New Economic Perspectives


05 November 2013


By Ben Strubel

Along with most Republicans, many Democrats, and Wall Street, President Obama wants to cut Social Security. Here is what you need to know.

What Cuts Are Being Proposed?

Obama is proposing, along with the support of Republicans and many Democrats, to change how annual increases in Social Security benefits are calculated. Obama wants to switch to a different formula, called Chained CPI. This switch would result in a benefit cut of $230 billion dollars over 10 years. All this is being done under the guise of “strengthening” the program and “securing it for future generations”.  (See here, here, here, here and here)

Right now, annual increases in Social Security benefits are calculated using changes in CPI (Consumer Price Index) which measures the price increases in various goods and services. Chained CPI is a twist on regular CPI in that it assumes that when the price of one good goes up people will substitute a cheaper good. For instance, if the price of steak goes up people will switch to chicken. While this makes sense for some things, it doesn’t for others. For instance, if the price of natural gas goes up you can’t just change the heating system you have. If the prices of essential prescription drugs go, up you can’t just substitute something different.

So how much would Social Security payments change under Chained CPI? At first, it doesn’t seem like a lot. Using last year’s data, the change would amount to only $3 less for every $1,000 received. The problem is that the money lost compounds over time. If someone draws benefits at age 62, then by the time they reach age 92 they will be losing a full month of income!

The changes being proposed are an insidious way of robbing the elderly as they grow older.

What makes these proposed changes even sadder is that according to surveys[1], 84%of people believe current Social Security benefits do not provide enough income for retirees, and 75% believe we should consider raising the amount of benefits paid and 68% support an outright raise in benefits.

In Washington, both sides of the aisle are hopelessly out of touch with ordinary Americans.

Social Security Is Remarkably Effective

Social Security has been a very effective program for combating poverty among the elderly. In 2012, approximately 9.1% of the population of the US age 65 and older lived in poverty. Contrast this with a poverty rate of 21.8% for children 18 and under, or 13.7% for adults ages 18 to 64. It’s also worth noting that under a new supplemental measure of poverty created by the US Census Bureau that takes into account other sources of cash payments or benefits such as SNAP (“food stamps”) and tax credits but also includes the cash cost of healthcare not covered by Medicaid or Medicare, the poverty rate for seniors rises to 16.1%.

Since the government started keeping data on official poverty levels in 1960, the poverty rate among those 65 and older has fallen from a high of 35%. Large increases in Social Security benefits from 1959 through the 1970s contributed to a steep drop in poverty rates. Poverty rates among those 65 and older continued falling but at a more moderate pace during the 1980s, 1990s, and 2000s except during recessions.

While Social Security has done well to keep seniors out of abject poverty, it is grossly insufficient to meet all income needs in retirement. According the Social Security administration, the average retiree is receiving $1,230 per month, or about $14,760 per year.

Unfortunately, due to the recession, poverty rates have started rising. Poverty rates among children have risen from 16.2% in 2000 to 21.8% in 2012. Poverty rates for working age adults have skyrocketed from 9.6% to 13.7% during the same period. Social Security has been instrumental in keeping the same thing from happening to seniors. The poverty rate among seniors was 9.9% in 2000 compared to 9.1% in 2012. Poverty rates for seniors, however, are now starting to tick higher with 2012 seeing the largest increase in poverty rates among seniors in the last decade.

For many seniors, Social Security is their only form of income in retirement, and living on less than $15,000 a year is a challenge to say the least. While programs designed to help the less well off, such as food stamps, heating subsidies, housing vouchers, and so forth, are sometimes vilified in the press and by politicians as just lining the pockets of the lazy; in fact, a majority of the benefits dispersed in those programs accrue to children, the disabled, and the elderly. In 2012, for example, 49% of all SNAP (“food stamps”) benefits went to children, 8% went to the elderly, and 20% went to the disabled. For programs such as LIHEAP, which provides cash assistance for heating bills, virtually all benefits accrue to households that contain an elderly person, a disabled person, or a child under age six. Housing assistance programs, such as Section 8 vouchers, see a plurality of their aid go to the elderly. In 2010, 49% of all Section 8 aid went to the elderly or the disabled (versus the categories of TANF recipients [those subject to work requirements], non-TANF, and others).

The fact is a very large chunk of social benefit payments are flowing to the elderly (with children being the other large demographic). In recent years, politicians on both sides of the aisle have been making cuts to many of these programs. For example, LIHEAP was funded at $4.7B which only met a quarter of the need in 2011, but Obama proposed cutting the funding to $3B for 2012. TANF (“food stamps”) have been the target of cuts, mainly from Republicans but with plenty of help from complicit Democrats, with a $5B cut coming on November 1 of this year. (Happy Thanksgiving from Washington!) Even larger cuts are being discussed.

For seniors, Social Security remains the one stalwart program that provides income they can count on. With severe cuts coming to many programs that seniors count on, they are even more dependent on Social Security to remain out of poverty. In light of the cuts made to other programs, the proposed cuts to Social Security would be especially draconian.

It’s also worth noting that this kind of spending has a positive effect on the economy. Every dollar spent by the government on Social Security, TANF, LIHEAP, or housing vouchers generates anywhere from $1.50 to $1.80 in economic activity. By way of contrast every $1 spent on something like the military generates only around 80 cents in economic activity (and if you take a look at all the defense contractors in our investment portfolio you certainly can’t call me biased!).

