The middle class is shrinking. Those in power have run up enormous debts on public credit while shoveling most of the money into private pockets. The corporations that have benefitted from this borrowing binge, meanwhile, leverage the global trade system to transfer their profits beyond the reach of national governments.

Meanwhile, we have been told lies by Democrats and by Republicans, divided into artificial camps and led into debates that are either irrelevant or so dramatically scripted that we fail to realize every choice leads to the same result: the dismantling of the social framework that defined and sustained the opportunity of the last century. National mobilization of resources has given way to radical individualism under a narrative that, in the wealthiest nation in the world, we must always expect less.

In this tumultuous time, we search for a way forward - a new Square Deal for the American people.

Monday, September 12, 2011

The Beginning of the End of Social Security

Note: From a legal perspective, the U.S. Social Security program includes an array of benefit programs. The Social Security Act has been amended several times since its original passage, and under the umbrella of that program is where one would find the legislation for all of our major social-welfare programs. Unemployment, Medicare, Medicaid, and TANF ("Welfare") are all components of Social Security. However, Americans link the words "Social Security" to the Old-Age, Survivors, and Disability Insurance (OASDI) program, which provides pensions to retirees. Throughout this commentary, "Social Security" refers solely to OASDI.

Social Security has endured many challenges over the 76 years since its passage on August 15, 1935.  Almost immediately after the collection of taxes under Federal Insurance Contributions Act (FICA) began collecting revenue for the program, for instance, Social Security was challenged on Constitutional grounds. The U.S. Supreme Court upheld the Act against two challenges:
  • Steward Machine Company v. Davis found that as Social Security taxes were to be paid into the Treasury in a manner consistent with all other taxes, these were as Constitutional as any other Congressional power to tax.
  • Helvering v. Davis found that the nature of the Great Depression made it impossible to view Social Security as being enacted "for any purpose narrower than the promotion of the general welfare."
Many Americans mistakenly think that because they have paid into Social Security, they are guaranteed benefits.  As its formal name indicates, Social Security is an insurance program.  It is not a pension fund, and the Supreme Court has repeatedly affirmed that someone paying FICA taxes is not guaranteed payment of benefits at any particular rate or at all.  Instead, under the Act, payments to FICA define the eligibility parameters to collect the benefits established by Congress.  Someone who meets these eligibility parameters is entitled to collect benefits to the extent that these are offered.

The nature of the Social Security program as defined in Public Law, and not any correlation to the politically motivated term "entitlement mentality," is why Social Security is referred to as an "entitlement."

A Brief History of Social Security, 1935-1983

For much of its history, the payment of Social Security benefits was considered virtually guaranteed.  Several generations of Americans grew old, gained eligibility for benefits, and collected them.  During that time, Congress raised benefit levels several times, recognizing both that there were current revenues to pay for them and also that these measures were popular with voters. 

In 1968, the U.S. government adopted a unified budget, which for the first time treated surplus funds in the Social Security Trust as offsetting a comparable amount of general U.S. government debt.  The driving force behind this change was the need to stabilize the budget in light of overwhelming spending on the Vietnam War, whose excessive cost relative to revenues threatened the stability of the Bretton Woods system under which American dollars backed by gold functioned as the world's reserve currency.

By the late 1970s, stagnation in the U.S. economy had changed the fiscal outlook, and the benefit increases made in prior decades were no longer so affordable.  The biggest driver was an accounting error that had led to double-indexed cost-of-living adjustments (COLAs) throughout the 1970s, a period of very high inflation.  Congress corrected the mistake and increased the FICA tax rate from its traditional rate of 2% to a rate of 6.15% in 1977.  (FICA is paid by both the employee and the employer, so this change equated to a jump from total funding of 4% to total funding of 12.3%.)

At the time, economists believed that the system would be stable for the foreseeable future.  That turned out not to be the case.  By 1983, Social Security was again in crisis, and with growing numbers of retirees projected in future years, Congress enacted changes that for the first time subjected portions of Social Security benefits to income tax so that more affluent beneficiaries would receive lower effective benefits than those who had more-limited incomes. 

Congress also raised the full-retirement age, removed Social Security from the unified budget, and established a requirement to invest the Social Security surplus in special, non-marketable U.S. government securities.  This last change was particularly impacting, because rather than simply tallying the surplus against outstanding U.S. debt as had been done for the preceding 21 years, the 1983 change permitted and in fact required by law that the U.S. government borrow each year's FICA surplus.  The huge amount of newly available money underwrote several of the tax cuts enacted by the Reagan administration -- particularly the Tax Reform Act of 1986, which lowered the top income tax rate in the United States to 28%.

