Whoops, and More

In my last post I erred by identifying the FICA tax cut from 6.2% to 4.2% as part of the Bush-era tax cuts--it wasn't.  A loyal reader pointed out that this was a 2010 Obama Administration decision, part of the broader stimulus program.  I had forgotten that.  Everything else I said about it, however, stands. But while we're on the topic of this tax, we might as well use the opportunity to elucidate this particular matter.

The reduction of the FICA tax was always meant to be temporary, but then again so were the Bush-era cuts.  Most people, I guess, are assuming that the Administration decided to end the two percent reduction because of concern over the balance in the Social Security trust fund. Ah, this is where things get interesting.

Some weeks ago an old acquaintance pointed out that there was something very strange about the discussion over the deficit and the so-called fiscal cliff. Why, he asked, should politicians be making equilibrations between entitlements, again so-called, like Medicare, Medicaid and Social Security when these programs all have separate revenue streams apart from the general Federal budget that pays for discretionary spending?  If these programs have separate revenue streams from the general budget, then what sense is there in talking about the sequestration of social spending and military spending, because the discretionary revenue pool has nothing to do with paying for Medicare, Medicaid and Social Security, right?

I thought this was a good question; I, at least, did not have a ready and persuasive answer to it, so I asked around of people who have been in this business for their day job. What I learned was quite interesting, and that is what I wish to share right now.

First of all, yes, there are separate revenue streams, and there are supposed to be separate revenue pots of money, to cover Medicare, Medicaid and Social Security. Technically, there are; in reality, it's all one big pot. The taxes that are supposed to pay for Medicare and Medicaid collect only a fraction of what those programs cost, and that fraction has gotten smaller and smaller over the years as these programs have become more expensive for a variety of reasons, some of them demographic and others politico-bureaucratic.

Social Security is a little different, but also somewhat the same. Of course there is supposed to be a special trust fund into which contributions go, and yes, as everyone knows, those who work and pay into the fund at any given time are really paying for those elders who are retired. These workers in turn will be paid back their contributions in retirement by subsequent generations of workers.  If this sounds like a Ponzi scheme, it's because it is, but there's nothing wrong with a Ponzi scheme that everyone recognizes as such, and that is not voluntary anyway, as long as the demographic realities support the scheme. Some observers have been pointing out now for more than twenty years that demographic change has put the Social Security trust fund balance in jeopardy. I am not exaggerating when I say that we have been warned now for at least twenty years about this--just look up Pete Peterson and you'll see. This makes it all the more amazing that our political class has failed repeatedly to heed these warnings and do anything to avoid the train wreck. I am also told, by the way, that the train wreck is actually here: that the Social Security trust fund is technically now in deficit.

I never understood until recently why our political class was so blasé about dealing with this problem. Now I get it: In reality, as opposed to law, there is no Social Security trust fund. And there is a good reason for that.

After the end of the Depression and World War II, the money began to pile up in the Social Security trust fund as the U.S. economy got back on its feet and began to excel. As it was explained to me, this put U.S. Treasury officials in a bind. They could do two things with all this money. First, they could just let it  sit there, but that would be a tremendous and irresponsible waste of capital, capital needed at a time when we were trying to build and broaden the American middle class through the G.I. Bill and a variety of other programs. Second, the Treasury could either invest the money in financial instruments or it could acquire real equity, by buying real estate, corporate stocks and the like. There were a few people who thought this was a good idea, but cooler heads prevailed. The idea that the government might own significant parts of the economy, even if only in trust for its retired citizens, raised all sorts of philosophical and practical warning flags, in particular the potential for corruption and insider dealing of several kinds.

Since it made no sense either to sit on this money or to buy things with it, the decision was made to merge the money "in effect" with the general revenue pot. You have probably heard accusations that from time to time the Congress has "raided" the Social Security trust fund.  Well it has, but it has more or less done so by mutual agreement. These "raiding" accusations tend to come from partisan quarters, or from those who do not like the purposes to which the money has been put. But this "one big pot" approach has become common practice in both Republican and Democratic administrations over many years.

And that is why our political class has not gotten all that exercised about the demographic-induced imbalance in the trust fund that is now upon us because of the Baby Boom generation. The basic idea is that, hey, if we, the Congress, took money out of the trust fund when that made sense, we can stick money back in it if we have to when that makes sense.  No big deal, really.

Well, that has not worked out so hot, because when it comes time to stick money back in, and that will be necessary, it is not at all clear where that money is going to come from. There are only four places it can come from. That money can be created anew, "printed."  It can be borrowed.  It can be acquired through higher taxes. Or it can be acquired at the same or lower tax rates if the economy grows rapidly. Those four options, or some combination of them, are I think the only ways to do this. Obviously, the fourth option is the most desirable, and in the end it may be our salvation––as, in the past, with no thanks to the government. The first option risks inflation. The second option risks deeper and more dangerous deficits, and it also rewards those who make money off money and thus exacerbates inequality. The third option risks recession, and is politically very difficult at the present. So this is the dilemma.

As far Social Security is concerned, this is really frustrating because there are at least three sensible ways to rebalance the system if we really felt like it, which is another way of saying "had the political will to do it."

We could go back to the original concept of Social Security as insurance for old-age, which means that we would means-test payments. Right now retired people who have skezads of money still get their benefits, even though they don't really need them. My father-in-law happens to be one of them, and he has said to me many times that it's ridiculous to pay rich people insurance money that they don't need, when so many other needs go unfulfilled. I think he's right. But we have distorted the original understanding of the program from an insurance pool to a kind of bank account that people have. I don't know exactly how or when this happened, but it was a huge mistake to let it happen.

Alternatively, and much easier to do politically, we could simply raise the cap on the Social Security tax. Right now there is a maximum amount that any individual has to pay into the pot. I see this every year when in November and December my take-home pay goes up by quite a bit because I've hit the ceiling. We could either eliminate the ceiling altogether, and tax all income, or we could raise the ceiling in order to make the program solvent over time. The latter would be probably easier to do politically, and it would solve the problem.

And yet another alternative, often discussed, is raising the retirement age. When Social Security was initiated, life expectancies were much lower. No one in 1933 or 1935 could have imagined so many people living so many years past age 60.  In many circles this seems to be the most popular option, but there are at least two problems with it. The first problem is how do you do this without reneging on promises solemnly made––in other words, how many people get grandfathered under the present system and how many younger people don't? The other reason this may not be such a great idea is that if we extend the retirement age, more older people will be working longer, and that is going to clog up the entry channels for younger workers. Ordinarily that would not be such a big deal, but we are in a time when globalization and automation are making job generation problematical, especially jobs that sustain a middle-class living standard.

In any event, some combination of these three ways to ensure the solvency other Social Security trust would definitely work. Everyone in Congress who has looked at the problem understands this, and so do their staffs, and so do the hundreds of academics and serious journalists who have looked at this problem over the years. And because we've done nothing to address this problem, not to speak of so many others, everyone's taxes went up two percent in 2013.

There, I think that's finally now got this about right. Sorry for the factual error.