How to fix social security

Would you settle your claims on Social Security for 83 cents on the dollar?  I would, gladly.  So would some others, especially young people, to whom I've suggested the idea. 

Social Security's finances have had a fateful collision with the demographic and economic realities. The unavoidable and well-known result is that Social Security's debt (its "promises," if you prefer) can't be paid in full.

If a debt can't be paid in full, the fundamental logic is to settle it at a discount, for less than 100 cents on the dollar. This can happen by voluntary agreement, for example, when a mortgage is settled for less than the amount of the loan through a short sale (a familiar transaction in the wake of the housing bubble).  It can happen when a company buys back its own bonds from investors at a discount.  And it can happen in a reorganization under the bankruptcy code.  In all cases, the point is for the parties to put the mistakes of the past behind them, and for life to go on.

COULD SOCIAL SECURITY'S DEBT be settled at a discount by voluntary transactions with its creditors, namely American citizens?  Yes, it could.  Every time this happened, it would reduce the system's deficit, because its debt would go down by more than its assets.

Enlarge ImageLarge numbers of people, notably young people, don't believe that they will ever fully collect on Social Security's promises that is, its debt at par-and they are right.  So I believe that a significant number would be interested in my proposal.  They might include the 68% of respondents aged 19 to 29 who were "not confident at all" (48%) or "not so confident" (20%) that they would get their promised benefits, according to a 2009 poll.  In a 2011 poll, only 2% of the respondents were "very confident" they would get Social Security benefits at least equal to today's value.

What would be a fair price to settle Social Security's debt? To answer this question, we need to focus on the part dealing with pensions. Old Age and Survivors Insurance represents about 85% of Social Security and is largely designed as a forced savings program. The other 15%-Disability Insurance-is a forced insurance program and is a different discussion.

The present value of future OASI cash income to the government is $34.5 trillion, according to the Social Security trustees' 2010 Report. This uses intermediate-case assumptions as the best guesstimate. (The system's so-called trust fund represents zero cash income to Uncle Sam and doesn't count.

Against the $34.5 trillion in OASI assets, there are liabilities of $41.4 trillion-the present value of all the future cash outflows promised by Social Security. The liabilities are $6.9 trillion greater than the assets. If your liabilities exceed your assets, you are insolvent.

The $34.5 trillion in Social Security assets available to pay promised pensions equals only about 83% of the promised $41.4 trillion. This points to the fair way to settle Social Security's debt to its creditors (namely, us): Pay 83 cents on the dollar.

The Social Security trustees also express the finances of Social Security in terms of future cash receipts and cash outflows as percentages of the total projected taxable payrolls. In the intermediate estimate, OASI cash receipts will be 11.3% of future payrolls, and the cash cost will be 13.6%, so receipts will be 83% of costs: another way to say 83 cents on the dollar.

So would you rather have 83 cents of your own, which you could invest, or would you prefer 100 cents of future claims on an admittedly insolvent government pension program? I'd take the 83 cents in a heartbeat. But I think the choice should be voluntary. So I propose that Americans be given this choice: Stay in Social Security as it is, or settle for 83 cents on the dollar.

How might such a program work mechanically? If you chose the 83 cents on the dollar, you would receive a rebate of all the Social Security tax you paid-normally, 6.2% of your wages-in each subsequent quarter, via inflation-indexed Treasury bonds deposited in your own tax-deferred retirement savings account. You'd own these securities outright.

You'd then have real assets and savings to replace some of the unenforceable, complicated, politicized promises of an insolvent program. And you'd know exactly what you had.

For those who choose to stay fully in Social Security, the program's net-worth deficit would become smaller every time someone else settles for 83 cents on the dollar.

As Prof. Laurence Kotlikoff rightly said in the Social Security debates of three decades ago, "The perception of Social Security as a savings account has been fostered by every major piece of Social Security legislation since the program's inception in 1935. Perhaps it is time to make de jure what has long been a de facto relationship." My proposal would achieve just that.

Your rebate would reduce your portion of the Social Security tax to zero in all future periods. Of course, your employer pays another 6.2 % Social Security tax, and ordinarily the total tax is 12.4% of your wages. The employer's portion would continue to be paid, and like all your past Social Security taxes, would generate benefits for you.

THE GOVERNMENT'S Social Security income from your wages would drop by 50%. But Uncle Sam would be happy about this. The entire transaction means that net government liabilities would shrink and the Social Security deficit would, too. Every 83 cents in bonds the government issues as rebates would cut the Social Security debt by $1.00. In other words, Washington bought a dollar for 83 cents and is definitely ahead.

The government would calculate your Social Security benefits by the normal formulas, in the normal, convoluted, opaque way. But over time, these payments would be reduced by the actuarial equivalent of all the Treasury bonds you received, divided by 0.83.

This proposal is a win-win proposition. It would improve the financial position of all four parties involved: those who settle the debt of an insolvent debtor at a discount; those who put faith in the existing Social Security promises; the Social Security program itself and the government as a whole. 



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