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  The truth is that the government’s Social Security guarantee is one huge unfunded promise. How can this be? I have mentioned the Social Security “trust funds,” where our payroll taxes go. All this money is transmitted to the federal government and credited to the Social Security trust funds. You would logically assume that these funds would have hard assets that have been saved and invested to cover the program’s future costs. However, rather than saving the money and investing it in a diversified pool of real and readily marketable assets, the government spends it and provides “special-issue” government securities in return.

  Just consider what actually goes into those funds. First there are the numbers reported in government financial statements. According to those numbers, Washington had issued approximately $2.4 trillion in special-issue U.S. government securities that had been credited to the Social Security trust fund as of January 1, 2009. The computer records documenting these securities are held in a locked file cabinet in West Virginia. But there is a reason they are called special-issue securities, and it’s not good. Unlike regular government bonds, which people like us and the Chinese government can buy, these special-issue bonds cannot be sold; in other words, they are government IOUs that the government has issued to itself, to be paid back later—with interest. Imagine if you or I could sit around writing IOUs to ourselves that were worth something. Great way to make a living.

  Washington says that we can count on these bonds because they are backed by the full faith and credit of the United States government, which guarantees both principal and interest. But—believe it or not—under current federal accounting principles, the government does not consider these bonds to be liabilities—which is another way of saying the government doesn’t really think that it’s our money.

  Think about that for a minute. If you or I lend the government money by buying a bond, the government has to pay us back with interest. In other words, that bond is a government liability. But when it comes to the Social Security trust funds, the government is saying the special-issue securities it deposits are not a liability—in other words, they’re basically worth nothing at all. Now get this: The trust funds report these securities as assets on the annual reports that they provide to the public. Does that sound like wanting to have your cake and eat it too? Con artists of the world, I hope you’re taking notes.

  In my view, these bonds should be treated as liabilities, and their value should be counted as part of our debt-to-GDP ratio. After all, they are backed by the full faith and credit of the federal government, and I do not believe the federal government will default on them.

  Under the current scheme, the Social Security program has been running large surpluses since the reforms of 1983. But in actuality, Washington has spent those surpluses every year on other government activities. That is one way the government can reduce its public borrowing and keep interest rates down.

  To say the least, the federal government’s accounting for these funds understates both its total liabilities and its annual operating deficits. That brings us to another clever bit of Washington word-smithing: the “unified deficit.” In public reporting, the government takes the real operating deficit, $638 billion in fiscal 2008, and subtracts the nonexistent amount credited to the Social Security trust funds, $183 billion in fiscal 2008. This “unified” figure—$455 billion—makes the federal budget deficit seem smaller than it actually is. And they have been doing this for many years.

  These accounting tricks would never be allowed in the real world, where trust funds are subject to stringent accounting rules and fiduciary standards. In essence, Washington is playing a massive con game—collecting your Social Security taxes, spending that money for its own purposes, and accounting for it in trust funds that are largely a fiction. A more proper description would be “trust-the-government funds.” Or as my boss, Pete Peterson, would say, “You can’t trust them, and they aren’t funded.” Just another example of how words used in Washington don’t have the same meaning they have in Webster’s dictionary.

  Don’t worry, the reforms of the 1980s are still keeping the system above water. Monthly benefits should be paid in full for at least another three decades. However, the Social Security program will begin to pay out more than it takes in much sooner than that. The retirement and survivors income program expects its payments to exceed its revenues in 2010 and 2011. That will happen because revenue has declined during the recession—while at the same time, more people are retiring. When the federal government has to start cashing in the special-issue securities in the trust funds in order to pay benefits, it will have to raise taxes, cut benefits, and/or sell real bonds to the public in order to raise real money for retirees receiving benefits. If the government issues more public debt—in part to attract more foreign investors—that will likely increase our foreign dependency.

  AVOIDING A CRISIS

  We have no alternative but to keep Social Security strong. Approximately 35 percent of current retirees rely on Social Security for over 90 percent of their retirement income. For these people above all, we have to make sure that Social Security’s “safety net” promise is kept.

  Yet the demographic time bomb keeps ticking. If we do nothing, the system will run dry again and the government will be forced to slap together new emergency reforms. Assuming that we will not cut benefits drastically, we will be looking at the only alternative: further tax increases for our children and grandchildren.

