Social Security: Debunking the Debunking

When the Social Security Administration released its annual Trustees’ Report last week, I crunched the numbers to show that the fiscal burden of the program is projected to dramatically increase.

Payroll taxes are going to climb rapidly, but spending will grow even faster. As a result, the program’s long-run shortfall is now $61.7 trillion.

That’s a lot of money, even by the standards of our fiscally incontinent masters in Washington.

The good news is that the program’s fiscal problems are getting some attention.

The bad news is that some of the analysis is sloppy.

For instance, Michelle Singletary, who writes about personal finance for the Washington Post, has a column about Social Security.

Social Security is a critical program for millions of Americans, yet there is so much that people don’t understand. …Without any change in current law, the Old-Age, Survivors and Disability Insurance (OASDI) trust funds combined are projected to have enough revenue — including current reserves — to pay 100 percent of scheduled benefits on a timely basis only until 2035. …This news rightly rattles a lot of people. It also leads to fearmongering. …As the retirement program faces a funding shortfall, it’s time to retire…five common myths.

Debunking myths is a good thing.

And what she wrote about two of the myths (dealing with when to retire and whether politicians are in the system) is accurate.

Unfortunately, the other three require elaboration/correction.

Here’s what she wrote, followed by my analysis.

Myth No. 1: Social Security is, or will be, ‘bankrupt’: Social Security will not run out of money. The program is financed by payroll taxes, so as long as workers pay into the system, money will always come in. …It’s the Social Security Trust Funds’ reserves that are projected to become depleted. …The Old-Age and Survivors Insurance (OASI) program, which pays retirement and survivor benefits, will be able to pay 100 percent of benefits until 2033.Even if Congress fails to act, there will be enough projected income coming in to cover 79 percent of scheduled benefits.

Reality: I’m baffled that she wrote that “Social Security will not run out of money” and then a few sentences later admitted that there will only be enough income “to cover 79 percent of scheduled benefits.” Makes me wonder about her definition of bankruptcy. I’ll simply note that if Social Security was a private pension system providing annuities, the government would shut it down and probably arrest the people in charge.

Myth No. 2: Young adults won’t benefit from Social Security: 42 percent of adults ages 18 to 29 are “extremely worried” that Social Security will not be available when they become eligible. …Some proposed changes to the program could affect younger workers, such as raising the age when full benefits kick in. For anyone born in 1960 or later, full retirement benefits are payable at age 67. Because so many Americans rely on Social Security, it’s not going anywhere.

Reality: Once again, the author must be using some strange definitions. Yes, today’s young people will receive money from Social Security, so we can consider that a benefit. But the real issue is whether they receive net benefits. The answer is no when you consider all their payroll taxes. And the answer is a very emphatic no if you compare what they are promised from Social Security compared to what they would get if they instead had private retirement accounts.

Myth No. 4: The federal government has raided the Social Security Trust Funds: Think of the Social Security Trust Funds like your savings account… By law, every dollar of income coming into the Social Security Trust Funds is invested in interest-bearing securities backed by the full faith and credit of the United States… Yes, that money has been spent for other government needs, but that does not mean Social Security gets worthless IOUs… The securities held by the trust funds have always been honored, as have all other Treasury securities.

Reality: Fortunately, I don’t need to debunk her analysis. I can simply cite what the Clinton Administration wrote about the so-called Trust Fund back in 1999 (see page 337).

These balances are available to finance future benefit payments and other trust fund expenditures–but only in a bookkeeping sense. …They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.

As I noted back in 2016, “the Trust Fund is like putting IOUs to yourself in a college fund. When it’s time for junior to start his freshman year, you’ll have to find the money to cash those IOUs.”

Since Ms. Singletary writes about personal finance, she presumably understands that’s not a smart strategy for a family. So I’m puzzled why she thinks it’s a good approach for a government.

I’ll close by expressing disappointment that both Biden and Trump favor the status quo on Social Security, which is a recipe for massive future tax increases, massive future debt increases, and/or massive future money printing. Too bad they are unwilling to learn from Australia, Chile, Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden, all of which show that it is possible to fully or partially replace debt-based systems with savings-based systems.

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Social Security’s $61.7 Trillion Problem

The Social Security Administration has released the yearly forecast of the program’s long-run finances. Jut like I did in 2023, 2022, 2021, 2020, etc, it’s time to see what to expect in the future.

Based on the annual fiscal data in Table VI.G9 (which is adjusted for inflation), we can see that the fiscal burden of Social Security is expanding rapidly.

The spending burden is growing faster than the tax burden, which means ever-growing levels of red ink.

As I show in this next chart, annual deficits eventually will climb above $1 trillion and the total shortfall over the next 75 years is more than $61.7 trillion.

Sadly, neither Joe Biden nor Donald Trump are willing to address the program’s huge fiscal problems.

This is a matter of math, not ideology. The Washington Post editorialized yesterday about their head-in-the-sand approach.

President Biden and former president Donald Trump don’t agree on much, but both have pledged not to touch Social Security benefits. …Financial reality, though, is that if the programs aren’t reformed, and run out of money to pay required benefits, cuts could become unavoidable. …The 2024 campaign is probably not going to feature much honest debate about this, but the conversation has to happen sooner or later. Saving Social Security and Medicare requires reform. …These won’t be popular or painless, but, as even dithering lawmakers often admit privately, the longer change is postponed, the more painful it will be in the end. Or, as the trustees’ report puts it, “significantly larger changes would be necessary if action is deferred.”

Kudos to the Washington Post for acknowledging the problem. That’s good news.

The bad news is that the editors think massive tax increases are the way to fix the problem.

My view is that we should not copy Europe. The right approach is entitlement reform, which would include shifting to a system of personal retirement accounts.

The transition to such a system would not be easy, especially since we have been kicking the can down the road. But Australia, Chile, Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden show that it is possible to fully or partially replace debt-based systems with savings-based systems.

P.S. Amazingly, some politicians want to expand Social Security and make America’s fiscal problems even worse.

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Blame Government, Not Free Enterprise

In 2021, I shared a cartoon strip about a worker blaming capitalism after losing his job following an increase in the minimum wage.

One month ago, I shared a meme with a similar message. It showed the European Central Bank investigating supposedly mysterious price increases when the ECB’s bad monetary policy obviously deserves the blame.

(A similar meme was used in a different column in 2021 about higher minimum wages.)

Today, let’s look at another example of free enterprise being blamed for problems caused by government.

Heather Long of the Washington Post opines about young people not being big fans of free markets. Here’s some of what she wrote.

…why Americans under 40 are so disillusioned with capitalism. …Young people in America have come of age during the Great Recession, the sluggish recovery that followed and then the coronavirus pandemic. Unemployment has been 10 percent or higher twice in the past 15 years. …shore up Social Security. …Young people have seen the headlines that, if nothing changes, Social Security will start having to reduce benefits in 2034. …a better way to ensure that Social Security will be there for younger generations is to raise taxes slightly on corporations and the wealthy. …Young Americans have had a harsh introduction to capitalism. …a wise place to start would be to give workers a secure retirement again, starting with Social Security.

There are two major flaws in her analysis.

First, the 2008 financial crisis was not the fault of capitalism. It was bad monetary policy and foolish Fannie Mae/Freddie Mac subsidies. And while I don’t particularly blame government for the pandemic, it also would be absurd to blame capitalism for the accompanying economic troubles.

Second, it’s even more absurd to assert that Social Security is good for young people. Those are the people who are getting a terrible deal from the program. And even if young people aren’t directly hit by the author’s proposed tax increases, they will indirectly suffer as the economy gets weaker.

Since Ms. Long was writing an opinion column, I reckon we can’t say that her piece is an example of media bias. But she deserves a booby prize for poor analysis.

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Fiscal Patriotism

Given what I recently wrote about America’s long-fun fiscal outlook, it is easy to understand why I expressed pessimism as part of a conversation with David McIntosh of the Club for Growth.

The presidential candidates are a big reason for my dour outlook. Joe Biden and Donald Trump have chosen to ignore  the massive long-run fiscal problems with Social Security and other entitlement programs.

Their kick-the-can-down-the-road approach is a recipe for fiscal chaos in the future. The result would be either massive tax increases, massive debt increases, or massive money printing.

Probably all three.

Given the track record (Barack Obama and Hillary Clinton both embraced big tax increases), I’m not surprised that Biden and congressional Democrats are bad on the issue.

And since Trump is a big-government populist rather than a Reaganite, his approach also is predictable.

But I have wondered whether congressional Republicans would take the same head-in-the-sand approach.

Fortunately, it appears many of them have – as I noted in the above interview – a more patriotic perspective. Andrew Biggs of the American Enterprise Institute wrote about a new budget proposal from the House Republican Study Committee. Here are some excerpts.

To the RSC’s credit – and, honestly, to my own surprise – the RSC took on the dangerous issue of reforming Social Security, standing up not only to Democrats looking to demagogue the issue but to former President Trump’s efforts to duck the issue. The RSC’s proposals “include modest and delayed changes to the Primary Insurance Amount PIA) benefit formula, the retirement age, auxiliary benefits for high income earners, and gradually moving towards a flat benefit.” If you don’t want the biggest tax increase in history, those are the sorts of things you have to do. …cheers for the RSC: They’ve stood up to Congressional Democrats by at least putting a plan on the table. And, more importantly, they’ve stood up to Donald Trump’s position that Social Security reform can be ignored or hand-waved away.

If you want to learn more about the Republican Study Committee’s plan, click here and here.

It also includes Medicaid reform and Medicare reform.

So kudos to the RSC members. They want to do what’s best for the nation, even if it means exposing themselves to demagoguery.

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Mexico’s Irresponsible Populist President Proposes Election-Year Giveaway

I’ve written many columns about Venezuela, Chile, and Argentina, but only one column specifically about Mexico.

Since I’m currently in Mexico City doing some meetings and research about Mexico’s economic policy, time to make up for that lack of attention.

The first thing I did when preparing for my trip was the check the IMF’s database to see what’s been happening to the burden of government spending.

Sadly, policy has moved in the wrong direction ever since leftist/populist President Andrés Manuel López Obrador (AMLO) was elected in 2018.

That’s the bad news.

If you’re waiting for me to share some good news, that’s not going to happen.

Instead, I’ll augment the bad news with some worse news.

Mark Stevenson of the Associated Press reported two days ago that “AMLO” has a new vote-buying scheme that would be economically ruinous.

Mexico’s president said Monday he will propose guaranteeing people pensions equal to their full salaries at the time they retire, something done by no other country, not even those much richer than Mexico. It…has almost no hope of getting passed in the eight months he has left in office, but which could be part of a bid to attract voters in the June 2 presidential elections. …In announcing the measures Monday, the president claimed it was an attempt “to recover holy rights, guaranteed to Mexicans by God.” It was among a package of reforms that included guaranteed annual increases in payments to the elderly and increases in the minimum wage and above the rate of inflation. …To cover the whole population with something approaching a ‘full wage,’ López Obrador’s program would have to increase the Afore pension fund by 2.5 times to meet the median wage, and then double it again to cover informal workers.

This is spectacularly bad policy. It makes Biden’s costly per-child handout scheme seem cheap by comparison.

Almost every nation in the world is in fiscal trouble because of aging populations and falling birthrates.

Responsible governments are trying to figure out how to curtail old-age entitlements.

AMLO, however, cares about buying votes rather than about Mexico’s economic future.

P.S. As you might expect, the tax-free bureaucrats at the Organization for Economic Cooperation and Development have been recommending huge tax increases in Mexico. But if AMLO’s proposal is ever enacted, even the pro-tax bureaucrats in Paris would be hard pressed to propose enough tax hikes to keep pace with that radical expansion in the burden of government.

