David R. Henderson  

Are Social Security Commitments a Sunk Cost?

David Warsh on Tyler Cowen... Klein, Laughter, and the Acade...

In a word, No.

In a comment on my post yesterday, Jim Glass writes:

This $15 trillion transfer owed to pre-2010 participants is a sunk cost.

He goes on to explain:
Whether it was a good idea or bad one for the polity to incur the debt resulting from this gift to the workers of the past is irrelevant today -- it is a debt incurred just the way the polity incurred the debts to fight WWII, for the moon progam, VietNam war, Obama stimulus, etc. We must pay it or renege upon it.

But with that last sentence of his explanation, he makes the point that it's not a sunk cost. Moreover, it's not a debt. The Social Security system is badly named, on purpose, I'm sure. The Supreme Court made it supremely clear in Flemming v. Nestor that the the Social Security system is essentially a tax and transfer scheme. If the government decides that it doesn't want to give benefits to people who paid into it over a lifetime, it can legally do so. So it's not a debt and it's not a sunk cost.

And we've even seen the government cut the benefits that were promised. In the 1983 Social Security law, Texas Congressman Jack Pickle insisted on long-term reform that raised the age to receive "full" benefits, in stages, from 65 to 67. [I use "full" in quotation marks because as someone, here or another blog, recently pointed out, you don't hit "full" benefits until you're 70.]

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CATEGORIES: Social Security

COMMENTS (16 to date)
Silas Barta writes:

So it seems the real question is whether we should view these obligations as optional for purposes of future fiscal planning. Is it your opinion that "forget the old people, cut them off" is an option worth discussing? (Or, what fraction of a full cutoff should be considered acceptable?)

Axel Kassel writes:

Section 1104 of the 1935 act creating Social Security reads,

"The right to alter, amend, or repeal any provision of this Act is hereby reserved to Congress."
In other words, as the Supreme Court has confirmed, your so-called "account" at Social Security is not your property. It is an accounting convention (and political talking point) utterly at the mercy of lawmakers. This is not the case (so far, anyway) with your savings account, IRA, or 401(k) balances--a point that some knee-jerk opponents of SS private accounts might do well to ponder.

Dan Weber writes:

Some kind of reduction in benefits -- whether that means raising the age, means testing, taxing it back, or a half-dozen other things -- is inevitable. You don't have to go all the way to "kill grannie."

gnat writes:

Flemming v Nestor (a 5-4 decision) found that the non-contractual interest of an employee covered by the Act cannot be analogized to that of a holder of annuity, whose rights are based on contractual premium payment. For this reason the SS actuary uses the term obligation in lieu of liability, because liability generally indicates a contractual obligation (as in the case of private pensions and insurance) that cannot be altered by the plan sponsor without the agreement of the plan participants.

The Act reserves to Congress the right to alter, amend or repeal any provision of the Act. According to Justice Black (in disent)it could repeal the Act so as to cease to operate Social Security activities for the future by stop covering new people and stop increasing its obligations to existing contributors.

Rebecca Burlingame writes:

This is not as much a moral issue as it may appear, but just a pragmatic financial one that needs to be prepared for. In the book, This Time Is Different, the authors made it clear that nations are more concerned with their solvency in terms of business dealings and credit standings with other nations, than with their own citizens. One of the reasons such a renege on social insurance of all kinds could get rough, is the degree to which rural America would scarcely exist, without it.

Jim Glass writes:
"$15 Trillion ... We must pay it or renege upon it."

But with that last sentence of his explanation, he makes the point that it's not a sunk cost.

I disagree -- because reneging on it does not avoid or reduce this cost at all, but only shifts who pays it. As the cost is already incurred and cannot be avoided, even by repealing SS outright, it is sunk.

Again, as a paygo program benefits = taxes, in total over its entirety. Thus if benefits earned by early participants exceed the taxes they paid by $X, that difference $X must land as a cost on later participants. It can't be avoided, it is arithmetic.

