The Independent Market Observer

4/23/13 – What Is the U.S. Spending Money On? (Part 2)

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Apr 23, 2013 12:04:42 PM

and tagged Economics Lessons

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Yesterday, we talked about how the opportunity cost of not spending on defense might in the end be greater than the spending. Today, I’d like to do the same for social security.

I don’t believe the case for spending is clear here, and I’m mindful of the weakness in the opportunity cost argument. After all, if I bought all of the great deals I get in my e-mail every day, I would be bankrupted by the savings. But that’s a different post.

Let’s go back to fundamentals for social security. Why was it created, and what were the conditions that applied at that time?

Social security was created in the middle of the Great Depression to solve a problem: elderly people, living in poverty, couldn’t work to alleviate their situation. It was structured so that existing workers would pay into a trust fund, which then would pay out benefits. At the time the system was set up, there were many more workers than retirees, for the simple reason that most people died before they could retire.

Looking at today’s system, a couple of critical differences exist. First, the elderly are no longer the poorest demographic cohort; rather, they are among the wealthiest. Second, people are living longer, so benefits are being extended for much longer. Third, with the change in the nature of work, from physically demanding to more office jobs, older people are increasingly able to and want to work longer. Finally, the demographic shifts since the creation of the system mean that far fewer workers are supporting each retiree.

To summarize, people need (in aggregate) the money less, they are living and working longer, and there are fewer people paying for it, but the system hasn’t really changed.

None of this is to minimize the very real benefit the present system provides to lower-income seniors, the original target. It is to say that the program’s actual beneficiaries are well in excess of what was originally planned.

What does this mean? In short, the existing program can (which isn’t to say should) be modified considerably and still meet its original goals. I doubt many people are actually in favor of letting the elderly live in poverty, but we can make substantial changes and still avoid that.

Driving the need for change, the current benefit system is unsustainable with the pending baby-boom retirement underway. We simply cannot afford our existing system, and, like it or not, changes will be made. We better make them in ways that are well thought out rather than rushed.

Much as with government finance as a whole, there are two options: raise more money or spend less.

To date, the focus has largely been on spending less, with the President’s proposal to lower (excuse me, revise) future CPI adjustments, and imposing what is essentially means testing on Medicare. Raising more money has also been introduced, though, with taxability of social security benefits up to 85 percent now. We have started the discussion, but the changes so far, including the proposed ones, don’t solve the problem.

I argued yesterday that military spending, by and large, is necessary. The case for social security spending, based on the original goals, is much less clear. As the program moves from surplus to deficit, the case for government borrowing to allow affluent, able-bodied retirees to play golf is not proven, to say the least.

What this means is that we can expect the programs to change. If I had to guess, I’d say means testing is the most likely way to cut spending, by limiting or eliminating benefits to seniors with incomes above a certain level. We have already seen something like this proposed for Medicare, so it’s not a stretch. Other probable changes include lifting the qualifying ages, which is already underway, and making it more difficult to qualify for other social security programs, such as disability. None of these compromise the program’s original goals, only the mission creep that has occurred in the subsequent decades.

People currently retired or getting very close have nothing to worry about, I expect, but people my age (47) or younger shouldn’t base their planning on the existing system. When asked, I say that I really hope I don’t get social security—because I expect when I retire that it will be means tested, and if I get benefits that means I’d have a much lower income than I hope to.

Ultimately, change in the programs will be necessary, and even good for the U.S. economy, but there’s no doubt it will also entail significant collateral damage. As I said, though, like it or not, something like this has to happen, so we should start planning for it now.

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