Social Security since 1983

Ever since 1983, annual U.S. spending has reflected the complete consumption of excess Social Security taxes.  In exchange, the Social Security Trust Fund has received assurance backed by the full faith and credit of the United States that the money will be repaid with interest.

Conceptually, the idea of "investing" Social Security in special bonds that pay a guaranteed return is a good one.  All pension plans invest the proceeds of their paid-in amounts, and the returns on these investments provide the primary source of benefit payments for later collections.  Defined-contribution plans such as thsoe defined under sections 401(k), 403(b), and 457 of the Internal Revenue Code as well as Individual Retirement Accounts (IRAs) also rely on the invest-grow-pay model of meeting future demand.

However, the Social Security Trust Fund is not "invested" in the manner of a pension plan.  Investment works first and foremost because the money is being put to a use that generates a native return; for instance, money given to a bank is lent out, money given to buy a corporate bond is spent on expansion, and money used to buy shares of stock is made available for business activities that aim to generate profits.

Government debt can be productive; for instance, infrastructure investment may yield significant expansions in economic activity, and as the economy grows in terms of Gross Domestic Product (GDP), if tax rates and other factors are kept constant, the government will receive a greater total-dollar amount of tax revenue under the same terms as originally applied.  The proceeds of an expanded economy can then be used to repay the cost of the investment.

However, the U.S. debt issued to Social Secuirty is not productive.  We know that to be true, because every year since 1983 (and for several years prior), the total sum of the Social Security surplus has not been enough to cover U.S. government spending.  Put another way, the published deficit reflects money borrowed in addition to having already taken every surplus dollar of Social Security tax in a given year.  Before any repayment to Social Security could possibly occur, GDP would already have to have grown broadly enough to repay what was owed to all of the bondholders who financed the rest of the Federal spending binge.

In thirty years, under the Republican administrations of Ronald Reagan, George H. W. Bush, and George W. Bush as well as the Democratic administrations of Bill Clinton and Barack Obama, under Congresses controlled by both parties, this has never happened.  Even the much-touted balanced budget of 2000 was a mere card trick, based on projections from the Dot-Com bubble that had already popped and whose revenues would never materialize.  Balancing the budget on current revneues would mean cutting Federal spending by 41%, something that could be done only through drastic measures that would be felt immediately and harshly by almost every American citizen and resident. 

Even a balanced budget would mean only that the amount that we owed would stay exactly where it is, presently in excess of $13 trillion -- to actually repay that debt, we would need to generate a revenue surplus -- and Medicare costs would continue to increase, making it increasingly difficult to maintain balance.  Under a balanced budget and with a tax rate of 6.2%, Social Security would already be able to maintain current benefits based on FICA taxes coming in.

The Twist: Payroll Tax Cuts

This year, aiming to improve the economy and reduce unemployment, Congress reduced the FICA tax rate by two percentage points, from 6.2% to 4.2%.  This change was made without any large-scale spending cuts, and while deficit-reduction activities are on the agenda for November 2011, we can confidently predict that these discussions will not yield a balanced budget. 

Last week, President Obama unveiled his framework for the American Jobs Act, which he today sent to Capitol Hill.  The American Jobs Act has many provisions, but two would directly impact Social Security:
  1. To encourage consumption, the Act would cut the effective employee rate to 3.1%, half of the rate in effect in 2010.
  2. To encourage hiring, the Act would match this FICA rate on the employer side.
If passed, the American Jobs Act would have the effective impact of reducing total FICA revenues from effective rates of 12.4% and 10.4%, in 2010 and 2011 respective, to an effective rate of 6.2% in 2012.

Understand: this has never been done before.  Social Security and its tax mechanism were actually put in place during the Great Depression, when the economy was as its very weakest in history.  The need to raise these revenues trumped any concern for impacting hiring, which economists at the time correctly understood to be a function of demand.  Since 1937, FICA has only ever gone up, and even at 12.4%, FICA in 2010 did not yield enough revenue to cover current benefits.

The Beginning of the End

Now, think for a moment about the tax mentality in the United States.  In 2001, President Bush lobbied for and enacted tax cuts that he touted as "targeted, temporary stimulus."  He pushed for another round of "targeted, temporary stimulus" in 2003.  The 2001 rates were intended to expire this year.  Did they?  And when the discussion took place, did you hear anyone categorize the cuts as "temporary stimulus?"

