Social Security: False Alarm Or False Hope?

This essay was originally published in April of 2008. Here are excerpts.

A Wall Street Journal MarketWatch column (4/17/2008) by Dr. Irwin Kellner entitled “False Alarm”, concludes Social Security is not likely to run out of money any time soon.

Kellner’s conclusion contradicts the findings of the fund’s Trustees in their 2008 report  “Status of the Social Security and Medicare Programs”.  As described in their summary: “The financial condition of ..  Social Security …. remains problematic. Projected long run program costs are not sustainable under current financing arrangements. Social Security's current annual surpluses of tax income over expenditures will begin to decline in 2011 and then turn into rapidly growing deficits as the baby boom generation retires. ….  Growing annual deficits are projected to exhaust …. Social Security reserves in 2041.”

Furthermore, Kellner’s conclusion also disagrees with the findings of the Congressional Budget Office which estimates Social Security insolvency will occur in 2052. Kellner points out the Fund’s Trustees assume an average annual growth rate of 2.3% per year in making their intermediate projections of American economic growth. He compares this rate of growth with the 3.4% per year America experienced from 1960 through 2005, and concludes the lower figure must be labeled as “conservative”. Furthermore, Kellner believes the Fund’s low cost projection, which assumes an average annual GDP growth rate of 2.9%, is more realistic because (we presume) it is closer to his historical benchmark of 3.4%. With this growth rate assumption, Kellner believes Social Security will never run out of money. There will always be sufficient funds to keep the fund solvent.

I disagree.  Predicting Social Security solvency is not an easy task, and it is not simply a mathematical exercise. We must consider both the economic and the cultural environment within which these estimates are made. By way of illustration, let’s look at two problems – one economic and one cultural.

First.  Conventional economists frequently fall into a credibility pothole because they project the future based on the past. With a little tweaking here and there, they believe the mathematical extrapolation of dead data can be used to predict future economic performance.

But this assumption is absurd. Life is not a catatonic repetition of events and circumstances. Cultures evolve. Lifestyles change. Immigration shifts the balance of political power and changes the economic landscape. Technology creates new products. Technological change destroys old markets. Once powerful institutions stumble and fade away. Life is a dynamic process. Credible economic analysis must be equally dynamic.  

For example, conventional economics does not handle resource depletion very well. Economic theory assumes increased demand will bring about higher prices; higher prices will stimulate additional production; and when production exceeds demand, competition will force prices down. That works just fine if we are forecasting the market for door knobs. It doesn’t work very well if there are serious limits to the addition of new production.

It should not come as a surprise if the average annual increase in GDP, adjusted for inflation, is less than 1% from 2006 through 2030. If this happens, Social Security will be in trouble long before 2041. (From 2006 – 2010 chained GDP averaged .8%)

Second. Conventional economics ignores people. It assumes human behavior will not change much in the future, or at least not enough to alter the results of an mathematical extrapolation based on dead data.

This assumption is also false. If the average annual Social Security payout is $12,000, then a couple can expect to have approximately $24,000 a year to spend (less Medicare). If the median income for an American couple is $48,500, and if we assume they need at least 70% of that amount to maintain their current lifestyle, then they need an annual income of $34,000 upon retirement. To this amount, one must add annual increases to cover the cost of inflation. That means, on average, American couples must fund $10,000 a year, plus additional sums to cover the cost of inflation, from other sources. Since the basis of projected Social Security benefits is projected to decline, and Medicare premiums are projected to increase, the spread between your Social Security benefits and the cost of living will increase over the years.  Because the Federal Government underestimates the rate of inflation, no sane person should anticipate annual increases in Social Security benefits will actually keep up with the rate of inflation.

Unfortunately, less than 50% of married couples (or domestic partners) will have additional income from pensions or annuities. More than 40% of all retirees will see their annual income decline by more than 30%. Really dumb agricultural policy is currently focused on increasing the price of food, and gasoline ain’t going to be cheap.

Baby Boomers (all born between 1946 and 1964) are not going to be happy when they retire and the reality of their desperate financial situation finally sinks in. These people are going to be really, really depressed when they have to sell their comfortable 2400 square foot middle class suburban home in order to scrape together enough money to rent a 420 square foot mobile home, endure unbearable cold in the winter because they can’t afford the cost of fuel, and eat dog food for meat.  No.  Baby Boomers will do what they have always done.

Protest. 

And politicians, ever mindful of the next election, will increase Social Security payments to help them out. That means current estimates of Social Security fund solvency are inherently bogus because they fail to consider the possibility of some unknown, but definitely probable,  increase in benefits.

Conventional economic research frequently yields inadequate conclusions based on irrelevant or obsolete data that has been interpreted using algorithms of questionable relevance. In other words - we play with the numbers. It's a great academic exercise.  Cultural Economists, on the other hand, must have a strong sense of the cultural matrix within which economic phenomena occur. Culture, in this sense, includes everything we are: our political systems,  economic psychology, mores, traditions, sciences, and education. These all play a role in how we make purchase and investment decisions.

As for the Social Security “Trust” Fund, it’s in more trouble than anyone can guess.

TCE

Postscript: Some people mocked me when I published this essay.   No more.