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The Case for Entitlement Reform, Part II

I periodically explain why and how to fix entitlements.

Here’s my latest attempt, as part of a conversation with David McIntosh of the Club for Growth.

A few months ago, I shared some alarming CBO data about the ever-growing burden of  government.

But rather than regurgitate that data, let’s look at the most-recent Financial Report of the United States Government, published each year by the Treasury Department.

There are dozens of tables and graphs in the report, but this excerpt from the executive summary captures the magnitude of America’s fiscal challenge.

At the risk of understatement, $79 trillion is a lot of money.

That number should be scary, but it’s probably not scary enough, because “PV” refers to “present value.”

So what the report is really saying is that we would need to set aside an extra $79 trillion of revenue today to cover the entitlement promises of politicians over the next 75 years.

And that’s far more than twice the size of the entire economy.

This is why I keep pointing out there we face an unavoidable choice of doing something good (entitlement reform) or doing something bad (massive tax increases).

By the way, the report also contains this table, which basically shows the cost of kicking the can down the road.

It shows that the Biden-Trump policy will increase future pain.

Do they not care because they are very old? Do they not care because of “public choice.” Do they not care because of limited cognitive ability?

I don’t know. But I know that both Trump and Biden are doing something that will cause America to become a European-style welfare state. And that won’t be good for national prosperity.

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Why Is Someone at AEI Proposing a Massive Tax Increase to Finance Ever-Growing Government, Part I?

Serious and responsible people (in other words, not Trump or Biden) know that Social Security has a massive long-run problem.

A fast-growing number of seniors are expecting future benefits but only a slow-growing number of workers will be paying into the system.

But even if this demographic problem didn’t exist, there is the underlying flaw of a retirement system based on tax-and-spend (or debt-and-spend) rather than wealth accumulation.

The solution is obvious.

We need to shift to a system based on personal retirement accounts.

The transition to a modern system will be expensive, to be sure, but not nearly as costly as the $60 trillion-plus burden of propping up the current system.

But some people prefer the more-expensive option.

Andrew Biggs of the American Enterprise Institute and Alicia Munnell of Boston College want to divert a massive amount of money from the private sector to the government, and they want to do it by double-taxing the money Americans have in retirement accounts.

Here are excerpts from their new report.

The U.S. Treasury estimates that the tax preference for employer-sponsored retirement plans and IRAs reduced federal income taxes by about $185-$189 billion in 2020, equal to about 0.9 percent of gross domestic product. …it actually offers policymakers an opportunity to strengthen the nation’s retirement income system. Revenues saved from repealing the retirement saving tax preferences could be reallocated to address the majority of Social Security’s long-term funding gap. …an opportunity to use taxpayer resources more productively. …the case is strong for eliminating the current tax expenditures on retirement plans, and using the increase in tax revenues to address Social Security’s long-term financing shortfall. …Tax expenditures for employer-sponsored retirement plans are expensive – costing about $185 billion in 2020. … reducing tax expenditures for retirement plans could be an effective way to help address other pressing demands on the federal budget, such as Social Security’s financing shortfall.

By the way, it is no exaggeration to say the authors “want to divert a massive amount of money” to politicians over the next decade. Based on the Congressional Budget Office’s latest 10-year forecast, 0.9 percent of GDP is about $3 trillion.

It’s not just that the authors want to prop up a system that needs reform.

They also want to undo provisions in the tax code (IRAs and 401(k)s) that allow people to protect themselves against two layers of tax on income that is saved and invested.

It’s also laughable that the report states that a huge tax increase will “use taxpayer resources more productively.” If higher taxes to fund bigger government was a good idea, Europe’s welfare states would be richer than the United States rather than way behind.

Even the title of the Biggs-Munnell study is offensive. It implies that taxpayers are getting a handout or favor if politicians don’t impose double taxation. At the risk of understatement, being taxed one time rather than two times is not a subsidy.

P.S. The better option is a shift to retirement systems based on private savings, like the ones in Australia, Chile, Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

P.P.S. Biggs and Munnell are misguided for wanting a big tax increase to prop up a bankrupt system. That’s the bad news. The worse news is that some people want to expand the bankrupt system. And they are proposing tax increases that arguably would cause even more economic damage.

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A Primer on Marginal Tax Rates, Part III: Hidden Taxes

In Part I of this series, we explained why marginal tax rates matter.

In Part II, we emphasized that low marginal tax rates are important.

Today, in Part III, let’s consider the role of payroll taxes, especially hidden payroll taxes.

To be more specific, governments often hide part of these levies (sometimes known as social insurance taxes) by ostensibly imposing them on employers.

Yet labor economists universally agree that workers actually bear the burden of those taxes. Simply stated, they are part of total labor cost, as illustrated by this chart.

The chart comes from a study on marginal tax rates, which was written by Cristina Enache and published by the Archbridge Institute.

The study has all sort of data and analysis on marginal tax rates, but let’s focus on the sneaky way that politicians try to hide the full burden of payroll taxes from workers. And we’ll cite what she wrote about the U.S. system.

In the United States, the marginal tax wedge spikes are driven by local and central income taxes, payroll taxes, and tax credits such as Earned Income Tax Credit (EITC) and Child Tax Credit (CTC). A U.S. worker earning $47,845 costs their employer $51,812. The employer cost includes the taxes the employer has to pay on the worker’s wages. While the average tax wedge for this worker is 6 percent, the worker faces a significant marginal tax rate spike on even a small wage increase. If the employer increases compensation by just $678, this would increase the employee social security contribution by $48, employer social security contribution by $48, local government income tax by $43, and reduce central government income tax credit by only $90. The net earnings increase is $448. This U.S. single parent with two children faces a marginal tax wedge of…34 percent.

There’s a very important economic observation about the difference between the 6 percent average tax rate and the 34 percent marginal tax rate.

It’s the latter (and higher!) rate that determines the incentive to work more hours and be more productive.

But for today, let’s focus on different numbers. In the above example, the worker thinks that his or her “gross earnings/gross wages” are $47,845, but the “total labor cost” to the employer is $51,812 because of all the payroll taxes that supposedly are paid by the business.

And in Cristina’s example, she looks at what happens if the employer decides to increase total compensation by $678. The main takeaway is that the worker gets a much smaller number, just $448.

And one reason why the number is much smaller is because of the $48 of payroll tax paid by the worker and the $48 supposedly paid by the employer. But notice that the real-world impact of both taxes is to reduce the worker’s take-home pay.

In other words, there is a bigger wedge – i.e., a bigger marginal tax rate on earning more money and being more productive.

This probably seems very wonky, so I’ll conclude with a very practical observation. When you look at your pay stub, or your W-2 statement for the past year, you’ll see a section for “FICA” withholding.

That’s the payroll taxes that the government grabbed out of your paycheck. But remember that the government forced your employer to pay an equivalent amount of money on your behalf. In other words, your FICA tax burden is twice as large as you’re being told.

Simply stated, Uncle Sam is deceptively taking a slice of your income before it even gets to your gross pay.

When private businesses mislead consumers about costs, they can be sued or prosecuted. When politicians do the same thing to taxpayers, they pat themselves on the back for being clever.

P.S. Payroll taxes are not as damaging as income taxes, but that’s hardly an endorsement. Such levies still discourage work and entrepreneurship.

P.P.S. Politicians also are deceptive about dividend taxes. In an honest (and sensible) system, dividend payments would include an acknowledgement that those monies already were hit by the 21 percent corporate tax. In other words, unambiguous double taxation, but politicians hope that voters are not aware that there are two layers of tax.

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Demographic Doom and the Welfare State

Many nations face a slow-motion fiscal crisis because of demographics.

To be more specific, politicians last century created welfare states and social-insurance systems that take money from workers in order to provide pensions and health care to old people.

Those decisions were misguided (compared to market-based approaches), but the math sort of worked. After all, everyone assumed there would be population growth, meaning there would always be enough future workers to support future retirees.

But the world has changed. Dramatically.

Let’s look at some data from a column in the New York Times by Dean Spears, who teaches at the University of Texas.

We’ll start with this chart showing that the world’s population will peak in 2085 and then dramatically decline.

Why will the world’s population shrink?

Because birthrates have plummeted. Many nations already have reached “below-replacement fertility” and others will reach that level in the near future.

There’s nothing wrong with lower levels of fertility, of course. Families should be as big or small as people want them to be.

But lower levels of fertility have a profound impact on social-insurance systems, as explained in Part I and Part II.

Let’s go to the Population Pyramid website and examine two countries.

We’ll start with the United States, since nearly 80 percent of my readers are American. As you can see, the USA had a population pyramid back in 1964, meaning plenty of working-age people and not that many old people to subsidize.

But that ratio is dramatically different in 2023 and it will change even more by 2050. With very grim fiscal consequences.

Let’s also take a look at Italy, since it is often viewed as a nation facing big demographic challenges.

The most shocking takeaway is that the population pyramid from 1964 is morphing into an upside-down pyramid.

So what can politicians do in response? There are three options.

1. They can try to cajole or bribe people to have more kids (i.e., more future taxpayers), but those policies don’t seem to be very effective – even in place such as Hungary.
2. They can impose massive tax increases on lower-income and middle-class households, which is the approach that is implicitly embraced by Trump and Biden.
3. They can shift to retirement systems based on private savings, like Australia, Chile, Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

The right answer should be obvious, though some politicians want to make the crisis worse.

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Political Drama: French Welfare State Showdown

I wrote last week about President Macron’s very modest effort to slow down the growth of the welfare state and started with a chart showing that France has the highest overall burden of government spending in the developed world.

The good news (relatively speaking) is that France is in third place, based on this chart from the OECD, when looking at the burden of government-provided retirement benefits.

To be sure, having the third-highest burden of retirement spending is hardly something to celebrate. And it is not exactly a big achievement to be slightly less worse than Greece and Italy.

This is why President Macron is pushing to increase the retirement age from 62 to 64.

But French voters and French lawmakers have an entitlement mentality and Macron’s initiative was faltering. So the government used executive authority to unilaterally impose the law.

Needless to say, this has triggered a lot of outrage. Here are some details from an article by Rich Noack in the Washington Post.

The French government used its executive powers Thursday to raise the retirement age to 64 and avoid a vote on an unpopular bill, outraging lawmakers who could retaliate with a no-confidence motion… Two-thirds of the French public have opposed the plans, and within minutes of Borne announcing the law’s adoption, demonstrators assembled near Parliament for their ninth day of mobilization, with some of them clashing with authorities. …Macron has been pushing for changes to the country’s pension system since he was elected in 2017… France has a lower minimum retirement age than many of its European neighbors… Germany, for instance, is preparing for an increase in the retirement age from 65 to 67, and lawmakers there have faced little public backlash. …Macron and his allies argue that the retirement age needs to reflect that increase if the country wants to preserve a welfare system that relies on a sufficiently large base of working-age contributors.

Here’s a chart from the article to show the excesses of the French system.

The Wall Street Journal opined this morning on the controversy.

The political difficulty of reforming pensions in Western democracies has been on display in France, with strikes and mass protests against Emmanuel Macron’s modest pension reform. …Give Mr. Macron credit for persistence—and political brass. …Thursday Prime Minister Elisabeth Borne invoked Article 49 of the French constitution, which enabled the Macron government to strong-arm a bill through the National Assembly without a vote. The National Assembly’s remaining recourse to block reform is to pass a motion of no confidence. That would block the legislation, oust Ms. Borne, and dissolve the government. …The opponents are on the populist left and right, including his presidential opponent in 2022, Marine Le Pen, who accused Mr. Macron of choosing “to govern with brutality” and called for Ms. Borne’s ouster. The cold reality is that France needs reform because its pay-as-you-go pension system is unsustainable. The retirement age is 62, one of the youngest in Europe, and Mr. Macron would stretch it only to 64 with some exceptions. The worker-to-retiree ratio has shrunk to 1.7 to 1 from 3 to 1 in 1970. French pensions already consume 14% of the economy.

