entitlement programs like Social Security and Medicare dwarf all other deficit and debt concerns.  Neither has a nest egg adequate to the soaring payouts the formulas predict as baby boomers become eligible for benefits and are expected to live longer than their parents and be supported by taxes on a smaller work force. Last year alone, the combined debt of these two programs rose $5 trillion
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The fiscal health of our federal government is also worse than today’s debt figures would indicate because they fail to include off-budget items like subsidizing Fanny May and Freddie Mac.  Last week, the Congressional Budget Office reduced its guesstimate of another decade of their financial support by a whopping $20 billion. Yea!  But that leaves $79 billion still expected to be expended and begs the question of why these important players in the real-estate bubble remain “outsiders” even though any pretense that they’re run for a profit should long have been abandoned.  Time will tell, but the move to increase their loss limits does not auger well for us taxpayers.  It’s a cheap trick for the government to take quick credit for the positive effects of subsidizing mortgages through Fan and Fred, their cousin Ginnie Mae and uncle FHA, while failing to account for all the default risks accumulating as loss ceilings rise.

And then there are all the times the federal government improves its budget by fobbing off responsibility for funding certain programs to the states.  Medicare mandates are one example of this cost shifting.  In assessing government debt issues, we should be looking at all three levels of government – national, state and local, with an eye not only to their totals but to whose debt is really whose.  Should federal mandates really be paid by the states?  For what government spending should the counties, cities and towns be responsible?

Another matter involves the cost of servicing all this debt.  Like entitlement programs, interest payments are a huge part of overall government spending – indeed, its fourth largest category.

To whom are all these interest payments made? In times past, almost all debt holders were Americans, so we could call these payments mere “transfers” among our citizens.  Increasingly, however, our debt goes overseas, where China, Japan and the UK are currently our largest debtors.  Their holding our debt helps finance our trade imbalances and keeps our interest rates lower than they might otherwise be, but it also makes us vulnerable to outside change and exchange-rate issues.

It’s a good thing that we are now talking about the Elephant of Debt in the room.  The focus for reform, however, should not be debt but rather the growth in government spending, expected to reach 35% of GDP this year.  That’s the real, and even larger elephant whose presence we’ve been ignoring.

In the case of pulling an economy out of recession, it can be argued, although not with complete confidence these days, that additional government spending can actually increase private production.   In the case of full employment, however, all government spending takes the place of private spending.  If it’s funded by debt, interest rates may rise and “crowd out” private investment.  If it’s funded by taxes, the consequent declines in consumer demand and company profits will also cause private investment to decrease.

The key issue then becomes whether diverting resources to government use improves the public weal or not.  The consequences of whether the spending is financed by today’s taxes or by tomorrow’s taxes, for all their importance, remain secondary.  An important difference would involve whether voters respond more strongly to tax or debt increases and through their response can impose adequate spending restraint on politicians approving the programs.

How do we change the current trajectory of the ratio of government spending to GDP?  Given all the worthy entitlements and the difficulty of defining and controlling “waste”, the most attractive option is to grow the economy.  Investment in equipment, technology and people is key.  The question, then, is whether and to what degree the government, rather than the  private sector, should undertake these investments.  We already know that predictability in tax and regulatory legislation is a necessary first step.

“Hardest hit?”

Over-60’s in America have the highest net worth of any age group in the entire world. In addition, seniors can’t be fired because they’ve already retired. It’s people in younger demographics who have lost their jobs and suffer as earned income has been reduced all the way down to zero. The more you have, of course, the more you can lose; perhaps President Obama was thinking about total financial losses, not relative loss and absolute suffering, when he continued, “This additional assistance will be especially important in the coming months, as countless seniors and others have seen their retirement accounts and home values decline as a result of this economic crisis.” This kind of thinking does not comport well with progressive values.

The subsidy for seniors is likely to be regressive for other reasons as well. As a group, seniors tend to follow investment rules that urge them to hold a smaller percentage of their portfolios in stocks the older they get. Seniors with relatively large holdings of T-bills, bonds and other fixed income did not suffer the huge losses of younger cohorts with portfolios more heavily weighted in stocks and new-fangled instruments like derivatives.. In any event, the stock market has already recovered an almost absurd percentage of its losses. Yes, housing values have fallen dramatically pretty much across the board, but seniors, at least, tend to have old mortgages, still worth substantially less than the market value of their homes. Among seniors, in other words, net worth in this asset is likely to remain positive.

