The year 2013 was quite an eventful one for the American democracy. We saw fiscal cliffs, government shutdowns, botched health-care websites, and a whole slew of other, self-inflicted embarrassments in front of the world audience.
In my view, it's fair to say that in today's U.S. of A., the government is more likely to kick important issues down the road rather than solve them proactively. For Social Security, that's a big problem.
In this post, I'll first explain why and how Social Security can be saved, and then, we'll circle back to why our government will likely fail to save the program, anyway.
Social Security can't go bankrupt
Recently, I read an article from 2011 by Forbes contributor John Harvey, who contends that it's a logical impossibility for Social Security to go bankrupt. First, Social Security is not a pension fund. You do not put in your money today to get your money out later. Social Security has always been an immediate transfer from current workers to older workers. The money you put in today immediately goes to pay a former worker's benefits.
Harvey takes the macro view, and describes this in terms of productivity and standard of living. As current workers increase their productivity, their standard of living goes up. Social Security slices off some of that productivity, and redistributes it to former workers, to allow them to maintain their standard of living.
The future of Social Security, in concept at least, is tied more closely to the working population's ability to increase productivity sufficiently to maintain or improve its standard of living, and simultaneously subsidize retirees. If productivity declines, then either the standard of living will decline for either current workers, former workers (via reduced income from Social Security) or both.
Viewed in this macro light, as long as there exists a productive U.S. economy, then Social Security can exist. It logically can't go bankrupt. There's no fund to dry up. There is only an immediate transfer of today's productivity from current worker to former worker.
Check out Harvey's post here for the extended explanation.
There are solutions to manage this increase in dependent individuals
The problem we face, then, is an increasingly elderly population of former workers who are (and will be) dependent on the transfer of productivity from a more or less static current workforce. As the chart at left illustrates, the ratio of dependent individuals will dramatically increase over the next 20 years. The increase is driven by an aging population.
There are three primary schools of thought on how to alter Social Security to support the increase in dependent individuals.
First, and most intuitive from Harvey's explanation, is lower benefits across the board. With so many more individuals taking pieces of the pie, the size of the slices must become smaller, so that everyone can still receive a slice. While many people see this solution as unfair, particularly to the poor, it would work. Social Security would survive. It would not go bankrupt.
Option two is higher taxes. Instead of shrinking the size of the slices, we simply increase the size of the entire pie. Very smart economists disagree on the size of the tax increase necessary to maintain current standards of living -- if today, we transfer $10 of productivity from current workers to former workers, in the future, we may have to transfer $15 or $20. Most economists agree that the tax hike would be substantial, but not so great as to have a meaningfully negative impact on most workers. Again, many people would disagree with the principle of raising taxes, but the solution would work.
Option three is a means-tested approach. Benefits would be delivered on a sliding scale based on financial need. Benefits for the wealthy would decrease, while benefits for the poor would remain at today's standard of living. The pie would be cut into different sized slices, and then given away selectively. Again, many people would likely disagree with this in concept as a redistribution of wealth, but it would work.
Picking up on the problem?
In all three solutions, certain subsets of the population disagree with each given approach to solve the problem. And when people who vote disagree, you have a political problem.
Unfortunately, the current political environment in Washington D.C. is not optimized, or perhaps willing, for compromise when solving complex, ideologically motivated problems.
So what did 2013 teach us about Social Security? It taught us that the policymakers and politicians tasked with solving this issue will most likely avoid the problem until the 11th hour. And even then, compromise won't come easy.
The government can't afford to fund the gap between former worker's standard of living expectations and current worker's productivity. The program must change. But it won't anytime soon.
Are you prepared for the future of Social Security?
Social Security plays a key role in your financial security. In our brand-new free report, "Make Social Security Work Harder For You," our retirement experts give their insight on making the key decisions that will help ensure a more comfortable retirement for you and your family. Click here to get your copy today.