The Third Rail

Thanks to the wonder of the internet, I recently learned the meaning of the "third rail of politics" metaphor so often used to describe verboten government programs like Social Security.

According to Wikipedia, the third rail is a high-voltage rail used to power trains in some electric railway systems and, being electrified, would likely kill anyone who touched it. This seems an appropriate metaphor since no major politician wants to tackle the funding problems associated with Social Security, even though there are some relatively simple fixes. Ultimately, the third rail goes untouched for fear of the outcome.

Since I've been getting more questions lately about the structure and health of the Social Security system, it seems appropriate to touch on some higher-level factoids about the program.

Social Security provides retirement benefits to over 40 million beneficiaries each year, and to millions more spouses, dependents, and survivors of deceased workers.

The average monthly benefit is $1,350 and 30% of retirees receive less than $1,000.

Social Security benefits make up more than half of the household income for more than half of married retirees.

For a chunk of retirees, Social Security is over 90% of their income and without it, half of all retirees would live in poverty. (14% of seniors currently live in poverty anyway – recall the average benefit numbers listed above and imagine trying to live on that.)

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The Social Security Administration includes the following message on benefit statements: "Congress has made changes to the law in the past and can do so at any time. The law governing benefit amounts may change because, by 2034, the payroll taxes collected will be enough to pay only about 77 percent of scheduled benefits."

Workers pay into the system via payroll taxes and these taxes go into the pot to pay for current beneficiaries. These amounts don't balance perfectly each year, so the program runs a surplus or deficit.

The payroll tax that funds Social Security is capped each year and adjusted for inflation. Currently set to $128,400, wages over this amount are not taxed. Since most Americans make less than this amount, raising (or removing) the cap would have minimal impact on the average taxpayer.

Projected tax revenues over the next 75 years fall short of projected benefits by 2.66% of taxable payrolls. This deficit reflects several factors, including longer lifespans, reduced birthrates (current birthrates are historically low – we need a minimum birthrate to sustain population growth and have more taxpaying workers entering the system), and lower immigration (larger amounts of immigration could fill the gap created by lower birthrates, but that's also politically toxic, another third rail).

According to econofact.org, a 16% reduction in benefits would fix the shortfall for the next 75 years. This reduction could be accomplished by simply reducing benefits of current and future retirees (less likely, in my opinion) or raising the Full Retirement Age (FRA) for younger workers (such as yours truly, age 41) from 67 and stair-stepping it up to 70.

When the program started in 1935, benefits were set to begin at 65 with no option for getting benefits early. Early benefits were added for women in 1956 and then expanded to both sexes in 1961.

In 1983, the Social Security Act was amended to step up FRA to 66 and ultimately 67 for those born in 1960 or later.

Consider the average life expectancy for someone turning 65 in 1940 (the first year that payments were made) was about 13 years for men and 15 years for women. For a 65-year-old today it's 19 and 21 years, respectively. So, we're living longer and costing the system more.

Interestingly, Social Security's original FRA was 65, yet there doesn't seem to be a good reason that age was chosen. According to a Congressional research report, age 65 could have been picked because the administration at the time thought 60 too young and 70 too old, so they split the difference. Others indicate age 65 was chosen after lengthy analysis and deliberation. My guess is it's both and age, in this case, is just a number.

If you live for exactly how long government actuaries think, it doesn't matter much in terms of total lifetime benefits whether you start drawing benefits early (at age 62) or hold off until age 70 (when your benefits stop accumulating). If you plan to (or hope to) live longer, that's when you come out ahead by waiting to start drawing benefits.

For a variety of reasons most filers claim their benefits early. According to the same research report, almost 45% of folks filed early, right at age 62. You can see from the chart below that most others filed before FRA, and a relative few held out longer than that. You can guess at the motivation for each of the groups.

ssi filing age distribution

The problems associated with funding Social Security are political and apolitical. Political for the obvious reasons but apolitical because it's math and math doesn't care about politics. To summarize, the relatively simple fixes to fill the funding gap seem to be:

1. Allowing large amounts of additional (payroll tax-paying) immigration for a sustained period
2. Incentivizing every family in the U.S. to have another child soon and get them paying taxes as quickly as possible
3. Reducing Social Security benefits by 16%
4. Raising (or removing) the cap on wages subject to payroll taxes
5. Raising the FRA over time to 70 from 67

Which of these do you think is most likely? My vote is option 5, given that it seems simplest and would likely be an easier sell to the public. Other options include just borrowing more money from China and Europe, but let's hope it doesn't come to that.

Here's a link to the Congressional research summary:
https://fas.org/sgp/crs/misc/R41962.pdf

And here's a link to the econofact.org piece:
http://econofact.org/social-security-benefits-when-do-you-plan-to-retire

Have questions? Ask me. I can help.

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