More on the Social Security Greenweasel scam

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Raleigh Myers
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More on the Social Security Greenweasel scam

"The federal budget surplus President Bush inherited came entirely
from Social Security surpluses resulting from the 1984 payroll tax
increase. Bush gave away revenues meant to provide for workers'
retirement as tax cuts for the wealthiest 10% of the population."

and consider,

"Opponents of Social Security have hated it since its creation in
1935. The first prediction of a Social Security crisis was published
in 1936! The Heritage Foundation and Cato Institute are home to many
of the program's opponents today, and they fixate on the concept of a
"demographic imperative." In 1960, the United States had 5.1 workers
per retiree, in 1998 we had 3.4, and by 2030 we will have only 2.1.
Opponents claim that with these demographic changes, revenues will
eventually be insufficient to pay Social Security retirement benefits.

"The logic is appealingly simple, but wrong for two reasons. First,
this "old-age dependency" ratio in itself is irrelevant. No amount of
financial manipulation can change this fact: all current consumption
must come from current physical output. The consumption of all
dependents (non-workers) must come from the output produced by current
workers. It's the overall dependency ratio??the number of workers
relative to all non-workers, including the aged, the young, the
disabled, and those choosing not to work?that determines whether
society can "afford" the baby boomers' retirement years.
[Secondly],..."

* * *

Social Security Isn't Broken

So Why Does Greenspan Want to Fix It?

BY DOUG ORR

Federal Reserve Chairman Alan Greenspan told Congress earlier this
year that everyone knows there's a Social Security crisis. That's like
saying "everyone knows the earth is flat."

Starting with a faulty premise guarantees reaching the wrong
conclusion. The truth is there is no Social Security crisis, but there
is a potential crisis in retirement income security and there may be a
crisis in the future in U.S. financial markets. It's this latter
crisis that Greenspan actually is worried about.

Social Security is the most successful insurance program ever created.
It insures millions of workers against what economists call "longevity
risk," the possibility they will live "too long" and not be able to
work long enough, or save enough, to provide their own income. Today,
about 10% of those over age 65 live in poverty. Without Social
Security, that rate would be almost 50%.

Social Security was originally designed to supplement, and was
structured to resemble, private-sector pensions. In the 1930s, all
private pensions were defined-benefit plans. The retirement benefit
was based on a worker's former wage and years of service. In most
plans, after 35 years of service the monthly benefit, received for
life, would be at least half of the income received in the final
working year.

Congress expected that private-sector pensions eventually would cover
most workers. But pension coverage peaked at 40% in the 1960s. Since
then, corporations have systematically dismantled pension systems.
Today, only 16% of private-sector workers are covered by
defined-benefit pensions. Rather than supplementing private pensions,
Social Security has become the primary source of retirement income for
almost two-thirds of retirees. Thus, Congress was forced to raise
benefit levels in 1972.

What has happened to private-sector defined benefit pensions? They've
been replaced with defined-contribution (DC) savings plans such as
401(k)s and 403(b)s. These plans provide some retirement income but
offer no real protection from longevity risk. Once a retiree depletes
the amount saved in the plan, that pension is gone.

In a generous DC plan, a firm might match the worker's contribution up
to 3% of his or her pay. With total contributions of 6%, average wage
growth of 2% a year, and an average return on the investment portfolio
of 5%, after 35 years of work, a retiree would exhaust the plan's
savings in just 8.5 years even if her annual spending is only half of
her final salary. If she restricts spending to just one-third of the
final salary, the savings can stretch to 14 years.

At age 65, life expectancy for women today is about 20 years, and for
men about 15 years, so DC savings plans will not protect the elderly
from longevity risk. The conversion of defined-benefit pensions to
defined-contribution plans is the source of the real potential crisis
in retirement income. Yet Greenspan did not mention this in his
testimony to Congress.

No Crisis

Opponents of Social Security have hated it since its creation in 1935.
The first prediction of a Social Security crisis was published in
1936! The Heritage Foundation and Cato Institute are home to many of
the program's opponents today, and they fixate on the concept of a
"demographic imperative." In 1960, the United States had 5.1 workers
per retiree, in 1998 we had 3.4, and by 2030 we will have only 2.1.
Opponents claim that with these demographic changes, revenues will
eventually be insufficient to pay Social Security retirement benefits.

The logic is appealingly simple, but wrong for two reasons. First,
this "old-age dependency" ratio in itself is irrelevant. No amount of
financial manipulation can change this fact: all current consumption
must come from current physical output. The consumption of all
dependents (non-workers) must come from the output produced by current
workers. It's the overall dependency ratio??the number of workers
relative to all non-workers, including the aged, the young, the
disabled, and those choosing not to work?that determines whether
society can "afford" the baby boomers' retirement years. In the 1960s
we had 1.05 workers for each dependent, and we were building new
schools and the interstate highway system and getting ready to put a
man on the moon. No one bemoaned a demographic crisis or looked for
ways to cut the resources allocated to children; in fact, the living
standards of most families rose rapidly. In 2030, we will have 1.27
workers per dependent. We'll have more workers per dependent in the
future than we did in the past. While it is true a larger share of
total output will be allocated to the aged, just as a larger share was
allocated to children in the 1960s, society will easily produce
adequate output to support all workers and dependents, and at a higher
standard of living.