The second-to-last sentence of the above excerpt deserves some emphasis.

Back in 1970, there were three workers (taxpayers) for every retiree. Now the ratio if 1.7 workers to every retiree, and that situation is going to get much worse over the next few decades (the same problem of demographic change exists in the United States).

So the real-world choice is reform or bankruptcy (especially since taxes already are maxed out).

P.S. Macron’s reform is better than the status quo, but it would be far better to shift to personal retirement accounts – which is something that has happened in dozens of nations.

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Biden and Trump Should Learn from Sweden’s Social Security Reform

Some American politicians, such as Joe Biden and Donald Trump, are very much opposed to dealing with Social Security, even though the current system has a massive $56 trillion cash-flow deficit.

For all intents and purposes, both the current president and his predecessor want to kick the can down the road, which surely is a recipe for massive future tax increases and may cause drastic changes to promised benefits.

Given their advanced ages, they probably won’t be around next decade when the you-know-what hits the fan.

But the rest of us will have to deal with a terrible situation thanks to their selfish approach.

Other nations are more fortunate, with leaders who put the national interest above personal political ambition.

Johan Norberg has a new column in the Wall Street Journal about how Swedish lawmakers adopted personal retirement accounts and undertook other reforms to strengthen their pension system.

President Biden refuses to consider any reforms, and so do many Republicans. But that won’t save the program; it’ll doom it. …Sweden faced the same problem in the early 1990s. The old pay-as-you-go pension system had promised too much. With fewer births and longer lives, projections showed the system would be insolvent a decade later. …Its politicians chose not to deceive the voters. …In 1994 the Social Democrats agreed with the four center-right parties to create an entirely new system based on the principle that pensions should correspond to what the beneficiary pays into the system—a system in which the contribution, not the benefits, is defined. …Sweden introduced partial privatization of the kind the American left derides as a Republican plot… The Swedish government withholds roughly 2.3% of wages and puts it into individual pension accounts. Workers are allowed to choose up to five different funds in which to invest this money…the average Swede has made an impressive average return of roughly 10% a year since its inception in 1995, despite the dot-com crash, the financial crisis and the pandemic. …Sweden’s pension system was recently described as the world’s best by the insurance group Allianz, based on a combination of sustainability and adequacy.

Back in 2018, I wrote about Sweden’s pension reforms, and I cited a study I co-authored back in 2000 for the Heritage Foundation.

Readers who want to learn more about the details of the Swedish system should read those publications.

For purposes of today’s column, though, let’s zoom out and see how Sweden’s system compares to other nations.

We’ll start by looking at a report by Mercer and the Chartered Financial Analyst Institute, which compared retirement systems in 43 developed countries. You can click here to view the full report and full rankings, but let’s focus on the United States and Sweden.

As you can see, Sweden beats America in every category, including a giant lead for integrity.

It’s also worth noting that Sweden is above average in every category while the United States is below average in two of the three categories.

Based on the Mercer/CFA report, we know Sweden’s system is good for workers.

But what about taxpayers?

Here’s a table showing the fiscal burden of old-age programs in European nations, taken from a report by the International Monetary Fund.

As you can see for both the present and the future, Swedish taxpayers face one of the lowest burdens, with old-age spending consuming significantly less than 10 percent of economic output.

I’ll close with a couple of very important observations about the international data.

• Sweden is not the top nation in the Mercer/CFA report. It trails Australia, Denmark, Iceland, Israel, Netherlands, and Norway – all of which have systems that are fully or partly based on mandatory private savings.
• Sweden does have the lowest spending burden in the IMF. The Baltic nations all do better – and all of those countries have systems that are partly based on mandatory private savings.

It’s almost as if there’s a lesson to be learned, even if Biden and Trump want to bury their heads in the sand.

P.S. Here’s my short video making the case for personal retirement accounts.

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The Adverse Economic Consequences of Busting Social Security’s Wage Base Cap

Today we are going to look at proposals to expand the burden of Social Security payroll taxes, and let’s start by recycling this 2008 video.

All of the analysis in the video is still accurate, but two of the numbers need to be updated.

• Social Security’s long-run deficit is now $56 trillion rather than $24.9 trillion as was the case back in 2008.
• Social Security payroll taxes now apply to income up to $162K rather than $102K as was the case back in 2008.

If you don’t have time to watch a 9-minute video, I can summarize the issue by noting that Social Security was designed as an “earned benefit,” which means workers contribute to the system in exchange for future benefits. The more you earn, the more you pay, and the more benefits you receive.

But because Social Security is supposed to be akin to an insurance program, there’s a limit on both the amount of benefits any retiree can receive and the amount of taxes that any worker must pay (the same principle applies in many other nations).

Some politicians want to get rid of the limit (the “wage base cap”) on the amount of taxes workers must pay. Instead of applying the 12.4 percent Social Security payroll tax on the first $162,000 of income, they want to impose the tax on all income.

In some cases, they want this big increase in marginal tax rates in order to prop up the Social Security system while in other cases they actually want to expand the program.

In either case, the economic consequences would be very bad.

In today’s Wall Street Journal, Travis Nix explains why this would be counterproductive.

…lawmakers in both parties are mulling the idea of lifting the payroll tax cap. The resulting increase in revenue would do little more than delay the inevitable by extending the program’s life a few more years. …European countries cap payroll taxes at much lower incomes than the U.S. does. Germany caps payroll taxes for health insurance at about $62,000 and the Netherlands caps theirs for social security at $40,370. Uncapping the payroll tax in the U.S. would only widen the disparity and make America a less attractive country in which to work and invest. …Uncapping the payroll tax would raise the top tax rate on Americans’ labor income—income and employee payroll tax combined—to as high as 43.2%. This excludes state taxes and the employer payroll tax, which make the rate even higher. The U.S. hasn’t seen labor tax rates that high since before Ronald Reagan. …European countries that cap their payroll taxes at relatively low incomes understand that you can’t fund a social-safety net without providing an incentive to work. The U.S. should too.

Let’s also look at what Mark Warshawsky of the American Enterprise Institute wrote last year.

…imposing a massive tax increase — 12.4 percentage points — on the earnings of about 10 million highly productive, mostly middle-class workers earning more than $160,200 would have several notable consequences. It would reduce their support for the program, severely discourage their labor market participation, and encourage payroll tax avoidance through converting earnings to incentive stock options and other forms of employee stock ownership. …In many instances, these workers would have their wages taxed at federal, state and local levels at rates exceeding 70 percent. …almost 20 percent of current and future covered workers are projected to earn above the taxable maximum in any one year.

And here is some of Allison Schrager’s analysis from 2020.

When it comes to financing the future of Social Security, many Democrats have a simple and wrong solution: lift the cap on earnings subject to the payroll tax. …there are costs to these plans. A 12.4% marginal tax increase is significant. If the cap is eliminated, an individual who makes $250,000 a year would see their Social Security tax liability increase by 88%. …many households—especially those in states with high state taxes—will be paying more than 60% in federal, state, and local income and payroll taxes… only 6% of the population earns more than the cap. But income varies over people’s lives: 36% of Americans will be in the top 5% of earners at least one year of their career.

I’ll close by observing that it we’ve had big fights under Bush, Obama, Trump, and Biden about whether the top personal income tax rate should go up by about 3 percentage points or down by 3 percentage points.

Since keeping marginal tax rates low helps encourage productive behavior, those were important fights.

Now we face a fight that should be far more important since some politicians want to raise the marginal tax rate by 12.4 percentage points.

It is true that Social Security is in deep financial trouble, but propping up (or expanding) the current system would be bad news for the economy and it would produce a bleaker future for young people.

It would be far better to begin a transition to personal retirement accounts.

P.S. Chile and Australia have created personal retirement accounts. You can also learn about reforms in Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

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Donald Trump Supports Massive Tax Increases on Middle-Class Americans, Part I

Copying some self-styled national conservatives, Donald Trump this week endorsed major tax increases on lower-income and middle-class Americans.

But he embraced huge tax increases in an indirect fashion.

• He did not say “let’s adopt money-siphoning value-added taxes” like they have in Europe.
• Nor did he say “let’s impose very high income tax rates on ordinary people” like they do in Europe.
• And he didn’t say “let’s have much higher payroll tax rates” like they have in Europe.

Instead, Trump embraced huge tax increases by default. He told congressional Republicans to ignore America’s slow-motion crisis of entitlement spending.

For all intents and purposes, that is the same as embracing huge tax increases.

To be more specific, if you endorse European-style government spending, you are necessarily and unavoidably endorsing European-style tax policy.

And that’s what Trump did. Here are some excerpts from a report in the Hill by Brett Samuels.

Former President Trump on Friday urged Republicans in Congress not to cut “a single penny” from Medicare or Social Security… “Under no circumstances should Republicans vote to cut a single penny from Medicare or Social Security…,” Trump said in a recorded video statement posted to Truth Social. …The former president’s message about protecting Social Security and Medicare is consistent with his previous comments on the issue as a candidate in 2016.

For what it’s worth, I’m not surprised at what Trump said.

He favored big government as a candidate in 2016 and he expanded the burden of spending when he was President.

But some of us don’t want to surrender and doom the United States to European-style economic stagnation.

Which is why I’ve decided to take a sentence I wrote last month and turn it into the 15th Theorem of Government.

Here’s the bottom line: Genuine patriots recognize America has a problem and they have the courage to advocate reforms that will actually solve the problem.

It will be interesting to see how many Republicans fit that definition.

P.S. I’m not a never-Trumper or anti-Trumper. For instance, I praised his tax policy and said nice things about his record on regulation. But I’m loyal to ideas, not to people, so I don’t hesitate to criticize any politician who pushes ideas that are bad for America.

P.P.S. Here are the other 14 Theorems of Government.

• The “First Theorem” explains how Washington really operates.
• The “Second Theorem” explains why it is so important to block the creation of new programs.
• The “Third Theorem” explains why centralized programs inevitably waste money.
• The “Fourth Theorem” explains that good policy can be good politics.
• The “Fifth Theorem” explains how good ideas on paper become bad ideas in reality.
• The “Sixth Theorem” explains an under-appreciated benefit of a flat tax.
• The “Seventh Theorem” explains how bigger governments are less competent.
• The “Eighth Theorem” explains the motives of those who focus on inequality.
• The “Ninth Theorem” explains how politics often trumps principles.
• The “Tenth Theorem” explains how politicians manufacture/exploit crises.
• The “Eleventh Theorem” explains why big business is often anti-free market.
• The “Twelfth Theorem” explains you can’t have European-sized government without pillaging the middle class.
• The “Thirteenth Theorem” explains that people are unwilling to pay for bloated government.
• The “Fourteenth Theorem” explains how poor people are hurt by big government.

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Macron’s Pension Reform Is Necessary (but Inadequate)

It is an understatement to declare that fiscal policy in France is terrible.

• The highest burden of government spending in Europe.
• The third-highest level of pension spending in the OECD.
• One of the biggest long-run fiscal gaps in OECD countries.
• The fourth-highest tax burden on workers in the OECD.
• The sixth-highest top tax rate among developed nations.

In recent years, France has had terrible presidents such as Nicolas Sarkozy and Francois Hollande.

