Social (In)Security

Social (In)Security If you've been following the discussion, the question on your mind probably is whether or not the system needs to be changed or not, so let's try and shed some light on it.

In last year's State of the Union address, President Bush said that Social Security was 'headed for bankruptcy'. Yet, many economists (and even one former Social Security Commissioner) disagree with that statement.

One of those dissenting voices belongs to Dr. Irwin L. Kellner, Augustus B. Weller Distinguished Chair of Economics at Hofstra University and chief economic expert for CBS. According to Dr. Kellner, at present, the system is in excellent financial shape. Social Security tax inflows far exceed benefit payments, putting the system in a surplus. Total benefits paid in 2003 were $471 billion, while income was $632 billion. Assets held in special issue U.S. Treasury securities totaled $1.5 trillion. Furthermore, under all assumptions made by the system's actuaries, this surplus is projected to grow for at least 10 more years. The combined assets of the trust fund, currently more than three times annual expenditures, are projected to grow to nearly 4-1/2 times annual outlays by 2013.

So where is the President getting his information that the system is headed towards bankruptcy? The problem, according to some, is that this happy state of affairs is expected to reverse around 2018, as benefits paid out begin to exceed revenues coming in. Soon after, the trust fund will begin to shrink, and finally become completely exhausted by 2042, according to this projection. This means that if no changes are made, Social Security from that point on will have enough money from payroll taxes to pay only about three-fourths of promised benefits.

This development is based on a number of assumptions underlying the actuaries & main projection, including one that seems both inevitable and extremely important ' a decline in the ratio of working-age people to persons 65 and older. A long-term trend, this is expected to continue well into the middle of this century due to such ongoing changes in demographics as the aging of the baby-boomer generation, a continuation of the low birth rate and increasing life expectancies But there are other assumptions that go into the actuaries' projection as well, including net immigration, wage and interest rates, inflation and economic growth.

Another thing you should know is that the system's actuaries produce not one but three long-range projections, each looking ahead 75 years; they are known as low cost, high cost and intermediate. It is the intermediate assumption that has become the basis for the conventional wisdom that Social Security is broken and needs to be fixed.

However, the assumptions underlying the intermediate projection are very conservative & especially when it comes to economic growth. The actuaries& low cost projection shows that even though the system eventually pays out more than it takes in, the gap is so small that the trust fund not only doesn't run out of money between now and 2080 but its assets actually swell to $70 trillion dollars.

How is such a huge disparity possible, you ask? As somebody who deals with long-term projections, I think I can shed some light on this issue. To put it simply, the longer the timeframe, the more of a difference will result from even a small change in the underlying assumptions. To provide a concrete illustration, a person retiring in three years will need $54,080 to buy the same amount of goods and services as they can today with $50,000 if we assume four-percent inflation. Bumping it up to six percent raises the projected amount to $56,180 & two grand, no big deal. Now, let's run this projection for my little girl & if Katherina retires at age 65, she will need around $640,000 in 2063 to match the purchasing power of today's $50,000 if we assume four-percent inflation. But if we increase it by the same two percent as we did in the previous example, we'll end up with an annual income need of $2,200,000 (yes, two-point-two million bucks!). So as you can see, increasing the underlying inflation assumption by a factor of 1.5 affects the final outcome by a factor of about 3.5 times! Why is that? Simply put, it's the effect of compounding over a very long period of time.

And that's precisely why every long-term projection needs to be periodically updated. Of course, Social Security actuaries are keenly aware of that fact and therefore re-crunch the numbers annually. The result? The projected exhaustion date of the trust fund has been moved up almost yearly! Five years ago, the system's actuaries thought the assets of the trust fund would be exhausted in 2032. Two years later it was 2037. Now the exhaustion date is 2042. Meanwhile, the Congressional Budget Office, which makes these projections as well, thinks the system will remain solvent until 2052. In other words - there is plenty of room for difference of opinion regarding when, if ever, the system will run out of money.

So what's the bottom line? As far as I'm concerned, there's no room for disagreeing that given the decline of traditional corporate pension plans over the last couple of decades, people need a predictable and guaranteed source of income. With the mind-numbing plethora of IRAs, SEPs, 401(k)s and similar savings vehicles out there, I don't think there's any need to create yet another type of savings account.

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