Second, the "demographic imperative" ignores productivity growth.
Average worker productivity has grown by about 2% per year, adjusted
for inflation, for the past half-century. That means real output per
worker doubles every 36 years. This productivity growth is projected
to continue, so by 2040, each worker will produce twice as much as
today. Suppose each of three workers today produces $1,000 per week
and one retiree is allocated $500 (half of his final salary)?then each
worker gets $833. In 2040, two such workers will produce $2,000 per
week each (after adjusting for inflation). If each retiree gets
$1,000, each worker still gets $1,500. The incomes of both workers and
retirees go up. Thus, paying for the baby boomers' retirement need not
decrease their children's standard of living.

So why the talk of a Social Security crisis? Social Security always
has been a pay-as-you-go system. Current benefits are paid out of
current tax revenues. But in the 1980s, a commission headed by
Greenspan recommended raising payroll taxes to expand the trust fund
in order to supplement tax revenues when the baby boom generation
retires. Congress responded in 1984 by raising payroll taxes
significantly. As a result, the Social Security trust fund, which
holds government bonds as assets, has grown every year since. As the
baby boom moves into retirement, these assets will be sold to help pay
their retirement benefits.

Each year, Social Security's trustees must make projections of the
system's status for the next 75 years. In 1996, they projected the
trust fund balance would go to zero in 2030. In 2000, they projected a
zero balance in 2036 and today they project a zero balance in 2042.
The projection keeps changing because the trustees continue to make
unrealistic assumptions about future economic conditions. The current
projections are based on the assumption that annual GDP growth will
average 1.8 % for the next 75 years. In no 20-year period, even
including the Great Depression, has the U.S. economy grown that
slowly. Each year the economy grows faster than 1.8%, the zero balance
date moves further into the future. But the trustees continue to
suggest that if we return to something like the Great Depression, the
trust fund will go to zero.

Opponents of Social Security claim the system will then be "bankrupt."
Bankruptcy implies ceasing to exist. But if the trust fund goes to
zero, Social Security will not shut down and stop paying benefits. It
will simply revert to the pure pay-as-you-go system that it was before
1984 and continue to pay current benefits using current tax revenues.
Even if the trustees' worst-case assumptions come true, the payroll
tax paid by workers would need to increase by only about 2%, and only
in 2030, not today.

If the economy grows at 2.4%?which is still slower than the stagnant
growth of the 1980s?the trust fund never goes to zero. The increase in
real output and real incomes will generate sufficient revenues to pay
promised benefits. By 2042, we will need to lower payroll taxes or
raise benefits to reduce the surplus.

The Real Fear: An Oversupply of Bonds

So why did Greenspan claim cutting benefits would become necessary? To
understand the answer, we need to take a side trip to look at how
bonds and the financial markets affect each other. It turns out that
rising interest rates reduce the selling price of existing financial
assets, and falling asset prices push up interest rates (see "How Does
the Bond Market Work?" p. 15).

For example, in the 1980s, President Reagan cut taxes and created the
largest government deficits in history up to that point. This meant
the federal government had to sell lots of bonds to finance the
soaring government debt; to attract enough buyers, the Treasury had to
offer very high interest rates. During the 1980s, real interest rates
(rates adjusted for inflation) were almost four times higher than the
historic average. High interest rates slow economic growth by making
it more expensive for consumers to buy homes or for businesses to
invest in new infrastructure. The GDP growth rate in the 1980s was the
slowest in U.S. history apart from the Great Depression.

But high interest rates also depress financial asset prices. A five
percentage point rise in interest rates reduces the selling price of a
bond (loan) that matures in 10 years by 50%. It was the impact of the
record-high interest rates of the 1980s on the value of the loan
portfolios of the savings and loan industry that caused the S&L crisis
and the industry's collapse.

Greenspan is worried because he sees history repeating itself in the
form of President Bush's tax cuts. In his testimony, Greenspan
expressed concern over a potentially large rise in interest rates.
This is his way of warning about an excess supply of bonds. Starting
in 2020, Social Security will have to sell about $150 billion (in 2002
dollars) in trust fund bonds each year for 22 years. At the same time,
private-sector pension funds will be selling $100 billion per year of
financial assets to make their pension payments. State and local
governments will be selling $75 billion per year to cover their former
employees' pension expenses, and holdings in private mutual funds will
fall by about $50 billion per year as individual retirees cash in
their 401(k) assets. Private firms will still need to issue about $100
billion of new bonds a year to finance business expansion. Combined,
these asset sales could total $475 billion per year.