But when Emmanuel Macron took over, I wondered whether he might push the nation in the right direction.

And he has pushed a few good ideas. But his achievements have been so meager that I was only half-joking when I wrote last year that his reelection meant that a socialist beat a socialist.

But maybe I’ll have to apologize for that column because Macron is pushing reforms to the country’s pay-as-you-go pension system.

In a column for CNN, David Andelman summarizes the plan and explains the motives.

…the French government announced plans to raise the official retirement age from 62 to 64 to qualify for a full pension. …The French budget risks floundering on pensions that are siphoning off nearly 14% of the nation’s GDP each year – roughly twice the drain than in the United Sates and behind only Italy and Greece in Europe. …Currently, all men and women in France can retire with full pensions at 62 – tied with Sweden and Norway for the lowest retirement age in western Europe. …there are special exemptions dating back to the time of Louis XIV. After performing on the stage for 10 years, actors of the Comédie Française…are entitled to claim a lifetime pension. This dates to the company’s creation in 1680. Dancers in the Paris Opera can retire with full pension at the age of 42, a custom that dates to 1689… Stagehands at both companies can still take their retirement at 57. Then there are train conductors who can bow out at age 52. …In all, there are at least 42 different pension schemes… “The French can count on our determination to block this unfair reform,” said Marine Le Pen, leader of the far-right National Rally party, who Macron defeated in the presidential elections last April. At the other end of the spectrum, Mathilde Panot, from the far-left France Insoumise (France Unbowed) party tweeted that the plan was “archaic, unfair, brutal, cruel.”

Meanwhile, the Wall Street Journal opined last week in favor of Macron’s reform.

France currently has 42 different government-funded pension programs, which vary in retirement age and payout. Mr. Macron wants to wind down some of these programs and transition more French workers to a general pension scheme. That would make it easier for workers to change jobs, and it would also be a step toward a fairer pension system. This job mobility point is crucial and would benefit most workers and employers. …the French system scored a D grade, or 40.9 out of a possible 100, on financial sustainability on the Global Pension Index 2022, created by the consulting firm Mercer… The French system is a pay-as-you-go model in which current workers fund retiree pensions. Yet today there are only 1.7 workers for each retiree, compared to 3-to-1 in 1970 and headed to 1.4-to-1 by 2050. …Nothing short of French economic vitality is at stake. Mr. Macron twice won the Presidency with a vision of a more energetic, entrepreneurial France with more opportunity for young people. A more rational pension system is an essential part of the project.

The WSJ editorial is correct. Macron’s reform would give France a “more rational pension system.”

But it would not give the country a good pension system.

Macron is basically asking workers to pay more and get less. And it is true that his plan will prop up the government’s tax-and-transfer, pay-as-you-go scheme.

But that’s like patching the roof of a rotten house.

What France really needs is genuine reform so that younger workers can shift to a system of private savings. Which is something that already exists to varying degrees in other European nations such as Switzerland, Sweden, Denmark, and the Netherlands.

But don’t hold your breath waiting for that to happen.

P.S. Back in 2010, France went through political turmoil to raise the retirement age from 60 to 62.

P.P.S. Sadly, most of the flaws of France’s government retirement system are the same as the ones that exist in the United States.

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America’s Looming Entitlement Crisis

Back in July, I made the case for the right kind of entitlement reform in a discussion with the folks at Live and Let Live.

Today, I want to underscore why it is important to focus on “the right kind” of reform.

On paper, you can save money with “means testing” of benefits, but that creates an indirect penalty on work, saving, and investment.

You can also, on paper, save money by imposing price controls on health care, but that policy has a long track record of failure.

At the risk of understatement, either of those approaches represents “the wrong kind” of entitlement reform. Indeed, those policies are not really reform. Instead, they are tinkering with systems that are fundamentally broken.

For what it is worth, most politicians do not support good reform or bad reform.

As predicted by “public choice,” their preferred approach is kicking the can down the road.

Which is what Greek politicians did for many years.

But they learned in Greece that ignoring a problem does not make it disappear. Instead, it is a recipe for fiscal crisis (and we will probably have to re-learn that lesson in Italy).

So my other goal today is to show why something needs to be done.

We’ll start with a look at Medicare from Brian Riedl’s chartbook.

That’s a very sobering image, so now I’ll share some very sobering words.

James Capretta of the American Enterprise Institute summarizes America’s grim fiscal future.

In 2001, the Treasury estimated the government’s net unfunded liabilities, in present value terms, at $6.5 trillion, or 61 percent of GDP, with federal debt accounting for $3.3 trillion of the measured obligations. …By 2021, the government’s net position had deteriorated to minus $29.9 trillion, or 128 percent of GDP, with federal debt accounting for $22.3 trillion of the liabilities. The government’s unfunded commitments beyond public debt had grown by $2.9 trillion over ten years. …The financial hole is actually deeper than these numbers reveal because they exclude the dramatic effects of Social Security and Medicare. …with Social Security and Medicare included in the assessment, the federal government’s unfunded liabilities in 2021 are $93.1 trillion, or nearly 400 percent of annual GDP. That compares with $11.1 trillion as calculated in the 2001 Treasury report, which was 105 percent of GDP. …The problem posed by unfunded public liabilities is a relatively new one in U.S. history. It has only been over the past half century that the combination of an aging population and the modern entitlement system has pushed the federal government toward a financial crisis.

Having shared all this depressing data, I’ll now close with a couple of observations.

• First, doing nothing almost surely guarantees massive future tax increases. Including European-style levies like a value-added tax that will be very bad news for lower- income and middle-class taxpayers.
• Second, “funded liabilities” are hardly an improvement over “unfunded liabilities” since that simply means debt-financed spending becomes tax-financed spending. From the frying pan to the fire, or vice-versa.

As I said in the above video, we need the right kind of entitlement reform so that we save money and have better policy for old people and poor people.

P.S. Entitlements are a ubiquitous problem in developed nations.

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The Case for Entitlement Reform, Part I

If Joe Biden’s bungled economic policy is any indication, the GOP may wind up controlling Washington in the not-too-distant future.

If so, I hope Republicans rekindle their interest in the kind of genuine entitlement reform discussed in this interview.

But I’m not sure whether to be optimistic or pessimistic.

On the plus side, the GOP supported pro-growth entitlement reform during the Obama years.

On the minus side, the party largely punted on the issue once Trump took over.

To be sure, punting is the easy route from a “public choice” perspective. Politicians like offering freebies to voters and many voters like getting handouts.

However, that approach means America’s economy is weakened by an ever-growing burden of federal spending and eventually is plunged into fiscal crisis.

And that’s based on the programs that already exist. Joe Biden wants to expand the welfare state with even more entitlements!

The Wall Street Journal editorialized about the downside of making America more like Europe last October.

The result of…expanded entitlements is likely to be reduced incentives to work and invest, slower economic growth, lower living standards, and less fiscal space for essential public goods like national defense. That’s the lesson from Europe’s cradle-to-grave welfare states… Europe’s little-discussed secret is that its cradle-to-grave welfare states are financed by the middle class via value-added and payroll taxes. The combined employer-employee social security tax rate is 36% in Spain, 40% in Italy and 65% in France. Value-added taxes in most European economies are around 20%. There simply aren’t enough rich to finance their entitlements.

Amen. I’ve repeatedly warned that a European-sized welfare state would mean European-sized taxes on lower-income and middle-class Americans.

And what’s remarkable (and discouraging) is that some politicians in the U.S. want to expand entitlements even though many European governments now realize they made big mistakes and need to scale back.

The irony is that some European governments have tried to reform their tax and welfare systems to become more competitive. Germany and Sweden over two decades reformed their welfare and labor policies. …Other European governments are also pushing welfare-state reforms. French President Emmanuel Macron has passed pension reform and cut the corporate tax rate to 26.5% from 33% in 2017… Greece is pulling out of its debt trap with Prime Minister Kyriakos Mitsotakis’s tax, pension and regulatory reforms.

For what it’s worth, I’m happy about these reforms, but I fear many European nations are in the too-little-too-late category.

Why? Because the demographic outlook is deteriorating faster than reform is happening. In other words, most of them are probably destined to suffer Greek-style fiscal crises.

But if (or when) that happens, maybe American politicians will finally wake up and realize we need good reforms to prevent Social Security, Medicare, and Medicaid from causing a similar collapse on this side of the Atlantic Ocean..

Hopefully that epiphany will take place before it is too late for the United States.

P.S. For those who are interested in the history of fiscal policy, John Cogan of the Hoover Institution wrote about pre-20th-century entitlements earlier this year.

Here are excerpts from his column in the Wall Street Journal.

The history of U.S. entitlements is a 230-year record of continuous expansion… The first major entitlement, Revolutionary War disability benefits, was initially restricted to members of the Continental Army and Navy who were injured in battle and survivors of those killed in wartime. Eligibility was then expanded, first to state militia soldiers, then to veterans whose disabilities were unrelated to wartime service, and eventually to virtually all people who served during the war regardless of disability. Civil War disability pensions followed the same…process, except on a far grander scale. Pensions were initially confined to U.S servicemen who suffered wartime injuries and survivors of those killed in battle. Eventually they were extended to virtually all union Civil War veterans regardless of disability. …Congress followed the same liberalizing process with 20th-century entitlements.

If this excerpt doesn’t satisfy your curiosity, here’s Cogan discussing the topic for 46 minutes.

P.P.S. Not all entitlement reform is created equal.

P.P.P.S. Here an informative chart if you want to know whether to blame defense spending or entitlement spending.

P.P.P.P.S. I always argue in favor of a Swiss-style spending cap, which presumably would force politicians to address America’s entitlement problem.

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Social Security’s Ever-Closer Fiscal Crisis

As part of my recent appearance on The Square Circle (we discussed Uvalde police, gun control, and Ukraine), I said that the new Social Security numbers were the under-reported story of the week.

For more details, I was referring to the latest Trustees Report, published yesterday by the Social Security Administration.

Most people, when that annual report is released, focus on when the Social Security Trust Fund runs out of money. But since the Trust Fund only contains IOUs, I view that as a largely irrelevant number.

Instead, I immediately look at Table VI.G9, which shows how much revenue is being collected and how much money is being spent every year.

Here is that data displayed in a chart. The left side shows actual fiscal numbers from 1970 to 2021 while the right side shows the projections between 2022 and 2100.

As you can see in the chart, revenues going into the system (the blue line) are growing rapidly.

But you also can see that Social Security spending (the orange line) is expanding even faster.

And when spending grows faster than revenue, one consequences is more red ink.

This next chart shows that annual deficits between now and 2100 will total $56 trillion.

At the risk of understatement, these two charts should be very sobering. Especially since they only show the taxes, spending, and red ink for Social Security.

If we also add the fiscal aggregates for other entitlement programs, it would be abundantly clear why we face a “crisis” and a “train wreck.”

So how do we solve this mess. I’ve written about the needed reforms for Medicare and Medicaid, so let’s focus today on Social Security.

The ideal approach is to take the current pay-as-you-go entitlement and turn it into a system of personal retirement accounts.

Many nations around the world have adopted this approach, most notably Chile and Australia.

But as I noted two years ago, there will be a big “transition” challenge if the United States decides to modernize.

P.S. I mentioned “public choice” at the end of that clip. You can click here to learn more about the economic analysis of political choices.

P.P.S. I mentioned that Chile and Australia have created personal retirement accounts. You can also learn about reforms in Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

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China’s Far-Too-Little Pension Reform

In the make-believe country of Libertaria, there is no such thing as Social Security or any other type of government-mandated retirement policy.

