Why delaying Social Security reform now could cause our children’s wealth to shrink further
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In early June 2018, the Social Security Trustees board reported that the Social Security Trust Funds — a main source of funding for Social Security benefits aggregated from Social Security taxes — would be depleted by 2034, one year sooner than previously estimated in last year’s report. According to the trustees, factors that would contribute to this increased depletion are general increases in the cost of living expenses like health care costs.
Possible reforms to the current Social Security system to help bolster its funding have not been an immediate priority for the Trump administration. The dangers of not acting on Social Security reform was one theme in the book “Rethinking Pension Reform,” written by Arun Muralidhar, founder of MCube Investment Technologies, and economist Franco Modigliani, who passed away in 2003.
Muralidhar joined David Brancaccio to talk about why it’s important to raise taxes on Social Security now in order to save future generations from dealing with potential funding fallout.
Below is an edited transcript of their conversation.
David Brancaccio: Let’s take a couple of seconds to cry over spilled milk. Back in 2004 you and a Nobel Prize winner, Franco Modigliani, had a plan to fix Social Security. In a nutshell how painful was it, that plan [all] those years ago?
Arun Muralidhar: Well it was quite simple because what we were arguing back then was that the taxes had been raised by 1.1 percent from 12.4 today that we pay to 13.5 and invest it in a simple 60/40 stock bond portfolio, we could actually stabilize the contributions at 13.5 forever. And by not doing that sadly, we missed the opportunity to invest that portfolio and that portfolio from 2004 to today would have earned something like 8.5 percent annualized which would have made Social Security much more stable than it currently is.
Brancaccio: Much more stable, we wouldn’t be having this discussion you think?
Muralidhar: We’d still be having the discussion but it would be a step in the right direction because we would be improving the funding of Social Security and Social Security is challenged because we’ve got low birthrates in this country. We’ve got increasing life expectancy and low productivity.
Brancaccio: But had Social Security created this massive portfolio of 60 percent cleverly chosen stocks and 40 percent cleverly chosen bonds, I mean, how do you manage something like that? That’s huge government involvement in financial markets. Can we borrow from other countries in thinking about this?
Muralidhar: In our book in 2004 we recommended that there was already a good model with the Canadian Pension Plan board. They have a supremely well designed board governance structure which ensures that the investments are made solely for the benefit of the beneficiaries and not for political reasons. And now even other countries are using that model. So Japan for example has used a similar structure for its Social Security fund. So there is plenty to be learned from other countries that the U.S. can benefit from.
Brancaccio: And whenever anyone here’s a proposal like this they say, “yes but the markets are so volatile.” But I suppose in the intervening years since you and the Nobel Prize winner proposed this idea — that was back in 2004 — we’ve had a couple of stupendous financial shocks yet you’re talking about a return of more than 8 percent.
Muralidhar: That’s what’s amazing is because Social Security could be there for the long term. It can withstand the volatility whereas currently the trust funds Social Security is invested in non-tradable government securities and under a 3 percent return last year. We had a cute tweak to this which was that Social Security would always earn the guaranteed return and U.S. Treasury would essentially be the buffer against bad years but then also benefit from the good years and that’s essentially what the long-term horizon of Social Security allows you to do.
Brancaccio: Now the Social Security system was set up with a couple of very important assumptions. One is that economic growth would help solve the problem that the very first generation that took out Social Security didn’t pay in. But also the ideas is we’re supposed to have a whole bunch of kids. We’re not really reproducing quite at that rate, are we?
Muralidhar: Unfortunately not. And so the decline in the birthrate [and] the increasing life expectancy essentially puts pressure on the system. So what we had argued in the book was that the only issue with the way Social Security is financed is the funding method, namely that the pensions of the old are paid by the taxes of the young. And so unless the base on which you are taxing is growing at a reasonable rate, you start to get challenges with Social Security and that’s what we are experiencing currently as represented in the latest trustees report.
Brancaccio: Also not helping … all this health care. We’re living longer.
Muraldihar: Exactly, that adds more pressure to the system because now you have to pay people their pensions for a much longer window. So that’s why, like you said, we need to be having more kids and having more fun. But sadly because we haven’t done that the taxes of Social Security, unless something dramatic is done, are going to jump from the current 12.4 percent to at least 16 percent and change in 2035. And as much as 17 and three quarters percent by 2075. So our kids are going to get taxed for the fact that we didn’t have enough babies.
Brancaccio: Arun, on a personal note your book with these proposals came out in 2004. But I see that the Nobel Prize winner that you work with, Franco Modigliani, he died the year before.
Muralidhar: That is correct in fact we finished the book literally one day before he passed away. But what was amazing was his commitment to this project and I included one of his favorite cartoons in the book and the cartoon was from the New Yorker where they had a man on an island stranded and he’s shouting to his rescuers, “Forget about me, save Social Security!” And that personifies his commitment to solving this challenge so I included that in the book as a tribute to him.
Brancaccio: Or it’s an irony that cartoon refers to that no one ever says that. They say, “I want benefits now, don’t worry about this longer-term problem.” Which is the problem here.
Muralidhar: What’s still feasible is there is an opportunity to still save Social Security. If Congress is willing to adhere to that theme of the cartoon which is, “Forget about me, let’s save Social Security.”
Brancaccio: All right so from your point of view, too bad they didn’t adopt this when your book came out in 2004, it might have helped. Is it the only approach? Is this the one thing that would fix this?
Muralidhar: No. There are alternative approaches. So some people have suggested that, you know, you could increase the current taxation on Social Security. Or you could raise the caps on what salary caps are implemented on as well. You could cut benefits but would we argued was that all of those approaches don’t change the underlying problem of Social Security which is its funding method. That is if you’re always going to base the pensions of retirees on the taxes of the young, then that system is highly susceptible to small changes in those parameters. And that’s not a stable system on which to run a national level Social Security system. So while there are other alternatives, this just gives a more stable system for the long term and the sooner we do it the better.
Brancaccio: Yeah, on that important last point, I think the left and right can agree on that point. Sooner is better but we tend not to do it. I guess last time we revamped this was in the early ’80s, mid-80s?
Muralidhar: That’s correct. Under Alan Greenspan’s direction where he recognized that there was a looming problem raised Social Security taxes so that they could set aside some monies in what’s called a trust fund which has now approached about $3 trillion. But if you don’t utilize that trust fund to generate sufficient returns then the only way you’re going to be able to pay pensions is by increasing taxes and you know as as the motto of Marketplace goes, let’s do the numbers. If our proposal had been adopted during the Clinton administration, we’d have required an additional tax of just 0.7 percent over the 12.4. Under the Bush administration it went up to 1.1. Under Obama went up to 1.3 and now we need a 1.5 percent increase at a minimum to be able to stabilize the system so under our approach the cost is growing as we delay this further and further.
Brancaccio: Yeah but the thing about delaying it is that someone else, if you really delay, it can pay it not us.
Muralidhar: Absolutely, our kids. In fact I wrote an op-ed six years ago which I titled “Honey I Shrunk the Kids’ Wealth.” And the whole point of that article is that as we delay Social Security reform we’re just sticking it to our kids who already have a lot of student debt and they’re going to have to pay our national debt of $20 trillion as well. So I think it’s up to our generation to fix the mistakes that we’ve made.
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