As a result of Ida May Fuller collecting $22,888.92 of benefits on her $24.75 of taxes paid in, and her other fellow early participants receiving generous benefits on their contributions, the SS Trustees tell us that $X is $15 trillion.

This $15 trillion has already been paid, so it cannot be not paid -- is that not the definition of a sunk cost? It is in the past. The only thing that can be affected in the future is how the bill for it is spread around, how we finance that cost.

To make this clear, take me as an example. I've worked since my teenage years, for three decades, and am at the happy demographic point where my future benefits are underfunded by 20%.

That is, my generation and later ones will receive benefits less than promised, so that they total less than the taxes we pay by a present value amount of $15 trillion.

How to "fix" this via "reform"? Here's three models:

1) Eat the benefit cut. (Means testing, delayed retirement age, straight cut, etc.)

2) Preserve promised benefits by raising taxes. But to pay all the promised benefits to ourselves we must increase taxes on ourselves by $15 trillion. So we are still out the same net $15 trillion.

3) Repeal SS entirely, end taxes and benefits both, cold turkey, as of tomorrow, 9/15/10. Renege! But now I get nothing on 30 years of payroll tax contributions. Hey ... that's a loss! And every worker in the nation under age 65 is just like me. Our combined loss: $15 trillion.

The only difference between 1 & 2 versus 3 is that with the former the loss is spread over future generations, while with 3 it lands as sudden hit on one working generation. But the total of the loss, $15 trillion, isn't changed at at, because it can't change, be because it is for a cost that has already been incurred in the past.

Hey, suppose that the govt decides to dig a hole half-way to the center of the Earth, then fill it in, at a cost of $1 trillion. About as useful as many things it does. (Maybe part of the next stimulus package?) Say the $1 trillion is the real market cost of digging/filling, and the govt promises to "pay on completion".

When the last shovel-full of dirt is filled in, the govt might cover the cost by...

a) Issuing $1 trillion of bonds, spreading the cost indefinitely into the future. Cost to taxpayers: $1 trillion at present value for taxes to finance future debt service.

b) Assessing an immediate one-year tax surcharge totaling $1 trillion on today's taxpayers.

c) Defaulting, not paying the bill. But this effectively is a confiscatory tax on the diggers/fillers and their employees, suppliers, etc., who wind up paying a cost of $1 trillion.

Once that hole is completed its cost is sunk and *somebody* is going to pay that $1 trillion. Politics only determines who.

It is the same with Social Security. "Making it whole for future generations" is not the issue -- to the extent that future taxes must exceed benefits by $15 trillion it can't be made whole. Ida May & Co. have already received that $15 trillion. That's done. Somebody is going to pay the cost of that transfer.

The real (if politically hidden) issue driving future SS reform is who is going to pay that $15 trillion, and how.

Patrick R. Sullivan writes:

Jim Glass is right, it is a sunk cost. The only question is, as he said, on whom that sunk cost falls.

Good rule of thumb; when Jim and Milton both disagree with you, re-check your logic.

Charley Hooper writes:

@ Jim Glass.

I made a promise to the bank to pay my mortgage for the next few decades. But I haven't yet repaid the entire loan, therefore my future mortgage payments aren't sunk costs. If a payment is in the future and you can get out of it some way or another, then it isn't a sunk cost.

It seems like you are saying past payments + future promises = sunk costs.

Dan Weber writes:

I think Jim was quoted a bit out of context.

Previous generations have received $15 Trillion more out of SS then they put in.

This $15T is "owed" to current and future generations, only in the sense that they paid in $15T more than they will get back out.

gnat writes:

I think that Jim Glass is saying obigatory past payments based on promised future benefits no matter how unspecific cannot be simply wiped out. I think that this is what the Court would hold. Its not a contract but it is an obligation.

Dan Weber writes:

obigatory past payments based on promised future benefits no matter how unspecific cannot be simply wiped out

I don't know how to parse that.

