Pension funds often are a source of revenue for governments desperate to close budget gaps or advance economic development — even when retirement plans are underfunded. Now the federal government is trying it.
President Barack Obama, relying on this perverse long-standing custom, has been trying to get Congress to pass an extension of this year's Social Security payroll tax cut, set to expire at the end of 2011.
The president proposed the extension to simulate the economy. But it would shortchange the Social Security System, weakening its funding — as shaky as it already is — while doing little to achieve the goal of stimulating the economy.
The gross domestic product grew at an annual rate of 2% in the quarter ended Sept. 30. The rate of GDP growth has been slower this year, when the Social Security payroll tax cut was in effect, than last year when Social Security participants paid the full amount of payroll tax.
The proposal also would deepen the federal budget deficit, reducing the stream of revenue coming into the Department of Treasury in the form of Social Security contributions, whose surpluses are placed in non-tradable Treasury bonds.
The existing cut, reducing the participant share of Social Security payroll tax to 4.2% from 6.2%, reduced federal revenue for this year by an estimated $70 billion, according to the Congressional Budget Office.
Ordinarily, tax cuts generally are a good thing to keep more money in the pockets of taxpayers, and the proposed tax cut would mean about an added $1,000 for the year for the average participant, according to the CBO.
But the payroll tax is a premium to finance Social Security benefits and its only funding source, along with the income from the contribution surplus it holds. Unless it is eventually raised to make up for the loss, the cuts ultimately require general Treasury revenue to subsidize Social Security funding, breaking the tradition of the system relying on participants and their employers to fund it, each group paying what is now 6.2% of payroll.
The debate on the proposals has focused on the potential economic stimulus, while neglecting the harm it will do to Social Security, worsening the troubles in the retirement program itself.
The payroll tax cut, assuming it is renewed and even assuming it is not carried out beyond 2012, will harm the already deteriorating finances of Social Security, moving up the day of reckoning for the system.
The Social Security Administration projects the trust fund will be exhausted by 2036. After that contributions are projected to cover only 77% of benefits until 2084 and then decline again.
Social Security is supposed to be the most dependable, albeit modest, foundation of retirement income, to be supplemented by employer-sponsored retirement programs and personal savings.
But clearly the system — structured as a mostly pay-as-you-go program with a small amount of Treasury bond-invested reserves — is not sustainable under current demographics, with ever fewer workers available to support each retiree.
That means without some combination of a boost in income from higher payroll tax revenue or investments, the system cannot generally meet its benefit promises.
It “has become a bad deal,” according to Sylvester J. Schieber, author of the “The Predictable Surprise: The Unraveling of the U.S. Retirement System,” a book forthcoming in March and published by Oxford University Press.
In it, he cites an estimate that “all birth cohorts from 1939 onward will receive less in Social Security benefits than the value of their lifetime contributions.”
It “is beginning to feel like a Bernie Madoff investment plan,” he writes.
At the end of 2010, contributing participants had earned $21.6 trillion in benefits in today's dollars, “for which no contributions have been set aside,” Mr. Schieber writes, citing Social Security actuarial estimates. Mr. Schieber retired in 2006 as Watson Wyatt Worldwide's director of retirement consulting services in North America and is former chairman of the Social Security Advisory Board.
Clearly, the president, Congress and policymakers need to consider ways to restructure the system to more of a funded system, investing its assets through the markets to earn higher returns.
They might look to the Canada Pension Plan, a funded program whose C$152.3 billion (US$149.1 billion) fund is invested by an independent board.
Another model is the Federal Retirement Thrift Investment Board, Washington, which oversees a defined contribution plan whose $264 billion in assets rank it as the largest U.S. retirement program. Federal government employee participants direct their allocations to a diversified set of index funds, designed to avoid potential political conflicts of interest in active investment management.
The Social Security System is the largest federal spending program, according to the Congressional Budget Office.
But like many federal programs, its spending is more ambitious than its revenue and cannot be sustained in the long run without substantive change.
If there is a positive to the cutting of the Social Security payroll tax in a feeble attempt to stimulate the economy, it is that the damage to the system's funding might spark efforts to improve its finances by moving toward a CPP or FRTIB model.