Not only will cuts to Social Security harm seniors, those cuts will also harm an already fragile economy. When seniors receive less income, they spend less. Since most Social Security payments are spent on necessities, payments have a high fiscal multiplier so cuts in payments cause greater harm to the economy.

Why Cuts Are Being Proposed

Three words: Wall Street + taxes.

Let’s tackle the first two words: Wall Street. Wall Street desperately wants to get their hands on your Social Security money, so they can manage it. If Wall Street were managing an investment portfolio the size of the Social Security trust fund and charging a somewhat typical 1% fee, they would make $27B per year. Wall Street desperately wants to get that money under their contact, and there are two basic ways to do it.

Option one is to convince everyone that they will magically be able grow your money beyond what you might get from Social Security payouts. Given the widespread public disdain for Wall Street and the big banks, this option has little chance of success in the near term. When the stock market does well, however, such as during the beginning of the Bush years when this trick was last tried, it has a better chance of success.

Option two is more sinister but very ingenious. You simply “break” the program so it is unappealing and appears dysfunctional (never mind that you were the one who broke it). By advocating for cuts in Social Security, Wall Street can make the program appear not to be working. If the cuts are successful, you will no doubt soon hear cries of how the low level of benefits provided is just not acceptable and we need to do something. People may become frustrated with Social Security and start seriously considering an alternative. And Wall Street will be right there waiting with the alternative: Imagine how much more money you would have if you just privatized Social Security and let them manage it! Such a strategy has been tried and completed successfully in other countries and with privatizing other social services (for example, private, for-profit charter schools as an alternative to defunded public schools).

The last word is pretty simple. Taxes. When Franklin D. Roosevelt created Social Security, he also created the bizarre, nonsensical system of accounting that the program uses for political reasons. When you and your employer pay FICA taxes, that money is nominally placed in the Social Security Trust Fund. When Social Security benefits are paid out that money again nominally is paid out from the trust fund. FDR did this for political reasons to try to prevent Social Security from ever being destroyed by politicians. He reasoned that if people believed that they were getting “their money” out of the program when they retired, then they would resist any cuts or adverse changes to the program since they viewed it as their own money rather than some entitlement program.

Because we live with this fiction that FICA taxes fund Social Security, we now have created the “problem” that in about 20 years the number written in the government’s spreadsheet for the trust fund of Social Security will be smaller than the amount of money that is being paid out in benefits. One of the ways to fix this non-problem is simply to raise payroll taxes. One widespread idea is to raise the cap on the amount of income subject to FICA taxes. Right now, only the first $113,700 of income is subject to FICA taxes. Everything after that is not subject to FICA. By removing the cap and subjecting all income to FICA taxes, the number on the government’s spreadsheet for the amount in the trust fund will be very big–big enough that the amount paid out in benefits can last another 80 years or so before the number on the spreadsheet starts getting smaller.

For many of the ultra-wealthy, however, Social Security is not part of their retirement plans. Even the worst corporate executives still receive gold-plated retirement plans and sky high compensation. For many people making a few hundred thousand a year, Social Security payments might, and probably are, part of their retirement plans. But the ultra-wealthy don’t need or particularly want Social Security benefits, so they do not care much what happens to the program. But they do care deeply about their taxes. Therefore, it is in their best financial interest to push for cuts in the program rather than take the chance of a possible tax increase.

In the accounting fantasyland of the government, there “appears” to be a “problem” with the number on a spreadsheet not being big enough. Back in the real world, Social Security is not funded by FICA taxes nor from payments from the trust fund.

How Social Security Really Works

Social Security funding works like this. Right now, the US has about 314 million people, of whom 58.6% or 184 million are currently employed in some capacity. These people generate all of the goods and services that are for sale. These people also get all of the income available in the economy. Also, the goods and services need to be purchased right away; they cannot be saved or hoarded for later. A barber can’t save a haircut for later. You either get your hair cut now or you don’t. You can’t stockpile future haircuts for when you retire. Some things might be able to be saved. You could certainly buy a car now and put it in storage to use 30 years from now when you retire. But it will lose a lot of its utility. You would have taken something worth say $30,000 and turned it into something worth maybe $1,000.

If current workers were the only ones who could buy things, what would happen? All of the workers would consume almost all of the goods and services available, since they receive all of the income. Nothing would be leftover for anyone else. But every society has some members who do not work: babies, children, disabled, sick, and elderly.  Do we want to live in a world where no one in any of these groups gets anything, except what they can beg, borrow, or steal?

There are about 62 million US retirees or disabled persons. What we do is enact some type of tax on the workers that reduces their income. Now all of the workers can consume only a fraction of the total goods and services available. We also have the government pay out some type of income to the 62 million retirees and disabled persons. They can then use this money to consume the leftover goods and services that are not consumed by the workers.

It’s important to remember that the point of the tax is to reduce the demand from the workers. The taxes do not serve to fund anything. The point of the payments from the government is to ensure that all available goods and services in the economy are being purchased. If there are leftover goods and services, then the payments should be increased or the taxes decreased.

Right now, the US has around 20 million unemployed and underemployed people, and record low industrial capacity utilization. We have plenty of idle capacity to take care of new retirees. The Social Security program is not in any kind of danger of being unable to meet the demands of existing and potential retirees.