In the real world, however, most nations have created “pay-as-you-go” retirement schemes based on taxing young workers to give benefits to old retirees.

That’s the bad news.

The good news is that a growing number of nations have created personal retirement accounts based on private savings. These “funded” systems are designed to replace and/or augment the government programs.

People who study these issues often refer to “three pillars” that represent the various potential sources of retirement income.

1. Payments from mandatory government tax-and-transfer programs like Social Security in the United States (Pillar One).
2. Payments from mandated private retirement accounts, such as those in places such as Australia and Chile (Pillar Two).
3. Payments from voluntary private savings, such as the funds put in IRAs or 401(K)s in the United States (Pillar Three).

In our libertarian fantasy world, everyone would use option #3 and there would not be options #1 and #2.

In a libertarian-ish world, everyone would use option #2 with option #1 only as an emergency back-up.

A few days ago, I saw a headline that got me excited. I thought China was joining the libertarian-ish world by shifting from a pay-as-you-go government system to mandatory private savings (going from option #1 to option #2). Here are some excerpts from a Nasdaq report.

The China Security Regulatory Commission (CSRC) announced the launch of the first private pension plan due to anticipated economic challenges with an aging population. …the CSRC said that pension money “can provide more long-term, and stable funds to develop the real economy, via capital markets.” …This program was created to add additional resources for China’s aging population. In 20 years, 28% of China’s population will be more than 60 years old, up from 10% today, according to the World Health Organization.

But as I read more details, I learned that China was keeping its government system and simply adding an option #3.

Public pensions are currently in place in China; both employees and employers have contributed fixed amounts under state pension plans. …Private pensions are seen as an additional program to state pension plans. Employees can contribute up to 12,000 yuan ($1,860) per year. Contributions will be eligible for tax breaks.

Since people already had the ability to save money, this is hardly an earth-shaking development.

To be sure, it seems like Chinese workers will not have their saving subject to any double taxation if they use these new pension vehicles, so I suppose that deserves some applause.

But it would be much more exciting and praiseworthy if the Chinese government (which has been backsliding in recent years) had proposed some something far bolder.

P.S. To understand why I’m not optimistic about China, here’s my summary of the nation’s post-World War II economic history.

P.P.S. And if China takes advice from either the IMF or OECD, I’ll be even less optimistic.

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Chile Election Week, Part III: Death Knell for the Private Pension System?

One reason I’m interested in Chile’s election is that the leftist candidate, Gabriel Boric, wants to eviscerate the nation’s successful private pension system.

Bettina Horst of Libertad Y Desarrollo gave me her analysis.

As an economist and Executive Director of the nation’s pro-market think tank, Ms. Horst understands that Chile’s system has helped workers by giving them real ownership of real assets.

And that’s much better than “pay-as-you-go” systems, like we have in the United States.

Chile’s private retirement accounts have enabled workers to build nest eggs, and the system has also provided a valuable source of capital for the nation’s economy.

So why would Chile’s voters consider a candidate like Boric, who wants to wreck that system?

We’ll find out Sunday night after the votes are counted, but a Boric victory would indicate that Chile’s workers decided to trust the free-lunch promises of a politician.

In a column earlier this year for the Wall Street Journal, another Chilean weighed in on this issue.

Axel Kaiser of the Atlas Research Network wrote that the left has a (long-standing) ideological agenda.

In 1981 Chile became the first country to privatize social security, ending the pay-as-you-go system that had been in place since 1924 and had collapsed. Now Chile’s left wants to resurrect it. …Last year a group of senators even introduced a bill to nationalize the pension funds, as Argentina did in 2008. An expropriation of workers’ savings looks increasingly likely, as the radical left dominates Chile’s recently elected constitutional convention. “The destruction of the AFP system is under way,” a far-left lawmaker recently said. …The attack on the AFP system is all about ideology and power. …Its destruction has long been a goal of the radical left. With the AFP out of the picture, politicians will recover the power they once had over retirees.

That’s Mr. Kaiser’s political analysis.

His column also includes some analysis of the economic benefits of the private system.

The state-run pension system was plagued by corruption and rent-seeking… Pension privatization reversed this perverse dynamic. Instead of taxing active workers to pay pensioners through the bureaucracy, the new system, created by former Labor Minister José Piñera, established that 10% of the employee’s salary is transferred automatically to an account under his name at one of the Administradoras de Fondos de Pensiones, or AFP. These private pension funds compete to attract workers and invest their pensions for a fee. …By subsequently relying on workers’ own savings to fund their pensions instead of taxing younger workers, privatization of social security ended dependency across generations. …Average pensions are also 41% higher in the AFP system than in the old one, according to the Libertad y Desarrollo research center, even as workers contribute a smaller fraction of their salaries. Between 1981 and 2019, the savings accumulated in workers’ accounts at the AFP reached $218 billion, or around three-quarters of GDP. About 70% of these funds weren’t contributions made by workers but profits generated for them by AFP investments. This accumulation of capital contributed an extra 0.5% of GDP a year to economic growth between 1981 and 2001.

As mentioned in the column, Jose Pinera created Chile’s system of personal retirement accounts.

You can click here to see him describing the case for private accounts, both in Chile and the United States.

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The Real (and Growing) Problem with Social Security

In an ideal world, Americans would have personal retirement accounts, just like workers in Australia, Sweden, Chile, Hong Kong, Israel, Switzerland, and a few dozen other nations.

But we’re not in that ideal world. We are forced to participate in a Ponzi Scheme known as Social Security.

By the way, that’s not necessarily a disparaging description. A Ponzi Scheme can work if there are always enough new people in the system to pay off the old people.

But because of demographic changes (increasing lifespans and decreasing birthrates), that’s not what we have in the United States.

And this is why Social Security faces serious long-run problems.

How serious? The Social Security Administration finally released the annual Trustees Report. This document has a wealth of data on the program’s financial condition, and Table VI.G9 is where the rubber meets the road.

As you can see from this chart, there will be an ever-increasing burden of Social Security taxes and spending over the next 75 years. And these numbers are adjusted for inflation!

The good news (relatively speaking) is that the economy also will be growing over the next 75 years, both in nominal terms and inflation-adjusted terms.

The bad news is that spending on Social Security will grow at a faster rate, so the program will consume a larger share of the economy’s output.

And because Social Security spending is growing faster than the economy (and also faster than tax revenue), this next chart shows there is going to be more and more red ink in the future. Once again, you’re looking at inflation-adjusted data.

As indicated by the chart’s title, the cumulative shortfall over the next 75 years is nearly $48 trillion. That’s a lot of money, even by Washington standards.

And with each passing year, the problem seems to worsen. The 75-year shortfall was $44.7 trillion according to the 2020 report and $42.1 trillion according to the 2019 report.

I’ll conclude by observing that today’s column focuses on the big-picture fiscal problems with Social Security.

But let’s not forget the program’s second crisis, which is the fact that Americans are deprived of the ability to enjoy much higher levels of retirement income.

Certain groups are particularly harmed by this aspect of the current program, including minorities, women, older workers, and low-income workers.

P.S. Our friends on the left argue that the program’s fiscal problems (the first crisis) can be solved with tax increases. Perhaps that is true, but it will mean a weaker economy and it will exacerbate the second crisis by forcing workers to pay more to get less.

P.P.S. I once made a $16 trillion dollar mistake on national TV when discussing Social Security’s shaky finances.

P.P.P.S. Much of the news coverage about the Trustees Report has focused on the year the Social Security Trust Fund supposedly runs out of money. But this is sloppy journalism since the Trust Fund has nothing but IOUs (as illustrated by this joke).

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Social Security’s Inevitable Decline

It’s understandable that we’re now paying a lot of attention to Joe Biden’s risky proposals for higher taxes and a bigger welfare state.

After all, it’s a very bad idea to copy the economic policies of nations such as Italy, France, and Greece (unless, of course, you want much lower living standards).

But let’s not forget that that the United States also has some big economic challenges that existed before President Biden ever took office.

Most notably the entitlement programs.

Medicaid and Medicare are the biggest problems, but let’s focus today on Social Security.

Richard Rahn has a column in the Washington Times that summarizes the program’s grim outlook. Here are some excerpts.

Politicians love to talk about the Social Security “trust fund” and assure us that it will not be raided.  But the unfortunate fact is the “trust fund” is an accounting fiction without any real assets. In actuality, Social Security is a giant Ponzi scheme operated by the government. Benefits that are paid to existing retirees come from the current taxes from those working today and borrowing. …But now, Americans have fewer children, and life expectancies are growing rapidly. …There is no easy way out.  Future Social Security benefits will be cut (probably by not fully indexing for inflation), and/or taxes will be greatly and continuously increased until the system collapses.

The fact that Social Security is a Ponzi scheme isn’t necessarily fatal. After all, the government has the ability to coerce new workers into the system.

The problem is that there are fewer and fewer of those new workers to support the growing number of people getting benefits.

Here are the numbers from Richard’s column. As the old saying goes, read ’em and weep.

Richard ends his column by fretting that the United States is on a dangerous path.

The world has seen this play before.  In 1906, Argentina on a per-capita income basis was one of the richest countries in the world, rivaling the United States.  It has bountiful agricultural and mineral resources and had a relatively well-educated population of mainly European origin.  But after a century of fascist/socialist/welfare-state governments, it is now a poor country.  Venezuela went from a rich country with civil liberties to a poor oppressed country in only two decades.  As Margaret Thatcher famously said, “the problem with socialism is that eventually, you run out of other peoples’ money.”  The Greeks built a nice welfare state, largely using German taxpayers’ money – the Euro – until the Germans said, “no more.”  As a result, the Greeks have seen a drop in real incomes of more than 30 percent in seven or so years.

The good news is that our economic policy won’t be nearly as bad as Argentina and Venezuela, even if some of Biden’s crazy ideas – such a massive per-child handouts – are enacted.

The bad news is that we could become a lot more like Greece.

And that’s where Margaret Thatcher’s famous warning could become an American reality.

There is a solution to this problem, by the way. It’s been implemented in a couple of dozen nations around the world.

Sadly, American politicians are more interested in making the problem worse (with predictable consequences).

P.S. Here are a couple of humorous items about Social Security.

The first one actually understates how bad the trade is because workers actually pay 12.4 percent of their income into the program (the so-called employer share simply means lower pre-tax pay).

And the second item points out that Bernie Madoff was an amateur.

P.P.S. If you want more jokes and cartoons about Social Security, click here. There are other Social Security cartoons here, here, and here. And a Social Security joke if you appreciate grim humor.

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The Looming Crisis of Demographic Decline and Entitlement Expansion

There are many compelling economic arguments against entitlement programs.

• They discourage savings.
• They discourage work.
• They are funded with taxes.
• They are funded with debt.

Since I’m a libertarian, I also have moral concerns about tax-and-transfer programs.

Today, though, let’s address the big problem of entitlements and demographics, especially with regards to social insurance programs that transfer money from young people to old people (most notably Social Security and Medicare).

But I’ll start by acknowledging that demographics doesn’t have to be a problem. When nations first created such programs, they generally had “population pyramids” featuring a few old people, lots of working-age people (i.e., taxpayers), and then an even greater number of children (future workers and taxpayers).

As illustrated by this image, entitlement programs can be sustainable with that type of demographic profile.

But there’s been a big shift in demographics in developed nations.

Simply stated, we’re living longer and having fewer kids. In some sense, population pyramids are becoming population cylinders.

And this creates major challenges for entitlement programs because instead of there being many workers supporting just a few retirees, you wind up with “old-age dependency ratios” that require very onerous tax burdens (or very high levels of government borrowing).

I’ve already written how this is a big problem for the United States.

