The Math Has Changed

While I was not impressed with President Bush's filing cabinet theatrics earlier this week, he did say something I completely agree with. Unfortunately, this more honest and germane statement got buried under the filing cabinet in most accounts, if it was printed at all:

"Franklin Roosevelt did a good thing when he created the Social Security system. It's worked. But the math has changed," he told a crowd at West Virginia University after his trip to the filing cabinet. "The longer we wait, the more costly it's going to be to a future generation of Americans."

Here the President hits the nail on the head: the math has changed. While some people are afraid of the math, there are some simple factors that go into this, that practically all Americans should be able to grasp intuitively, so I don't see why our leaders seem afraid to acknowledge them. The Social Security equation depends on the ratio of workers to retirees. In FDR's time, there were approximately 16 workers paying into the system for each 1 retiree drawing out of it. More recently, that ratio has dropped to 3 workers per retiree, and is heading toward 2. Why is the ratio of workers to retirees dropping? For one, the "baby boom" has been passing through our national demographics, like a snake digesting a rabbit, for the last sixty years, and now that generation is about to retire. Post-boom Americans just haven't been having as many children as their parents did, so as a large generation grows old, there aren't as many younger people coming along to replace it. More significantly, we're living longer. While our life expectancy has been increasing, the retirement age hasn't changed very much. In FDR's day, retirees typically enjoyed retirement for about 5 years before they died. Now, it's upwards of 10 years and growing.

If that's too abstract, perhaps an image will help. Picture the population of America standing on a football field, arranged youngest to oldest from one goal line to the other. In 1945, everyone below the 30 yard line are children, and everyone above the 90 yard line are retirees. Those 60 yards in between are filled with working Americans. Flash forward to 2005. Now the children don't quite make it to the 25 yard line, while the retirees are approaching the 70 yard line (and in control of the ball, first down, moving down field). Working Americans are left defending 45 yards in the middle.

The gist of the problem is that Social Security, as currently constructed as a pay-as-you-go system, depends on a balance of workers paying into the system to pay the retirees collecting from it. If the number of retirees gets bigger compared to the number of workers, the system gets out of balance. When the system gets out of balance, there are only three ways that it can be re-balanced:

• have workers pay more (raise taxes)
• have retirees get less (reduce benefits)
• change the ratio of workers to retirees (raise the retirement age)

The first option, raising taxes, is advocated by some and deplored by others (mostly along the usual ideological divides). The second option, reducing benefits, is advocated by others and deplored by some. The third option (to my mind the most reasonable) seems to be the true "third rail". I hear neither Democrats nor Republicans talking much about raising the retirement age. For one thing, raising the retirement age would preserve Social Security as it was originally intended. It was meant to keep Americans from eating cat food for the last few years of their lives (and to insure against outliving one's savings). It was not meant to provide Americans greens fees for the last decades of their lives. People can work hard and save up extra to achieve earlier and/or more comfortable retirement. (In fact, having the security of insurance against complete destitution in one's old age affords the freedom to take a bit more risk in one's youth, enabling prudent young entrepeneurs to be bolder than they might otherwise be.)

By far the most intriguing proposition I have heard salvages the system by diverting a small part of current payroll taxes to personal accounts (as President Bush wants), but finances that and preserves the existing system by raising the retirement age to 72. This shift in retirement age changes the equation enough to rebalance the system and finance the new personal accounts. The enticing twist is that the personal accounts can be used to finance an earlier (or a more comfortable) retirement. This hybrid system keeps the good part of the traditional system (protection against outliving one's assets, and the security of a defined benefit) and adds the good part of the personal accounts (enabling each person to make their own decisions about risk vs. potential rewards) while avoiding the bad parts of personal accounts (the possibility of risks gone bad or outliving one's savings). In this scenario, the risk of personal accounts is shifted from end-of-life to late middle age, where the worst downsides are working for a few more years or living more frugally, but not sleeping on the streets in advanced old age. This makes a heck of a lot of sense to me. I wish our leaders would start talking about some real solutions like this one.