David R. Henderson  

The Nightmare in Your Future

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Mean Reversion and the Permane... Mean Reversion and the Permane...

The title of this post is the subtitle of a talk I gave in about 2004 at Santa Clara University. The whole title was "Social Security: The Nightmare in Your Future." I had two goals: (1) to get students paying attention to how much they were likely to pay in Social Security taxes for not very good benefits--I also threw in Medicare, which was worse; and (2) to get them to think seriously about ending Social Security and Medicare, both of which I called "intergenerational abuse."

My daughter was a student at SCU at the time, but, not being in economics, she was not required to attend. She came up with a guy friend beforehand and explained that they would probably stay for half an hour at most because Tuesday night was party night. I told her I understood. An hour and a half later, after the talk had ended, they both came up and my daughter said, with a lot of energy, "I didn't know these things." It opened her eyes. Count me a proud papa.

Now, Mauricio Soto, a senior economist with the IMF, has produced a short readable analysis that backs up my point, not just for the United States, but for many rich countries. (HT2 to Timothy Taylor.) The piece is appropriately titled "Pension Shock."

Soto writes:

Population aging puts pressure on pension systems by increasing the ratio of elderly beneficiaries to younger workers, who typically contribute [sic] to funding these benefits. The pressure on retirement systems is exacerbated by increasing longevity--life expectancy at age 65 is projected to increase by about one year a decade.

To deal with the costs of aging, many countries have initiated significant pension reforms, aiming largely at containing the growth in the number of pensioners--typically by increasing retirement ages or tightening eligibility rules--and reducing the size of pensions, usually by adjusting benefit formulas. Since the 1980s, public pension expenditure per elderly person as a percent of income per capita--the so-called economic replacement rate--has been about 35 percent. But that replacement rate is projected to decline to less than 20 percent by 2060 (see Chart 1, right panel).


Solutions? One is a change in government policy:
For those born between 1990 and 2009, who will start to retire in 2055, increasing retirement ages by five years--from today's average of 63 to 68 in 2060--would close half of the gap relative to today's retirees.

The other is private:
Simulations suggest that if those born between 1990 and 2009 put aside about 6 percent of their earnings each year, they would close half of the gap in economic replacement rate relative to today's retirees.

My advice to young people: start now.

Soto makes one claim that needs to be challenged. He writes:

Pensions and other types of public transfers have long been an important source of income for the elderly, accounting for more than 60 percent of their income in countries that are members of the Organisation for Economic Co-operation and Development (OECD). Pensions also reduce poverty. Without them, poverty rates among those over 65 also would be much higher in advanced economies.

See the problem in the last sentence? What is he assuming about people's actions absent Social Security and other such intergenerational tax-and-spend schemes? If he had said "higher," I might not object. But "much higher?" Soto doesn't know that and there is good reason to doubt his claim. Ask yourself this: how many people do you run into who tell you they will be fine in retirement because they have Social Security? How many people would say the same if there were no Social Security? What percent of people would act differently if there were no Social Security? For Soto's claim to be correct, it would have to be a low percent.


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CATEGORIES: Social Security




COMMENTS (16 to date)
ahw writes:

If the purpose is to help old people who are in poverty then why have a program that "helps" everyone? Why not have a program that helps people who are in poverty?
It seems rather stupid to throw money to a whole bunch of rich people in order that some of that money hits a poor person.
And doubly stupid to throw MORE money at rich people and LESS money at poor people and then claim your program is designed to help the poor.
Anyone who supports U.S. Social Security is an idiot or a charlatan.

Garrett M writes:

I wonder what the relative rate of poverty was for the elderly compared to the rest of the population prior to social security. That's where I would start such an analysis.

David R. Henderson writes:

@Garrett M,
I wonder what the relative rate of poverty was for the elderly compared to the rest of the population prior to social security. That's where I would start such an analysis.
Sounds reasonable in normal times. Not for the United States, though. It started in 1935, which was during the Great Depression. So it’s dangerous to generalize from that.
It might work for Canada, though. Canada had the small old-age pension for a long time. But in about 1965, Canada’s federal government under Lester B. Pearson started its version of the U.S. Ponzi scheme. It was called the Canada Pension Plan. So looking at 1965 would be informative.

Jake writes:

Most people I have talked to about Social Security think their contributions are being saved somewhere in order to be paid back to them when they retire.

They also doubt they will be able to collect because they fear SS will "run out of money" by the time they reach retirement age.

Obviously both statements are false and show that these people don't really understand how SS works.

But given these beliefs, you would expect people to want to stop participating in something they perceive is ripping them off.

And yet support for abolishing -- or at least reforming -- SS is quite minimal outside of libertarians.

mariorossi writes:

If there is a relationship between life expentancy and lifetime earnings, uniform increases in pension age are not quite as neutral as they sound. In an entirely private market annuity rates would be cheaper for poorer individuals due to their expected lower life expectancy. There seems to be some evidence in favour of such hypothesis.

If that was true, you could get a situation where a higher pension age makes social security a terrible deal for both the poor and the rich (if you get a significantly differnt life expectancy between poor and average households).