Indeed, I periodically cite long-run forecasts from the Congressional Budget Office to warn about the worrisome fiscal implications.

And I’ve also noted that Japan is in serious trouble.

Today, let’s look at some recent data to show that Europe is another part of the world where this problem is acute.

The European Commission published its 2021 Ageing Report late last year and there are three visuals that deserve attention.

First, here’s a look at the European Union’s population cylinder (or maybe an upside-down pyramid).

And here’s a table that compares the number of old people with the working-age population in 2019, 2045, and 2070.

At the bottom of the table, I’ve circled in red the averages for the eurozone (nations using the single currency) and the entire European Union. From the perspective of fiscal policy, these are horrific numbers.

But there are numbers that are even worse.

Our final visual is a table showing the economic dependency ratio, which the European Commission defines as “… the ratio between the total inactive population and employment. It gives a measure of the average number of individuals that each employed person ‘supports’ economically.”

Once again, I’ve circled the averages at the bottom of the table.

The bottom line is that most European nations already have a stifling fiscal burden, yet it’s all but certain that there will be even higher taxes and more government spending in the near future.

Which means more economic stagnation for Europe (and those of us in America face that possibility as well).

At the risk of stating the obvious, there is a solution to both Europe’s woes and America’s woes. Simply stated, there needs to be genuine entitlement reform.

That means “pre-funding,” which is the jargon for mandatory private savings, presumably augmented by some form of safety net.

Singapore is probably the world’s leading example for mandatory savings, while Australia, Denmark, Chile, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden are a few of the many other jurisdictions that have fully or partially shifted to systems based on real savings.

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The Destabilizing Mix of Demography and Entitlements, Part I

I’ve written many times about demographic change and the implications for public policy – both in the United States and around the world.

Simply stated, it will be increasingly difficult to maintain tax-and-transfer entitlement programs in societies where people are having fewer children and people are living longer.

I’m raising this issue because I spoke on this topic earlier today at an e-symposium organized by Trends Research in Abu Dhabi, UAE. Here’s a slide with my main message.

Why is it bad news from an economic perspective?

As I noted in the next slide, tax-and-transfer entitlement programs for the elderly (most notably Social Security and Medicare in the United States) become harder to finance when there are lots of beneficiaries and too few taxpayers to support them.

So what’s going to happen in various nations when the irresistible force of more beneficiaries meets the immovable object of fewer taxpayers?

In my presentation, I pointed out that there are only three potential solutions.

• More taxes – A policy that Barack Obama, Hillary Clinton, and Joe Biden explicitly have embraced.
• More debt – A policy that politicians such as Donald Trump have implicitly embraced.
• Entitlement reform – A policy that some Republicans supported in the pre-Trump era.

I explained that higher tax burdens and higher debt levels would not be economically prudent.

The right approach is genuine entitlement reform, but I freely admitted that this “pre-funding” model probably won’t happen.

Here’s the relevant slide.

By the way, Singapore is the role model for pre-funding, but many other nations have adopted that approach for retirement income (such as Israel, Denmark, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden).

Unfortunately, most nations are heading for a demographic iceberg (including the U.S.) but I fear few of them will enact the reforms that are needed to avert a bad outcome.

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Israel’s Shift to Private Social Security

What’s the best economic news of the past 40 years?

• Was it Reaganomics, which restored America’s economic vitality?
• Was it the collapse of the Soviet Empire, which freed many nations from communist tyranny and allowed at least some of them to successfully shift to markets?
• Was it partial economic liberalization in China, which lifted hundreds of millions of people out of severe poverty?

Those are all good choices, but let’s not overlook Israel.

This chart from Economic Freedom of the World shows that economic freedom dramatically expanded in that nation between 1980 and 2000 (and has since gradually risen).

Israel’s shift away from the voluntary socialism of the kibbutz has paid big dividends. The nation has become far more prosperous.

I’ve already written how Israel benefited from supply-side reduction in tax rates.

Today, let’s learn about the country’s shift to private social security.

To find out what happened, let’s look at some excerpts from an article in Economics and Business Review. Authored by Moshe Manor and Joanna Ratajczak, it starts by observing there’s been a global shift to private social security systems.

The first paradigmatic shift towards a private pension system was performed in Chile in 1981 and had its followers in Latin America… The Chilean example inspired the World Bank to propose that such a shift should become a key element of the pension reform for postsocialist countries… The shift towards private pension schemes was assumed to meet demographic challenges and the secondary goals of the pension system, especially economic growth accomplished thanks to an acceleration of domestic savings.

This has been a very positive development for the countries that made the shift, by the way.

But let’s focus specifically on the reform in Israel. Here’s some of what the authors wrote.

Israel…abandoned a controlled economy and introduced the market economy only in the last three decades. …In the last 30 years Israel has faced many reforms of the pension system as part of broader economic reforms. …the stabilization programme allowed the Ministry of Finance (MOF) to start a series of structural changes, including pension reforms… The reasons for the reforms were not strictly economic but they also were based on neoliberal economic beliefs, political motives and international relations. …The USA feared Israel’s possible economic collapse and requested that the Israelis execute reforms designed according to Milton Friedman’s neoliberal principles in order to gain American economic support.

For what it’s worth, I’m in favor of “neoliberalism” when it’s defined as pro-market (which seems to be the case in many parts of the world).

Here’s a description of how the reform moved the country from a defined benefit model (often unfunded) to a funded defined contribution model.

The pension reforms were intended to stabilize the system and prepare it for the future difficulties such as ageing and poverty relief; they were also meant to develop the capital market and reduce the burden on the state budget. The main steps included introduction of the mandatory private pension pillar.. The reforms also eliminated PAYG for new joiners and turned the system from actuarially imbalanced, DB…to actuarially balanced, DC, privately managed and invested in capital markets. …The comparison of the reforms in Israel and those in Chile…shows a large similarity: shutting down the PAYG system to new joiners; a shift to funds which are privately managed, DC type, invested in capital markets system; a mandatory pension in the second pillar; development of the local capital markets using the pension accumulation; reduction of government involvement in pensions and of the burden on the state budget.. The main differences encompass low contribution rates in Chile that led to low net replacement rates, while in Israel the contribution rates and net replacement rates are high.

Oddly, the article never states how much of a worker’s paycheck goes to mandatory savings (i.e., the contribution rate).

So here’s a blurb from a recent report by the Organization for Economic Cooperation and Development.

Since January 2008, mandatory contributions have applied to earnings up to the national average wage for all employees… Initially the rates were modest with a total contribution of 2.5% but increased to 15% (5% from employees and 10% from employers) by 2013. In 2014 the contribution rate increased further to 17.5% (5.5% from employees and 12% from employers)and since January 2018 increased to 18.5% (6% from employees and 12.5% from employers). Six percentage points out of the employers’ contribution provides severance insurance which, if utilised, diminishes the pension.

That is a significantly higher level of mandated private savings when compared to countries such as Australia and Chile.

Sadly, the United States isn’t part of that conversation since we’re still stuck with our actuarially bankrupt Social Security scheme.

P.S. While researching this column, I read the OECD’s recent Survey about Israel’s economy. The bureaucrats in Paris groused that there’s a lot of inequality and poverty in that country.

This set of data perfectly illustrates why the OECD is an untrustworthy and biased bureaucracy.

As noted by my Eighth Theorem of Government, it should focus on economic growth to reduce poverty rather than fixating on whether some people are getting richer faster than others are getting richer.

Speaking of which, the supposed poverty data doesn’t actually measure poverty. Instead, “relative poverty” is simply the share of people are below “50% of median household income,” which the OECD then dishonestly characterizes as a measure of poverty (this is how the OECD came up with the absurd claim that there’s more poverty in the United States than in comparatively poor countries such as Turkey and Portugal).

Ironically, the same OECD report admits that Israel is out-performing other developed nations.

Israel is growing faster, as you can see, while also reducing government debt at a time when it’s going up in other countries (I’m sure coronavirus has since wreaked havoc with the Israeli economy, but that’s also true for other OECD countries).

Yet the OECD can’t resist grousing about inequality and lying about poverty.

P.P.S. Shifting back to social security reform, here are some of the other nations (beside Israel, Chile, and Australia) that now benefit from private savings instead of empty political promises: Denmark, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden.

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Everything You Need to Know about America’s Future Entitlement Crisis

Before our depressing discussion today about the fiscal impact of entitlement programs (Social Security, Medicare, Medicaid, EITC, Food Stamps, welfare, and Obamacare, etc), here’s a video of how it all began.

I think this is a great introduction to the issue, particularly since you learn how “public choice” (i.e., politicians engaging in self-serving behavior) played a key role in the development of today’s welfare state.

But if you don’t have the time to watch a long video, here are four key things to understand.

1. Entitlements (budget geeks sometimes use the term “mandatory spending”) are programs that automatically give people money if they meet certain requirements (such as reaching a certain age or having income below a certain level).
2. Since these programs automatically give people money, they are not part of the annual appropriations process (the “discretionary spending” parts of the budget that are determined on a yearly basis).
3. Some entitlement programs are “means tested” and designed to funnel money to low-income individuals. This type of spending is sometimes referred to as “unearned benefits.”
4. Some entitlement programs are “social insurance” since people pay specific tax in exchange for specific benefits. This type of spending is sometimes referred to as “earned benefits” (though in many cases recipient receive much more than they paid).

By the way, there’s one additional thing to understand.

Indeed, it may be the most important thing to understand if you care about America’s fiscal and economic future.

5.  Entitlement programs are a slow-motion fiscal train wreck.

Let’s look at a new study authored by James Capretta of the America Enterprise Institute. He also has some sobering observations on the history of entitlement programs.

The growing expense of entitlement programs has occurred steadily for more than a half century and is reflected in the shifting distribution of federal spending activity. …by the early 1960s, two-thirds of all spending continued to require approval by the House and Senate appropriations committees each year, and less than a third was spent on entitlement programs. … By 2019, nearly two-thirds of all spending in the budget was for entitlement programs, and less than a third went to annually appropriated accounts.

If you prefer this information visually, here are a couple of pie charts from the study.

While there are dozens of entitlement programs, the big three are Social Security, Medicare, and Medicaid.

The largest entitlement programs are Social Security, Medicare, and Medicaid. Together, they now make up nearly half of all federal spending. Their combined growth over the past half century is the primary source of intensifying fiscal pressure. …In 2019, combined federal spending on them was 9.8 percent of GDP, up from 3.7 percent in 1970. CBO expects them to cost 17.2 percent of GDP in 2050, which is almost equal to the average annual revenue collected by the federal government from 1970 to 2019.

And here’s how they’ve been consuming ever-larger shares of America’s economic output.

What’s driving this ever-increasing fiscal burden?

In part, it’s because we have more and more old people and they are living longer.

So what does all this mean?

Capretta points out that uncontrolled entitlement spending may lead to a debt crisis.

I don’t disagree, but I think that’s a secondary concern. The real problem is that government spending will become an ever-larger economic burden. And that will hinder growth whether it’s financed by borrowing or taxes.

Speaking of taxes, here’s the chart from the study that deserves our close attention. It shows the relationship between demographics, benefit generosity, and tax burdens.

Here’s how Capretta describes the relationship.

…for each of the stipulated replacement rates (25, 50, and 75 percent), the tax rate necessary to keep the program solvent rises with increases in the aged dependency ratio. This explains why social insurance taxes in many aging societies have been increased to high levels in recent decades.

I’ve taken the liberty of augmenting the chart to show how these factors interact (though the order of #1 and #2 doesn’t matter).

The bottom line is that the United States is on track to become a high-tax, European-style welfare state if fiscal policy is left on autopilot.