Its not a contract but it is an obligation.

As has been pointed out, this obligation can change 100% at the whim of Congress. Like when my credit card company offered me a "fixed 9.99% APR," it was only "fixed" until they wanted to change it. (It wasn't dependent on the Prime Rate so it wasn't called variable.)

Patrick R. Sullivan writes:
It seems like you are saying past payments + future promises = sunk costs.

That is definitely not what Jim is saying.

In the case of mortgage loans, a lot of homeowners (and speculators, aka house-flippers) did treat their 'past payments'--their minimal down payments and past monthly payments--as sunk costs. Irrelevant as to whether to continue to make their future mortgage payments.

Having no equity in their current house, nor any hope of a market correction restoring equity, they merely evaluated whether they could rent a better house for the size of their mortgage payment, or an equivalent house for less than that payment. If they could do so, they walked away from their sunk cost.

Charles R. Williams writes:

There is a confusion here between legal categories and political realities. The question is how much Social Security will be cut before the US chooses to default on its debt. The legal status of Social Security is irrelevant. Since the US is sovereign, it can change that status at any time. After all the GSE debt was explicitly not guaranteed by the federal government. Will we take the Social Security checks away from retirees to pay our sovereign debts? Would you take food from your children's mouths to pay the mortgage? Well, children don't vote and retirees do. There may be some long range tinkering to cut promises to future retirees but we will default before we cut Social Security benefits to current retirees in a serious way.

gnat writes:

@ Dan Weber
"As has been pointed out, this obligation can change 100% at the whim of Congress."

That is not what the Nestor Decision said. It said:
"We must conclude that a person covered by the Act has not such a right in benefit payments as would make every defeasance of "accrued" interests violative of the Due Process Clause of the Fifth Amendment."

"This is not to say, however, that Congress may exercise its power to modify the statutory scheme free of all constitutional restraint. The interest of a covered employee under the Act is of sufficient substance to fall within the protection from arbitrary governmental action afforded by the Due Process Clause."

Jim Glass writes:

Guys, "sunk cost" is a simple concept: "A cost that has been incurred and cannot be reversed."

Ida May Fuller & Co. received $15 trillion as a one-way transfer gift from the USA. $15 trillion net, more than they paid in.

They took that money and are gone. The cost is already incurred. It is history. The money has moved on ... (I want to mimic the Monty Python parrot sketch here). It cannot be "unpaid".

It is a sunk cost.

But it hasn't been finally financed yet. Who will get the final bill for the $15 trillion hasn't been determined. For instance,

[] By continuing SS as is under current law, cutting benefits 25% when the trust fund runs out, we can have future generations finance it by paying payroll taxes in excess of benefits they will receive to the tune of $15 trillion.

[] We could avoid any benefit cut by, say, creating a new VAT that will collect $15 trillion of tax present value, dropping the cost on those who consume, as Kotlikoff as proposed.

[] We could follow the libertarian ideal and kill SS outright tomorrow, having all living participants take an immediate lump sum loss equal to all the tax they've paid into the system (minus benefits received, if any) total = $15 trillion.

Whatever, many options are possible. But *somebody* going forward is going to pay $15 trillion in tax net, more than the benefits they receive! Because it is a sunk cost that already has been incurred, and can't be "unpaid".

Thus, regarding the original complaint about Bryan's proposal to let workers keep their own SS money, that it doesn't increase freedom because the govt then just collects the same amount of money another way -- it is true but pointless. Because the govt MUST collect that amount of money one way or another from somebody.

The issue that should be addressed is: who do we believe should pay that $15 trillion, and how.

Rebecca Burlingame writes:

@ Jim,

Some of us are not necessarily saying that Social Security should be outlawed. It is just a good idea to be prepared for the possibility that our government could in fact default on its obligation. By being prepared to take care of ourselves in new ways that are culturally acceptable to ideas of freedom both male and female, no one has to be overly upset at our government if it indeed happens.

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