Higher required saving is mostly a function of lower demographic growth. It's not actually obvious to me we have the ability to save the required amount. You cannot store hair-cuts (or maybe you can when we have robot hair-dressers). At a global level, we actually need to store future consumption in some way. This is not entirely trivial I think. Each of us can save more, but it needs to go into productive investment for it to guarantee future welfare. We seem somewhat short of those investments. It's not obvious any more that capital (especially financial capital) itself is a binding constraint...

LK Beland writes:

"It might work for Canada, though. Canada had the small old-age pension for a long time. But in about 1965, Canada’s federal government under Lester B. Pearson started its version of the U.S. Ponzi scheme. It was called the Canada Pension Plan. So looking at 1965 would be informative."

Not as much as we might think. The Guaranteed Income Supplement kicked in around that time. Also, the CPP and QPP were progressively phased-in and only fully went into effect in 1976. At the same time, the first generation to benefit from substantial employer-based pensions started to retire.

In that context, trying to isolate the effect of the CPP/QPP on poverty rates is far from trivial.

(The good news is that during the 1976-2006 period, elderly poverty rates decreased from 30% to 5%.)

Rob writes:

SS ramped up full retirement age from 65 to 67, but capped it there for those born in 1960 or after. If they had continued the expansion at 2 months per year as they did before, then retirement age would reach 68 for 1968 birth, 69 for 1974, 70 for 1980, 71 for 1986, 72 for 1992, 73 for 1998, etc.

Keep that up and you effectively end SS. Slowly.

Rob writes:

Math is hard, I am off by 2 years everywhere. But the idea stays the same.

AlanG writes:

I find discussions of extending the retirement age laughable. Most of us other than tenured university professors have little control over when we will retire. In my own case, a change in management where I worked meant that I was headed out the door two years before I had planned to retire. The industry I worked in (pharma) was downsizing all over the place and lots of my peers were being let go as well. There was no way that I was going to find a new job (relocation was out of the question as my spouse had a good paying job). Bottom line, I retired at the age of 63 and was lucky to have a modest pension and health insurance that covered the gap until Medicare kicked in.

For blue collar workers, lifetime factory work with a pension is a thing of the past.

I'm not whining as our retirement (wife just retired from her university job) is secure. My only point is look beyond your own cloister to see what it might be like for others who don't have your shared benefits.

JFA writes:

You rightly note the static nature of Soto's poverty analysis. I do wonder if his calculation about stock market returns takes into account the reduction in the rate of return if there were more savings.

Floccina writes:

Here is a solution. Each month take FICA revenue for that month,divide it by the number of citizens over 65 and send that much out to each of them.

john hare writes:

Floccina,
Under that scenario, people that had paid in nothing would be getting the same as those that had paid in the max. No incentive to pay in anything you weren't forced to.

Thaomas writes:

I think Henderson is mixing up different ideas. US Social Security and Medicaid have benefit and (dedicated) tax formulae that make the current structure financially “unsustainable.” This “unsustainability” could be easily fixed by shifting to a dedicated consumption tax whose rate could be adjusted for changing demographic trends. And by shifting away from wage taxation the overall structure could be make more progressive.

Independent of the financial sustainability of SS-Medicaid, there are good reasons to increase the “retirement age” so as to encourage more people to remain in the labor force.

Also Independent of the financial sustainability of SS-Medicaid, there are good reasons to encourage more savings for retirement. This could be done by giving partial tax credits (rather than tax deductions) for contributions to IRA-401K type accounts. The shift from deductions to partial credits would be more progressive and indeed the percentage credit given for savings could be higher for low-income people.

The rhetorical charge of “Ponzi scheme” however is ludicrous as it implies that SS wage taxes are voluntary and are being made out of a misunderstanding of present and future benefits to be received. Does the writer also think that “employers” pay half of the wage tax?

Floccina writes:

@john hare
As far as I can tell, very few people let themselves be taxed FICA who are not forced to, and it would motivate the elderly to support growth.

Mike W writes:

I wonder, has your daughter taken any action as a result of your revelation in 2004?

The earliest public discussion that I can remember about the unsustainability of SS and Medicare were in the early 1980s when they were last reformed. And even before that there were questions about the inadequacy of retirement savings that prompted the creation of IRAs in 1974.

So the current crop of retirees has been aware of what you revealed to your daughter for their entire working lives. And yet,

Only 24% of Baby Boomers are confident they will have enough savings to last throughout retirement, down from 36% in 2012.

Of the Baby Boomers who lack confidence, 68% said they would have saved more, and 67% said they would have started earlier, when asked what they would have done differently.

There seems to be plenty of evidence that "poverty rates among those over 65...would be much higher" without Social Security and Medicare.

J Mann writes:

Jake writes:

Most people I have talked to about Social Security think their contributions are being saved somewhere in order to be paid back to them when they retire.

They also doubt they will be able to collect because they fear SS will "run out of money" by the time they reach retirement age.

Obviously both statements are false and show that these people don't really understand how SS works.

It's false in the details, but not really in the bottom line, right?

If I understand it correctly, the truth is that there is a notional claim on future tax revenues as a result of their contribution, and that in the future, voters might not be willing to satisfy this claim because the demands might be too large relative to available revenue and competing demands. That looks about the same from a participant level view as the social security vaults running low on money.

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