No.  Instead, we heard that allowing the tax cuts to expire would be "the largest tax increase on the American people in history."  That is the nature of American politics.  We are told that we already pay too much, so any cut is not a gain but merely a move towards the tax rates that we deserve -- not low but lower taxes, the difference being that the former is a goal (which we already have) while the latter is a direction (which we now mindlessly pursue).

Payroll taxes are particularly interesting as an example of the U.S. tax code because, unlike the income tax, FICA does not offer deductions, credits, or any loopholes.  The revenue that FICA brings in is pure, and the sheer scope of what it does generate -- in 2010, the revenue generated by FICA matched that brought in by the income tax -- reflects what is possible when something is broadly based.

But the same reason why FICA is effective is also why it will be very difficult to ever allow these rates to return to their original levels: they affect everyone, including people whose incomes are too low to pay any income tax (a category whose membership strikingly includes nearly half of the U.S. working population).

Do you think that Republicans will for one moment not insist that the FICA cuts be made permanent, and categorize anything less as a tax increase?  And given that Democrats could not even manage to hold together to oppose tax cuts for the wealthiest Americans, do you think that they will stand up and vote to raise taxes on all Americans?

A Long-Sought Outcome

Social Security is the poster example of progressivism.  It has been reviled by the crony capitalists since its inception.  Repeated attempts to challenge it in court failed, and it has always proven too popular to eliminate under a system of government that, money aside, is still a democracy.  But in recent years, the crony capitalists have found a tactic that resonates with the American people:
  1. Cut taxes so that there is insufficient revenue to pay bills.
  2. Scream about deficits, drawing comparisons to personal checkbooks and credit cards and pretending as if nations were nothing more than consumers in a divinely overseen economy rather than being compacts that create money.
  3. Explain that "hard choices" need to be made, referring not to the return of the earlier tax rates but rather that whatever they supported is no longer affordable because "we're broke."
Barack Obama surely must know this.  He has seen it now three times.  How one explains his advancing cuts to FICA anyway therefore depends on one's perspective of the President.

From my perspective, Obama is a New Democrat in the tradition to Bill Clinton -- the man who, despite our rosy picture of him thanks to the coincidence of the Dot-Com boom, bears primary responsibility for the dismantling and outsourcing of U.S. manufacturing through the passage of various "free-trade" deals and laying groundwork for China's entry into the World Trade Organziation.  That many firebrand conservatives and Tea Party members buy into the hype that calls him a progressive (to say nothing of a socialist or -- ha ha! -- a Marxist) is a testament to how well the multinational corporations that are the true powers in the West have co-opted the political process, giving us a choice of two parties whose key candidates pursue the same pro-business agendas while throwing out enough distracting fluff topics for us to not notice how the march continues in the ways that matter down the same path.

I see that path as the dismantling of national institutions whose primary mission is the wellbeing and benefit of the citizenry in favor of those whose mission is the facilitation and support of private profit.  And while he gives nice speeches, I see Barack Obama as complicit in that goal, through the policies that he actually puts in place regardless of what he says at a fundraiser.

You may see him differently -- as someone who has been outmaneuvered by opponents better suited to their roles than he is, perhaps.  Maybe you even want to believe that, somehow, Obama will be able to restore the FICA rate when the time comes.  Do as you will.  I personally believe that there is a point at which hope becomes a little too audacious.

Conclusions

If you are under 50, you probably will not see anywhere near the benefits from Social Security that are reflected in the estimates that the Social Security Administration mails out to people.  If you are under 35, it would be best if you really, truly base your current choices on the assumption that you will get nothing at all.  That means saving, and you need to start now.

How much should you save?  The short answer is that you should save all that you can spare.  The legacy of FICA tells us that you can at least spare the amount that was already being taken from you in 2010.  If the 2012 rate is 3.1% instead of 6.2%, put aside each month an amount that matches what you see on the line for FICA.

It would be better to put aside a lot more.  Maybe you are a high earner.  The conventional wisdom is to put enough towards a 401(k) or 403(b) to get any employer-provided matching funds (free money), then focus on putting enough into an IRA to meet the limit.  If you have more, max out your 401(k) or 403(b).  Money beyond that can be invested any way that you like.

Take it seriously, though.  Remember that it takes 12.4% of your pay just to mimic the total FICA contribution.  You don't want to be the first person to be without Social Security and find that you had nothing else in place.

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