Excessive Pay
Young to Old
Social Security
PAYGO
Health Care
Medicare Reform
Conclusions

Social Security Financing

The “little guy”: Democratic policies produce weaker competition, lower business investment, and higher unemployment with the greatest loss of income and prospects for the young and least-skilled—the little guys
Social Security has a Pay-as-you-go system of financing—money received from FICA taxes on workers is immediately paid out to retirees
When SS receives more from payroll taxes than it pays out to beneficiaries, as it has from 1983 to 2010:
the excess is not invested but spent by the Federal government, and
the Social Security Administration is given special Treasury Bonds equal to the amount spent (the mythical “Trust Fund”)
PAYGO financing is a great boon to the first generations receiving benefits and to the Federal Government to fund programs before benefits have to be paid, but is a poorer and poorer deal with each following generation (Ponzi scheme)

Worker to Beneficiary Ratio

The Chart shows the Ratio of workers paying Social Security FICA taxes to retirees drawing SS retirement benefits

For the years 1960 to 2010 the numbers are actual falling from 5:1 to 3.4:1 in 2000 and 3:1 in 2010.

The Social Security Actuaries predict the ratio will fall to 2.1:1 for the years 2040 to 2060 and 2:1 thereafter according the their preferred Intermediate Scenario. Their High Cost Scenario envisions the possibility that the ratio could be 1.5:1 by 2080 if fertility rates and immigration rates fall more than they anticipate

PAYGO Financing

Over the past century life expectancy has increased. Thus when Social Security was instituted in 1936 the average worker age 60 would life 15 years to age 75. On average a worker would spend 10 years drawing SS
In 2006 average workers at age 60 would live 22 years to age 82 and draw benefits for 17 years an increase of 70% per retiree. If, on average, workers paid into SS for 40 years, this factor alone would reduce the ratio of workers to retirees from 4:1 to 2.35:1
In advanced developed economies fertility rates have tended to fall over time tending to increase the number of retirees. The “baby boom” generation retiring from 2008 to 2031 is the main cause of the ratio falling from about 3.2:1 to 2.1:1
An example of PAYGO financing: My father contributed to SS for 35 years from 1945 to 1980, the year he retired. He and my mother enjoyed benefits for 26 years. He died in 1997 and my mother in 2006
A calculation of the amount of money needed at retirement to fund the retirement benefits they received would have required the employee and employer contributions to earn an average of 17% per year for 35 years from 1945 to 1980
My father contributed the maximum amount each year. Due to the progressive nature of SS benefits many retirees must have done better. Those who retired in the 1940’s and 1950’s after paying in only a few years like my grandparents did far better yet
If we take a person with the same 35 years of contributing at the maximum beginning in 1975 and retiring in 2010 and receiving benefits for 26 years to 2036, the interest rate needed to accumulate the funds needed would have been 5.51%
26 years of benefits however is greater than average. At age 25 a person on average can expect to live to age 79 with 14 years of retirement benefits. The funds needed for a 2010 retiree to draw maximum benefits for 14 years would only need to have grown at 1.5% interest from 1975 to 2010
Consider what would happen if our 2010 retiree could have invested the 10.6% employee and employer contribution in a private account with stocks and it grew at an average rate of 6.5%. By 2010 he would have $384,000 more than needed to fund the 14 years of SS benefits he would receive. Moreover he would not lose all benefits if he died prematurely
Many young people retiring 30 or more years from now will receive less than 1.5% returns from SS. Many will receive negative returns. Compared to a system with private accounts this is a very bad deal
Because the SS retirement system has unfunded liabilities of $5.3 trillion over the next 75 years and $15.1 trillion beyond, many say the system is bankrupt
The unfunded liabilities do show that changes are needed in the near future: we must reduce benefits, raise FICA taxes, or move to a system with private accounts, etc.
To understand the situation consider the following: The SS benefit formula is set to provide retirees about 41% of their pre-retirement wage and salary income if they have average earnings. Those with low earnings get about 55% of pre-retirement wages and those with maximum covered earnings receive about 21%
Consider the situation in 2000 when the worker to beneficiary ratio was 3.4. Since the employee + employer share of wages and salaries going to retirement is 10.6%, on average, 3.4 workers contribute 3.4 x 10.6% x Average Earnings = 36.04% of Average Earnings. This is close enough to the 41% x Average Earnings of a retiree to provide adequate funding (many retirees have been retired for a number of years when the 41% of Average Earnings was a lesser amount)
Now consider the situation when the ratio is 2.1:1 as it will be by 2040, then 2.1 x 10.6% x Average Earnings = 22.26% of Average Earnings. This amount is insufficient to sustain benefits at current levels, but could sustain benefits reduced by 30% with the average benefit being about 28% rather than 41% of pre-retirement earnings
Social Security Pay-as-you-go financing can continue indefinitely to fund benefits but only if benefits are reduced about 30% or if FICA taxes are raised
Moving to a system with voluntary private retirement accounts for part of the benefits (those who wished could remain under the current system) could stabilize the system over the long term without reducing benefits from current levels