This level of bond sales is more than double the record that was set
in the 1980s following the Reagan tax cuts. But back then, the newly
issued bonds were being purchased by "institutional investors" such as
private-sector pension funds and insurance companies. After 2020,
these groups will be net sellers of bonds. The financial markets will
strain to absorb this level of asset sales. It's unlikely they will be
able to also absorb the extra $400 billion per year of bond sales
needed to cover the deficit spending that will occur if the new Bush
tax cuts are made permanent. This oversupply of bonds will drive down
the value of all financial assets.

In a 1994 paper, Sylvester Schieber, a current advisor to President
Bush on pension and Social Security reform, predicted this potential
drop in asset prices. After 2020, the value of assets held in 401(k)
plans, already inadequate, will be reduced even more. More
importantly, at least to Greenspan, the prices of assets held by
corporations to fund their defined benefit pension promises will fall.
Thus, pension payments will need to come out of current revenues,
reducing corporate profits and, in turn, driving down stock prices.

It's this potential collapse in the prices of financial assets that
worries Greenspan most. In order to reduce the run-up of long-term
interest rates, some asset sales must be eliminated. Greenspan said,
"You don't have the resources to do it all." But rather than
rescinding Bush's tax cuts, Greenspan favors reducing bond sales by
the Social Security trust fund. Doing that requires a reduction in
benefits and raising payroll taxes even more.

Framing a question incorrectly makes it impossible to find a solution.
The problem is not with Social Security, but rather with blind
reliance on financial markets to solve all economic problems. If the
financial markets are likely to fail us, what is the solution? The
solution is simple once the question is framed correctly: where will
the real output that baby boomers are going to consume in retirement
come from?

The federal budget surplus President Bush inherited came entirely from
Social Security surpluses resulting from the 1984 payroll tax
increase. Bush gave away revenues meant to provide for workers'
retirement as tax cuts for the wealthiest 10% of the population.

We should rescind Bush's tax cuts and use the Social Security
surpluses to really prepare for the baby boom retirement. Public
investment or targeted tax breaks could be used to encourage the
building of the hospitals, nursing homes, and hospices that aging baby
boomers will need. Such investment in public and private
infrastructure would also stimulate the real economy and increase GDP
growth. Surpluses could be used to fund the training of doctors,
nurses and others to staff these facilities, and of other high skilled
workers more generally. The higher wages of skilled labor will help
generate the payroll tax revenues needed to fund future benefits. If
baby boomers help to fund this infrastructure expansion through their
payroll taxes while they are still working, less output will need to
be allocated when they retire. These expenditures will increase the
productivity of the real economy, which will help keep the financial
sector solvent to provide for retirees.

Destroying Social Security in order to "save" it is not a solution.

Doug Orr is a professor of economics at Eastern Washington University.
He is a regular speaker on the issues of private sector pensions and
Social Security and has published articles on these issues in national
and international journals. His e-mail is dorr@ewu.edu.

Resources Dean Baker and Mark Weisbrot, Social Security: The
Phony Crises, University of Chicago Press, 1999; William Wolman and
Anne Colamosca, The Great 401(k) Hoax, Perseus Publishing, 2002;
Sylvester J. Schieber and John B. Shoven, "The Consequences of
Population Aging on Private Pension Fund Saving and Asset Markets,"
National Bureau of Economic Research, Working Paper No. 4665, 1994.

= = = Side Bar = = =

How Does the Bond Market Work?

A bond is nothing more than an IOU. A company or government borrows
money and promises to pay a certain amount of interest annually until
it repays the loan. When you buy a newly issued bond, you are making a
loan. The amount of the loan is the "face value" of the bond. The
initial interest rate at which the bond is issued, the "face rate,"
multiplied by this face value determines the amount of interest paid
each period. Until the debt is paid back, events in the financial
markets affect the bond's value.

If market interest rates fall, prices of existing bonds rise. Why?
Suppose you buy a bond with a face value of $100 that pays 10%. You
then collect $10 per year. If the current interest rate falls to 5%,
newly issued bonds will pay that new rate. Since your bond pays 10%,
people would rather buy that one than one paying 5%. They are willing
to pay more than the face value to get it, so the price will be bid up
until interest rates equalize. The price at which you could sell your
bond will rise to $200, since $10 is 5% of $200.

But changes in bond prices also affect interest rates. If more people
are selling bonds than buying them, an excess supply exists, and
prices will fall. If you need to sell your bond to get money to pay
your rent, you might have to lower the price of the bond you hold to
$50. Because the bond still pays $10 per year to the owner, the new
owner gets a 20% return on the $50 purchase. Anyone trying to issue
new bonds will have to match that return, so the new market interest
rate becomes 20%.

 

Issue #256, November/December 2004

http://www.dollarsandsense.org/1104orr.html

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Ra Energy Fdn.
Raleigh Myers
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http://raenergy.igc.org/bio.html
Blog
http://raenergy.blogspot.com/

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