Preserving America’s Retirement Security

An interesting analysis was published last week on by Emily Ekins entitled “Differences on Social Security Reform.” In her article, Ekins presented data from a poll that asked whether or not the respondent would support or oppose reducing Social Security taxes and allow individuals to invest in their own retirement instead.

The results were stratified by age, education, income, ethnicity, gender, political ideology, party affiliation and union membership. Some of the results were predictable and showed strong polarization – the older the respondent was, for example, the more likely they were to favor preserving social security as it is, and the younger the respondent was, the more likely they were to favor reducing social security taxes and benefits. Another obvious result from the survey was the split between progressives and libertarians, where the mirror image expressed by their sentiments – progressives 58% vs. 35% opposed, libertarians 57% vs. 31% in favor – bordered on parody.

Crucially, Hispanic voters, rising demographically in the U.S., were opposed 52% vs. 38%; African Americans also opposed lowering social security taxes and benefits, 59% vs. 32%. One needn’t read too much into that, while Hispanics may be destined to become the decisive swing vote in elections of the future, if not already, their political sentiments may change. But reality is about to trump the political debate between those who believe in the ownership society and those who believe in the great society.

The most glaring example of “ownership society” ideology in practice, ironically, is that of the government employee pension funds, and their union apologists. They not only believe, like many libertarians, that investment returns can yield a lifestyle in retirement far, far greater, per input, than one fueled merely through transfer payments from taxpayers, but they have put it into practice. Unlike libertarians, of course, the government employees expect taxpayers to cover the difference when their collectively invested inputs fail to yield the lifestyle in retirement they’ve defined for themselves.

The problem with all this “ownership,” however, rests on two twin phenomena that will derail extravagant, investment return fueled retirements whether they are those of collectively invested public employee pension funds, or individually invested 401K accounts. They are the reality of the American (and global) economy’s debt hangover that has just begun, which is going to cause real returns on invested funds to drop precipitously, combined with the reality of an aging population both inside and outside the public sector. The private sector worker-to-retiree ratio in America will drop from roughly 3-to-1 today to 2-to-1 within the next 20 years; the public sector worker-to-retiree ratio is on track to move from today’s 2-to-1 to nearly 1-to-1 within the next 20 years (based on their lower retirement ages).

The basis for these worker-to-retiree ratios, as well as calculations that estimate how much taxpayers will pay, and retirees will receive, under various realistic assumptions, are explored in depth in the posts “The Cost of Government Pensions” and “Funding Social Security vs. Public Sector Pensions,” but here’s a summary:

On a pay-as-you go basis, if a retiree receives a defined benefit equal to 2/3rds of their average career salary, and there is one worker for each retiree, then each worker must set aside 2/3rds of their paycheck to fund their retirement. This is a roughly accurate presentation of what the public sector faces. On the same basis, if a retiree receives a defined benefit equal to 1/3rd of their average career salary, and there are two workers for each retiree, then each worker must set aside 1/6th of their paycheck to fund their retirement. This is a roughly accurate presentation of what social security faces.

As calculated in the post “The Cost of Government Pensions,” because public sector workers, on average, make 50% more in base salary than private sector workers, the projected amount of retirement payments for the 20% of the working population who are government employees will actually exceed the projected amount of social security payments to the entire remaining 80% of America’s workers (to calculate this, you have to also take into account the fact that government workers, because they retire earlier, comprise 30% of all retirees even though they are roughly 20% of all workers, i.e., if “S” represents salary, [(S + .5S) x .66 x .30] > [S x .33 x .70]). And the government worker unions who cling to the fiction that these levels of benefits are sustainable suggest that this disparity doesn’t matter, because investment returns will obviate the need for pay-as-you go funding. Those libertarians who actually think that an “ownership” society, where social security is scrapped and everyone invests, will enable everyone to enjoy this level of retirement benefits, are even more delusional. Government employee pension funds that cover 20% of the workforce are already the biggest players in the investment market – they must beat the market to deliver the returns they claim they can deliver for decades on end. Libertarians apparently think that 401Ks invested by 100% of the workforce can beat the market too. You can’t beat the market when you are the market.