Health Care Costs

Demand Curves

The problems with our health care system are due to funding by health service contracts, which, for the most part have very low deductibles and low co-pays
Low co-pays and deductibles encourage many Medicare patients overuse medical services
Employees with generous employer provided care also tend to overuse medical services, because the services essentially seem to be free
Despite Pres. Obama’s claims that the new health care plan passed by Congress would not increase costs, it is clear that if the plan succeeds in bringing in millions of uninsured voters, they will use medical services more frequently than just for emergencies
Basic economic theory of supply and demand shows that when the demand curve is shifted up, the PRICE MUST RISE for ALL goods or services being supplied

Obamacare Costs

Romneycare Costs

Because the Massachusetts health care system instituted in 2006, and in effect for 4 years, has community rating and guaranteed issue like Obamacare, it gives an idea of what we might expect with Obamacare when it is implemented
Massachusetts Romneycare was projected to cost $350 Million over four years. It has cost over $4 Billion in four years—over 11 times what was predicted
The Congressional Budget Office is required to use static scoring rather than more realistic dynamic scoring. We should expect the costs of Obamacare to be much greater than its proponents claim
When Medicare was introduced in 1967 proponents claimed it would cost only $30 Billion a year 23 years later. In fact the costs in 1990 were above $300 Billion and more than 10 times predicted costs

Medicare Reform

The “baby boomers” are about to start going on Medicare after January 1, 2011. In short order the FICA taxes on workers for hospital insurance will be inadequate to cover benefits paid
The perpetual unfunded liability of Medicare has been estimated by Social Security Actuaries to be $36.4 Trillion. They figure that an increase of 6.5% in FICA payroll taxes would be needed to eliminate the perpetual unfunded liability
If the Intermediate assumptions pan out, an increase of 1.95% each for Employee and Employer would cover unfunded liabilities for the next 75 years. For the High Cost scenario 4.9% each would be needed
Given past underestimates, it is quite likely that future increases in medical costs have been underestimated
Needless to say, a major fix to Medicare is needed soon

The Medicare Fix

If one wants to really fix a problem, it is essential to understand the causes and then address the causes to fix them
Medicare’s increasing costs are largely due to patients overuse of the system. Why do they overuse it? Because it is so generous and they pay so little out-of-pocket for doctor and hospital visits
The solution that will hold down costs is to require seniors, who can afford to, to pay more. Many seniors have sufficient income to easily pay considerably more than they do for their medical care
Unfortunately, politicians tend to procrastinate until problems require more severe action. They will ignore the problem as long as they can and then impose government mandated price controls that will reduce the quality of care, eliminate availability of some procedures for the elderly, and stifle innovation

Final Conclusions

Pay-as-you-go financing is a bad method for social insurance:
Pay-as-you-go financing is basically a Ponzi scheme
PAYGO financing was a bad idea when introduced with Social Security in 1936, but since then has become even worse. Fertility rates have dropped and average life expectancy after retirement has increased from about 10 to 17 years sending the workers to retirees ratio toward 2.0 in the near future. The burden of Social Security and Medicare on our young people will increase. With unfunded liabilities of 15 trillion and 35 trillion for Social Security and Medicare significant changes are essential
Although Social Security and Medicare have some effects that cause some redistribution from rich to poor, the primary basis for the programs is for the younger who are working to support the elderly and is a transfer of wealth from the young to the old. Democrats who love the programs as they are, speak of a “sacred bond and trust between generations” but ignore the fact that successive generations receive a poorer deal.
The new health care bill passed in 2010 is also based on the young paying for older people and transferring wealth to them. The idea is to try to force the uninsured to buy health insurance. Since no-one is to pay more than 3 times anyone else and the unhealthy ( other than smokers) are in the same pools, most of the young will end up paying premiums that are more than double the health costs of their age group and so will subsidize the elderly

Needed Action

Young people strongly supported Obama and the Democratic Party in the 2008 elections
Yet it is clear that the policies of the Democrats with respect to entitlements, health care, government deficit spending, taxation, and unemployment are very exploitive of the young and not in their interest
If we are to get our economy back on the right track and fix the entitlement problems, it seems highly desirable that the young make clear to the politicians that they are going to oppose being exploited
The young need to be persuaded of the truth and must stop voting for Democratic politicians who get most of their support from government unions, trial lawyers, and radical environmentalists who exploit the public, and in particular the young
We need alternate independent candidates or an alternate party advocating fiscal responsibility committed to reining in government spending, taxation, and to fixing entitlement programs

Entitlement and Health Transfers

Who is Getting Excessive Pay?

Wealth Transfer from Young to Old