In other words, unless there’s genuine entitlement reform, future Americans will be condemned to lower living standards.

P.S. Here’s some more history. In a column for the American Institute for Economic Research, Richard Ebeling looked at British history to explain how the private sector played a role in social insurance before being displaced by government.

Throughout the 19th century, a primary means for the provision of what today we call the “social safety nets” was by the private sector outside of government. The British Friendly Societies were mutual assistance associations that emerged to provide death benefits for the wives and children of the breadwinner who had passed away. But they soon offered a wide array of other mutual insurance services, including health care coverage, retirement pension programs, unemployment insurance, savings clubs to purchase a family house, and a variety of others. …by the end of the 19th century around two-thirds to three-quarters of the entire British population was covered by one or more of their programs and insurances. The research also discovered that a large majority of the subscribers were in the lower income brackets of the time… What stands out is that these were all private and voluntary associations and exchanges, in which the government paid little or no role.

On a related note, here’s an excellent short video on the English “poor laws” from the 1800s.

P.P.S. In addition to the fiscal burden of entitlement programs, there’s also a major problem in the way these programs discourage work.

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The Economic Consequences of Expanding Pay-as-You-Go Social Security Systems

Despite the fact that Social Security is an ever-increasing fiscal burden with a 75-year cash-flow deficit of nearly $45 trillion, many politicians in Washington have been trying to buy votes with proposals to expand the program (Barack Obama, Hillary Clinton, Bernie Sanders, Elizabeth Warren, etc).

A new working paper from the European Central Bank gives us some insights on what will happen if they succeed.

Authored by Daniel Baksa, Zsuzsa Munkacsi, and Carolin Nerlich, the study look at the long-run impact of related policies in Europe, using Germany and Slovakia as examples.

Here’s their description of the study.

In view of the adverse macroeconomic and fiscal implications of ageing, many European countries have implemented significant pension reforms… More recently, however, the reform progress has stalled, and despite an unchanged demographic outlook, several European countries reversed, or plan to do so, parts of their previously adopted pension reforms. In this paper we offer a framework that allows us to evaluate the macroeconomic and fiscal costs of pension reform reversals. …By using a general equilibrium model with overlapping generations we can account for feedback effects between changes in pension parameters, pension expenditures and macroeconomic variables. …The model is calibrated for Germany and Slovakia.

Before sharing their findings, here’s a look at how demographics are a ticking time bomb for Europe.

The yellow dots are the 2016 numbers for the old-age dependency ratio (the number of people over 65 compared to the 15-64 working-age population) and the red dots show how that ratio will deteriorate by 2070 (the numbers for the United States are similarly grim).

These bad numbers mean that Europe’s economic outlook will worsen over time.

…population ageing has adverse macroeconomic and fiscal implications. …the results show an increase in the public debt-to-GDP ratio by around 100 percentage points until 2070, compared to the initial period, for both Germany and Slovakia. Moreover, real GDP per capita is projected to decline by almost 14% in Germany and 9% in Slovakia, compared to the initial period.

But it’s possible for the numbers to get better or worse, depending on changes to public policy.

…similar to other studies we find evidence that pension reforms help to contain the adverse implications of ageing… In particular, increases in the retirement age appear to help to alleviate ageing pressures most. …we find strong evidence for the presumption that reversals of pension reforms are potentially very costly. In fact, reform reversals would not only result in higher aggregate pension expenditure and public debt-to-GDP ratios, but would in most cases also exacerbate the adverse macroeconomic impact of ageing.

Unfortunately, public policy is now trending in the wrong direction. Here’s what’s been happening in Germany and Slovakia.

Germany recently decided to cap the decline in the benefit ratio and the increase in the contribution rate until 2025 at certain levels, and is considering whether to extend this cap even until 2040. Slovakia decided to break the automatic link between changes in life expectancy and retirement age, by capping the retirement age at 64 years. …in the reversal scenario for Germany we freeze the benefit ratio at its current level of 48% and assume that the contribution rate would not exceed the threshold of 20% until 2040. With this reform reversal scenario we assume that the agreed freeze of the benefits ratio and contribution rate until 2025 will be ex-tended until 2040. In Slovakia, we assume the retirement age to stop increasing from the year 2045 onwards.

And what do they find when countries backtrack on reform?

Here’s what they estimated in Germany.

For Germany, we find that the reform reversal would imply sizeable costs (see Table 6, column “reform reversal”). Specifically, by 2070, the increase in the public debt-to-GDP ratio can be expected to be ceteris paribus almost 60 percentage points higher than under the baseline scenario, as a result of higher pension expenditures, adverse feedback effects and lower contribution rates.

For those interested, here’s Table 6, which I’ve augmented by highlighting in red the most relevant changes. Yes, the debt increases compared to the baseline, but I think it’s equally important (if not more important) to see how young people are hurt and how the burden of government spending goes up.

Now let’s see what the authors found for Slovakia.

…we quantify the fiscal costs of the reform reversal in Slovakia by comparing the debt impact under the reform reversal scenario with that under the baseline scenario. Our results show that such a reform reversal would be very costly. In fact, the increase in the public debt-to-GDP ratio would be more than 50 percentage points higher than the estimated increase of around 100 percentage points of GDP under the baseline scenario (see Table 7).

Here’s Table 7, and again I have highlighted in red the increase in debt as well as the data showing additional harm to young people and a much bigger increase in the burden of government spending.

So what do these findings mean for the United States?

Let’s explain using a homemade infographic. I’ve put four options for Social Security on a spectrum. Here’s what they mean.

• “Expand Social Security” means more taxes and spending in pay-as-you-go systems that are already costly and out of balance.
• The “Status Quo” is a typical pay-as-you-go-system (where the United States is now and where Germany and Slovakia were before their reforms).
• “Conventional Reform” means trying to stabilize a pay-as-you-go system by demanding that workers pay more while promising to give them less (what Germany and Slovakia did).
• The most market-friendly position is “Personal Retirement Accounts,” which transforms creaky pay-as-you-go systems into real individual savings.

Here’s the infographic, including arrows to indicate that some options mean more government and others mean more prosperity.

What Germany and Slovakia did was move from “Status Quo” to “Conventional Reform.” But now they’re backtracking on those reforms and shifting back to the old version of the “Status Quo.”

In other words, a move in the direction of “More Government” and the European Central Bank’s study shows such a step will have negative consequences.

In the United States, by contrast, some folks on the left want America to move from “Status Quo” to “Expand Social Security.”

Like Germany and Slovakia, we’d be moving in the wrong direction. But the damage for the U.S. presumably would be worse because we didn’t first take a step in the right direction.

P.S. If you want to learn more about the best option, Australia, Denmark, Chile, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden are a few of the many jurisdictions that have fully or partially shifted to systems based on real savings.

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New Numbers Confirm Social Security’s Dismal Fiscal Outlook

When I put forth the “The Case for Social Security Personal Accounts” in early 2011, I pointed out that the program’s long-run fiscal shortfall was more than $27 trillion.

We should be so lucky to have that problem today.

The Social Security Administration just released the annual report on the program’s finances, so I went to to Table VI.G9 of the “Supplemental Single-Year Tables” to peruse the yearly projections for future revenue and spending (which are adjusted for inflation so we have a more accurate method for comparisons).

The bad news is that an ever-increasing amount of our income is going to be grabbed by payroll taxes. The worse news is that Social Security’s spending burden will climb at an even-faster rate (historical data to the left of the red line, future projections to the right of the red line).

For those who focus on the less-important issue of red ink, the gap between revenue and spending over the next 75 years is projected to reach $44.7 trillion.

The gap in this year’s report is not directly comparable to the number I cited in 2011, but there’s no question the program’s finances are heading in the wrong direction.

This is partly because Social Security – as a “pay-as-you-go” program – is very vulnerable to demographic changes.

Like other types of Ponzi Schemes, it can work so long as there are always more and more new people entering the system.

But America’s demographic profile is changing. We’re living longer and having fewer kids.

In a column for the Foundation for Economic Education, Daniel Kowalski has a summary of how the program works and why it has a grim future.

Social Security recipients are not paid with the money that the government deducted directly from them and their past employers. Instead that money was used to pay the benefits for past retirees, while current retired recipients are getting their money through Americans who are currently working and contributing to the system. …the first recipients of the Social Security program took out far more than they put in with the difference being made up by the fact that active workers then greatly outnumbered beneficiaries. In 1940 this was not an issue as there were 159 workers supporting one beneficiary. …By 1960, 15 years after President Roosevelt’s death, that ratio was reduced to 5 workers for every beneficiary. In 1980, the ratio dropped to just above three and in 2010 it dropped below that. …there is one thing that Millennials and Generation Z can do to prepare themselves for that day. Start saving and planning for retirement now and make a plan that does not count on a government-issued Social Security check.

He’s right, and his column doesn’t even address the other problem for young people, which is the fact that they get a rotten deal from the program, paying in record amounts of money in exchange for hollow promises of a meager monthly benefit.

By the way, the numbers in the two charts above are based on the Social Security Administration’s “intermediate” assumptions.

I’ve never had any reason to question the reasonableness of those numbers. But in a world with coronavirus, which is causing crippling short-run economic damage and could cause significant long-run harm, it may be more prudent to look at SSA’s “high-cost” assumptions.

The bottom line is that the program’s long-run shortfall could be more than $20 trillion higher.

And remember, these numbers are in 2020 dollars. In other words, adjusted for inflation.

So how do we solve this mess? How do we avoid a grim fiscal future?

Shifting to a system of personal retirement accounts would be the most prudent approach. Yes, there would be an enormous transition cost since we would need to pay benefits to current retirees and many older workers, but that transition cost would be less than the $44.7 trillion unfunded liability (or even more!) of the current system.

I’ve written many times about the benefits of personal accounts for the United States, but I find most people are more interested in real-world evidence. Here are just a few of the several dozen nations that either fully or partially utilize private savings instead of political promises.

• Australia
• Denmark
• Chile
• Switzerland
• Hong Kong
• Netherlands
• Faroe Islands
• Sweden

P.S. Some folks in Washington want to exacerbate Social Security’s fiscal burden by expanding the program.

P.P.S. I hate to add to the bad news, but the long-run finances for Medicare and Medicaid are an even-bigger problem.

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Michael Bloomberg and Entitlements: Rational (at Least in the Past), but not Right

The race for the Democratic nomination is very depressing. All the candidates – even supposed moderates such as Biden and Buttigieg – are openly advocating a much bigger burden of government.

I’m hoping some of their proposals are simply election-year pandering, that they really don’t believe in statism, and that they would be reasonable if they got to the White House.

We got a good bit of economic liberalization under Bill Clinton, for instance, even though he didn’t campaign as any sort of libertarian.

Some people speculate that Michael Bloomberg, the former New York City mayor, might be this year’s closet moderate. A few people have even sent me this CNN article as proof of his underlying rationality.

…when he was mayor of New York City, Bloomberg twice compared Social Security to a “Ponzi scheme” and repeatedly said cuts to that program as well as Medicare and Medicaid had to be part of any serious solution to reducing the federal deficit. …if there’s ever a Ponzi scheme, people say Madoff was the biggest? Wrong. Social Security is, far and away,” Bloomberg said in a January 2009 appearance… “We are giving monies out with the next guy’s money coming in and at the end of — when the music stops — it’s just not gonna be enough chairs for everybody,” Bloomberg said. …Bloomberg’s past comments are at odds with the mainstream positions within the Democratic Party. …During other radio appearances, Bloomberg called for passing Simpson-Bowles, the deficit cutting plan named after former Wyoming Republican Sen. Alan Simpson and former Clinton White House chief of staff Erskine Bowles.