This is perhaps the prevailing financial question of our time: What real rate of return can be siphoned out of retirement accounts to augment taxpayer generated pay-as-you go retirement funding, when there are only two workers for every retiree, and 100% of retirees depend on these investment returns? Put another way, if retirees who number 1/3 of the entire population are pulling money out of invested funds, can those funds, in aggregate, even match the rate of general economic growth, much less exceed it?

Seen in this context, it may be that ideology and wishful thinking will be trumped by economic and demographic reality. Public sector pensions and 401Ks alike may not be able to perform to expectations when more people are retiring than ever, and economic growth itself is constrained because growth is no longer catalyzed by debt accumulation. In this environment, social security, which already (notwithstanding a most irresponsible temporary lowering of the rate of employee withholding) claims through the employee and employer a combined 12.5% of payroll, is revealed as pretty much sustainable. At a rate of withholding increased to 1/6th of pay, or 16.7%, social security benefits will be solvent forever. If that rate of withholding, from 12.5% to 16.7% is unpopular with voters, than means-testing, raising of the retirement age, raising of the absolute ceiling on withholding, or reduction of benefits can make up the difference. But the adjustments necessary to preserve social security, which is a defined benefit, are incremental.

On the other hand, when pension funds acknowledge that their projected rates of return cannot be achieved (the idea they can earn 7.75% per year when the Fed borrows money at less than 1.0% per year is absurd), they will be revealed to be completely insolvent (for more on this read the posts “How Rates of Return Affect Pension Contribution Rates,” and “How Rates of Return Affect Required Pension Assets“). On a pay-as-you go basis, public employee pensions would have to contribute 66% of base pay from current workers to support retirees. On an aggregate basis, the funds necessary to pay retired public employees, who represent less than 20% of the workforce, will actually exceed the funds necessary to pay social security benefits to everyone else, representing more than 80% of the workforce.

The good news here is that as investment returns are revealed, through economic and demographic reality, to be far from adequate means to sustain America’s retired population, taxpayer funded defined benefits will be the only choice left. This, in-turn, in order to be sustainable and equitable, will mean that while public employees will continue to receive defined benefits, and while for many strata of the public sector workforce these defined benefits may still exceed what social security would pay, overall their benefits will have to be greatly reduced. Taxpayers cannot be expected to contribute 16.7% of their payroll to keep social security solvent in the future, yet at the same time also pay taxes that would amount to another 16.7% of their payroll simply to keep public sector pensions (as they are currently formulated) solvent as well.

The solution to providing for retirement security in America is to retain defined retirement benefits for everyone, providing all workers a defined benefit in the form of social security, with premiums granted in some cases to government workers who endure risks in their professions. This will require a modest increase in the rate of social security withholding, from 12.5% to 16.7%. If the social security trust fund and all public sector pension funds were then invested in short-term T-bills, it would both hedge these funds against inflation, eliminate their volatility, and provide a market for federal debt. It would also remove speculative taxpayer-funded Wall Street gamblers from the market – public sector pension funds who pursue risky investment strategies, motivated by a need to deliver over-market returns.

Rationalizing the taxpayer-funded elements of retirement security in the ways just described would also return the market to individual investors. Eliminating taxpayer funded, aggressively managed, trillion dollar pension funds, whose sophisticated machinations extract over-market returns, would allow privately managed funds and individuals to again receive market-rate returns on their investments without having to engage in inordinate risk. Breaking the tyranny of Wall Street pension funds, and their last, biggest suckers, the government worker union leadership who – again quite ironically – believe these trillion dollar pension funds can beat the market forever, will provide Americans the best of both worlds. They will all have secure, sustainable defined retirement benefits, and they will have a market for their supplemental 401Ks that again delivers a decent return to small investors.

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