The case for the $250 giveaway is less weak when the conversation shifts from assets to income. The fall in interest rates has also been dramatic. To the degree that seniors have owned bonds that were called or came due, they have suffered from significant declines in income. But America’s expansionary monetary policy will soon raise interest rates back to or above the old rates to compensate for expected inflation, and financing so much additional debt will force real interest rates to new highs as well. Runaway debt will help seniors recoup their losses sooner than other groups.

If hardship is the real criterion here, government gifts should be handed to the poor. There’s nothing “needs based” with the current proposal. It’s simple age discrimination in a positive direction for our seniors. Surely increasing the bank accounts of the elderly is not the best use of additional government funds.

Obama’s proposal and pitch for the second stimulus spending package for seniors occurred the day before the government announced that there would be no increase in individuals’ Social Security monthly checks next year. The reason for no raises is not fiscal constraint and stinginess but formula. And the asymmetric way the formula works – automatic compensation for inflation, no charge for deflation – has already guaranteed recipients increased real benefits in 2010.

2010 is the first year Social Security benefits have not increased since 1975, when Congress passed Cost of Living Adjustment (COLA) provisions for Social Security. Some have argued that the index Congress chose overcompensates elders because its weighted basket of goods was designed to reflect the spending patterns of the urban employed, not the urban and rural retired. Whatever. Last January, following this formula, Social Security payments increased by 5.8%. Not since 1982 had so substantial an adjustment occurred, and the spike in energy costs was the driving factor. As we all know, one of the few benefits of this recession has been the fall in energy prices – 30% in gasoline alone and 23% in energy as a whole. Accordingly, the index for 2010 payments showed a decline of 4%. Holding monthly payments steady actually represents a significant increase in real benefits and purchasing powers. The American Enterprise Institute calculates this gain at $725 per person.

Are all seniors grateful for the asymmetric application of COLA that precludes any decline in nominal benefits even though the COLA turned negative? No, they are not. Is their discomfort assuaged by Obama’s $250? No, it is not. At least some seniors fail to understand or refuse to accept the formula for their benefits and the fact that 2010 benefits do increase their welfare. The Senior Citizens League (TSCL) reports rather angrily that people retiring in 2009 (maybe the first of the baby boomers, taking slightly early retirement) will each lose $10,134 over 20 years. TSCL, a soi-disant “nonpartisan” group of 1.2 million seniors, sources this sum in its projection of the compounding effects of 3% average annual benefits over two decades. Few of us know where that 3% figure came from, but we all know that $250 is chump change compared to $10,134.
Okay. Seniors are probably less hard hit by the recession than other worthy subsets of the population, and they’ve already been promised a reward in 2010 by experiencing no decline in their monthly checks from Social Security.

The ethics of additional $250 gifts are dubious. Maybe the lump-sum payment still has some economic justification as a delayed addition to the stimulus package? Perhaps. But this motivation is also shaky. People tend to save some of the relatively small lump-sum payments they’re doled out on a non-recurring basis from the government. A program like this doesn’t provide a large stimulus bang for the buck. It doesn’t increase consumption and investment as much as direct government spending or reductions of current and future taxes on marginal income. Has anyone actually studied the stimulus effects of the first $250?

Any other explanations for this gift? How about politics? Obama needs more support for healthcare reform. Elders are not lining up to sing the praises of any Democratic plan, nor are they promising votes and sending money. Rather, they worry about what happens to their Medicare and Medicare Advantage benefits when $500,000,000 in “waste” moves from these programs to expanded healthcare for the previously uninsured.

$250 given to 57 million people costs $14,250,000,000. But don’t worry: it won’t add to the record federal fiscal-year deficit of $1,420,000,000,000. That budget year is already over, and only the first $14,250,000,000, doled out starting last February, made it into the record books. September, usually a surplus month, ended the fiscal year by adding $46,000,000,000 to the mind-boggling total.

One can only conclude that the proposed $250 handout to the elderly is designed to win their political support for Obama’s extensive agenda. Everyone knows that seniors vote in disproportionately large numbers. But perhaps they’re not so easily bought. To imagine that checks for a mere $250 will assuage the fears surrounding proposed Medicare and Medicaid cuts assumes a high degree of senility among American seniors. Wisdom comes with age, and often people nearing the end of their lives are more likely to choose principles over expediency.