I have mixed feelings after reading that article.

The good news is that Bloomberg at one point was semi-rational about entitlements.

• He understood Social Security is a Ponzi scheme, meaning that the system is only made possible by having new people enter the scheme to finance promises made to people who joined earlier.
• He recognized that some sort of corrective action was needed on entitlements because of enormous unfunded promises, driven by demographic change and poorly designed programs.

The bad news is that Bloomberg never supported the right policies that would address both Social Security’s gigantic fiscal shortfall and the fact that the program is a really bad deal for younger workers. Instead, he supported plans such as Simpson-Bowles that would merely make people pay more to get less.

The worst news is that Bloomberg has abandoned his semi-rational view and is now urging higher taxes and program expansions. He’s presumably not as bad as some of the other candidates, but that’s damning with faint praise.

Here’s a simple way of thinking about Social Security. First, are people actually connected to reality? Do they understand math and demographics? If yes, they’re on the rational (left) side of this 2×2 matrix.

But even if people are rational and recognize there’s a problem, do they support the right type of reform (top half), which is personal retirement accounts?

As you can see, Bloomberg used to be in the bottom-left quadrant, which is bad but rational. Now he’s in the bottom-right quadrant, which is bad and irrational.

A politician who is good and rational will be in top-left quadrant.

P.S. Social Security technically isn’t a Ponzi scheme. That’s because people have the freedom to reject a con artist peddling a pyramid scam. With Social Security, by contrast, participants are legally required to be part of the scheme.

P.P.S. The logical assumption is that the top-right quadrant is empty other than a question mark. After all, any politicians who supports good policy presumably would also recognize there’s a problem. That being said, Trump could be the exception. He doesn’t think we have an entitlement problem, so he obviously belongs on the right side of the matrix. But if he decided to support individual accounts (Trump is very inconsistent on policy, but that does mean he is good on some issues), he could replace the question mark.

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Elizabeth Warren’s Reckless Scheme to Expand the Social Security Burden and Undermine American Competitiveness

Social Security is projected to consume an ever-larger share of America’s national income, mostly thanks to an aging population.

Indeed, demographic change is why the program is bankrupt, with an inflation-adjusted cash-flow deficit of more than $42 trillion.

Yet Senator Elizabeth Warren wants to make a bad situation even worse.

In a blatant effort to buy votes, she is proposing a radical expansion in the old-age entitlement program. Here’s how USA Today describes her proposal.

Warren’s strategy would make major changes to Social Security, boosting benefits for all and imposing new taxes on high-income earners to finance them. …Under the proposal, everyone would get a $200 increase in monthly payments from Social Security, including both retirement and disability benefits. …Certain groups would see even larger increases. …In order to cover these benefits and shore up Social Security’s future finances, Warren would impose two new taxes. First, a new payroll tax would apply to wages above $250,000, with employees paying 7.4% and employers matching with 7.4% of their own. This is above the 6.2% employee rate that applies to current wages up to $132,900 in 2019, …Second, individual filers making more than $250,000 or joint filers above $400,000 would owe a heightened net investment income tax at a rate of 14.8%. …The Warren proposal breaks new ground by largely disconnecting the benefits that Social Security pays from the wages on which the program collects taxes.

In a column for the Wall Street Journal, John Cogan of the Hoover Institution explains why the proposal is so irresponsible.

It’s a strange campaign season, loaded with fantastical promises of government handouts for health care, college and even a guaranteed national income. But Sen. Elizabeth Warren ’s Social Security plan takes the cake. With trillion-dollar federal budget deficits and Social Security heading for bankruptcy, Ms. Warren proposes to give every current and future Social Security recipient an additional $2,400 a year. She plans to finance her proposal, which would cost more than $150 billion annually, with a 14.8% tax on high-income individuals. …the majority of Ms. Warren’s proposed Social Security bonanza would go to middle- and upper-income seniors. …The plan would cost taxpayers about $70,000 for each senior citizen lifted out of poverty.

Cogan also explains that Warren’s scheme upends FDR’s notion that Social Security should be an “earned benefit.”

The cornerstone of FDR’s Social Security program is its “earned right” principle, under which benefits are earned through payroll-tax contributions. …in a major break from one of FDR’s main Social Security principles, the plan provides no additional benefits in return for the new taxes. …Such a large revenue stream to fund unearned benefits, aptly called “gratuities” in FDR’s era, would put Social Security on a road to becoming a welfare program. …Ms. Warren’s proposal returns the country to an era when elected officials regularly used Social Security as a vote-buying scheme.

For all intents and purposes, Warren has put forth a more radical version of the plan introduced by Congressman John Larson, along with most of his colleagues in the House Democratic Caucus.

And that plan is plenty bad.

Andrew Biggs of the American Enterprise Institute wrote about the economic damage it would cause.

…the Social Security 2100 Act consists of more than 100% tax increases – because it not only raises payroll taxes to fund currently promised benefits, but increases benefits for all current and future retirees. …Social Security’s 12.4% payroll tax rate would rise to 14.8% while the $132,900 salary ceiling on which Social Security taxes apply would be phased out. Combined with federal income taxes, Medicare taxes and state income taxes, high-earning taxpayers could face marginal tax rates topping 60%. …Economists agree that tax increases reduce labor supply, the only disagreement being whether it’s by a little or a lot. Likewise, various research concludes that middle- and upper-income households factor Social Security into how much they’ll save for retirement on their own. If they expect higher Social Security benefits their personal saving will fall. Since higher labor supply and more saving are the most reliable routes to economic growth, the Social Security 2100 Act’s risk to the economy is obvious. …an economic model created by a team based at the University of Pennsylvania’s Wharton School…projects GDP in 2049 would be 2.0% lower than a hypothetical baseline in which the government borrowed to fund full promised Social Security benefits. The logic is straightforward: when taxes go up people work less; when Social Security benefits go up, people save less. If people work less and save less, the economy grows more slowly.

And the Wall Street Journal opined about the adverse impact of the proposal.

Among the many tax increases Democrats are now pushing is the Social Security 2100 Act sponsored by John Larson of House Ways and Means. The plan would raise average benefits by 2% and ties cost-of-living raises to a highly generous and experimental measure of inflation for the elderly known as CPI-E. The payroll tax rate for Social Security would rise steadily over two decades to 14.8% from 12.4% for all workers, and Democrats would also apply the tax to income above $400,000. …The proposal would also further tilt government spending to the elderly, who in general are doing well. …Democrats are also sneaky in the way they lift the income cap on Social Security taxes. The Social Security tax currently applies only on income up to $132,900, an amount that rises each year with inflation. But the new payroll tax on income above $400,000 isn’t indexed to inflation, which means the tax would ensnare ever more taxpayers over time. …The new 14.8% Social Security payroll-tax rate would come on top of the 37% federal income-tax rate, plus 2.9% for Medicare today (split between employer and employee), plus the 0.9% ObamaCare surcharge on income above $200,000 and 3.8% surcharge on investment income. …As lifespans increase, the U.S. needs more working seniors contributing to the economy. Yet higher Social Security benefits can induce earlier retirement if people think they don’t have to save as much. Higher marginal tax rates on Social Security benefits and income also discourage healthy seniors from working.

Now imagine those bad results and add in the economic damage from a 14.8 percentage point increase in the tax burden on saving and investment, which is the main wrinkle that Senator Warren has added.

Last but not least, using Social Security as an excuse to push higher taxes is not a new strategy. Back in 2008 when he was in the Senate and running for the White House, Barack Obama proposed a Warren-style increase in the payroll tax.

Here’s a video I narrated that year, which discusses the adverse economic effect of that type of class-warfare tax hike.

By the way, Hillary Clinton supported a similar tax increase in 2016.

Though it’s worth noting that neither Obama nor Clinton were as radical as Warren since they didn’t propose to exacerbate the tax code’s bias against saving and investment.

And don’t forget she also wants higher capital gains taxes and a punitive wealth tax.

Her overall tax agenda is unquestionably going to be very bad news for job creation and American competitiveness.

The “rich” are the primary targets of her tax hikes, but the rest of us will suffer the collateral damage.

P.S. Instead of huge tax increases, personal retirement accounts are a far better way of addressing Social Security’s long-run problem. I’ve written favorably about the Australian system, the Chilean system, the Hong Kong system, the Swiss system, the Dutch system, the Swedish system. Heck, I even like the system in the Faroe Islands.

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How Women Are Disadvantaged by the Tax Code and Social Security System

I’m not a big fan of the current tax system. I’m also not supportive of America’s bankrupt Social Security system.

The country would be much better off with fundamental reform of both the tax system and Social Security.

Some groups will be reap especially large rewards if that happens.

For instance, a new report from the National Bureau of Economic Research examines the impact of taxes and Social Security on female labor supply.

…we ask to what extent the fact that taxes and old age Social Security benefits depend on one’s marital status discourages female labor supply and affect welfare. …as couples file taxes jointly, the secondary earner in the married couple faces a higher marginal tax rate, which tends to discourage their labor supply. …reduced labor supply does not necessarily imply lower Social Security benefits. Since women have historically been the secondary earners, both provisions tend to discourage female labor supply… to what extent are these disincentives holding it back? …We estimate our dynamic structural model using…data from the Panel Study of Income Dynamics (PSID) and from the Health and Retirement Study (HRS) for the cohort born in 1941-1945 (the “1945” cohort). …we also estimate our model for the 1951-1955 cohort (the “1955” cohort),

This chart from the study shows that married women face a tax penalty – i.e., higher marginal tax rates – compared to single women.

The main takeaway is that this marriage penalty, combined with discriminatory features of Social Security, discourages women from working.

How big is the effect?

The report, authored by Margherita Borella, Mariacristina De Nardi, and Fang Yang, finds that government policies have a significant adverse impact on labor-force participation.

For the 1945 cohort, we find that Social Security spousal and survivor benefits and the current structure of joint income taxation provide strong disincentives to work to married women and single women who expect to get married… For instance, the elimination of all of these marriage-based rules raises participation at age 25 by over 20 percentage points for married women and by five percentage points for single women. At age 45, participation for these groups is, respectively, still 15 and 3 percentage point higher without these marital benefits provisions. In addition, these marriage-based rules reduce the participation of married men starting at age 55, resulting in a participation that is 8 percentage points lower by age 65. Finally, for these cohorts, these marital provisions decrease the savings of married couples by 20.3% at age 66.1 In terms of welfare, abolishing these marital provisions would benefit…over ninety percent of the people in this cohort. …We find that the effects for the 1955 cohort on participation, wages, earnings, and savings are large and similar to those in the 1945 cohort, thus indicating that the effects of marriage-related provisions are large also for cohorts in which the labor participation of married women is higher.

What if these discriminatory policies were fixed?

It depends, of course, on how the problems are addressed.

The report finds that a budget-neutral approach (i.e., returning any budgetary windfall to taxpayers) would be a significant net plus.

…there would also be large aggregate gains from removing marriage related provisions and reducing the income tax… Overall our policy experiments thus indicate that removing marriage related taxes and Social Security benefits would increase female labor supply and the welfare of the majority of the populations.

Here are a couple of charts from the study, showing both an increase in labor supply and an increase in labor income.

I’ll close with a final point about family structure.

Some people will argue that the current penalties in the tax code and Social Security system are desirable because they don’t punish stay-at-home moms as much as working women.

That’s a very strange argument. Sort of like the folks on the left, including the IMF, who advocate policies that hurt the poor if rich people suffer even more.

P.S. If there’s reform, older people also will enjoy significant gains.

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