  Here’s the bottom line: Social Security does not face a crisis immediately, because, as I noted earlier, the government will honor its special-issue securities. It does, however, face those $7.7-trillion-and-growing unfunded obligations that should be addressed sooner rather than later. Due to interest costs and projected demographic trends, these obligations grow by hundreds of billions each year that action is not taken. The disability program is in much worse financial shape than the retirement and survivors program. It began experiencing a negative cash flow in 2005, and its trust fund is expected to become exhausted in 2020. Historically, the disability fund has borrowed from the retirement and survivors fund when necessary. But that doesn’t solve its financing problem. It only defers it.

  One major lesson from past reform efforts is clear. If we want to make major program changes, jury-rigged reforms will not do. We will have to crank up the government reform machine again, probably in the form of the Fiscal Future Commission I proposed in the last chapter. I’ll give you my views on how that process should play out later in the book.

  We have to change more than the program. We have to change our attitudes. To get Social Security working again as its originators intended, we have to renew the American practice of saving for our own retirement.

  In the late 1980s, we Americans saved an average of 7.3 percent of our disposable income. But then came the stock boom of the 1990s and the housing boom of the decade that followed. We felt rich, credit was easy to get—and we spent and spent. Our personal savings rate plummeted to less than 2 percent in 2005. (See figure 5.) By early 2007, at the height of the market bubble, the savings rate stood at an anemic 0.7 percent. After the bubble popped in 2007–08, not surprisingly, our savings rate increased as home equity and the stock market declined dramatically. By the summer of 2009, the individual savings rate had grown to over 5 percent. But you get the long-range picture: When times are good, many individuals spend more than they take home—becoming debtor citizens of our debtor nation.

  This savings drought is another major reason Social Security has become indispensable. A government-funded retirement income plan is vital for Americans who are not saving for their own retirement. Yet much more than Social Security is at stake. Savings—generated by the government, by private enterprises, and by individuals—represent the seed corn of our future. With saving comes investing, which contributes to research and development, which results in innovation, productivity increases, process improvements, and quality enhancements. From these come increased employment and wa
ges, and from these an improvement in our standard of living. As Alan Greenspan has said, “Without savings there is no future.” I think that sums it up pretty well.

  Figure 5 U.S. personal savings rate as a percentage of disposable income. Personal savings rates increased to over 5 percent in the summer of 2009. It remains to be seen whether this will be temporary or lasting.

  Social Security’s designers intended it to be supplemented by employer pension plans and personal savings. As Roosevelt himself said, “We shall make the most lasting progress if we recognize that Social Security can furnish only a base upon which each one of our citizens may build his individual security through his own individual efforts.”

  Yet these nongovernmental efforts have consistently come up short. Company pension plans have never covered enough people. Today, about 50 percent of the workforce is covered by a private plan, a percentage that has not changed much in the past forty years. At the same time, despite the recent uptick in savings, the United States still has one of the lowest savings rates of any industrialized nation.

  In our system, people who do save probably don’t do much to take the pressure off Social Security. They tend to be better off financially—saving money mainly because they have more than they need to spend. Their retirements are generally more secure, even if recent market declines have made many 401(k) plans look more like 201(k) plans.

  The government has tried to encourage personal thrift, offering numerous tax incentives for people to save. A significant percentage of savers put money aside to take advantage of these programs, which include pension plans, 401(k)s, individual retirement accounts, health savings accounts, and the like. But the impact of these programs is questionable, since those incentives actually cost the U.S. Treasury more than $120 billion a year.

  Such tax-advantaged saving has become more common now that employers are allowed to automatically enroll their employees in private pension plans such as 401(k)s and similar offerings. Employees have to opt out of the savings plan rather than opting in. Don’t get me wrong; I believe automatic enrollment is a good idea and will generate some incremental savings. It will also help to ensure that more employees take advantage of employer matching contributions. But at the same time, I do not see automatic enrollment as a major leap forward in our effort to boost our overall savings rate. After all, as I said above, these programs cover only about half of all workers.

  We need to consider other ways to increase our savings and to make sure that people who actually will need the money after they quit working are among those who save. One answer might be to implement an automatic savings plan as part of comprehensive Social Security reform. After all, as my mother often said, “Once you touch the money, you will spend the money.” Nowadays, many people spend it more than once!

  SOME COMMONSENSE PROPOSALS

  Increasing our savings rate will take some of the pressure off Social Security, but won’t save it. We do need a government reform plan—and hopefully a better one than we’ve had in the past.

  The reform process must have integrity: It must be nonpartisan, fact-based, inclusive, and transparent. Whatever we do will be controversial, because the system needs to change and humans don’t like to change. There will be inevitable controversy over specific reform proposals; we don’t need an additional controversy over whether the reform process itself is fair. If we get it wrong, we will be fighting a two-front war—one over substance and one over process. As Germany found out the hard way twice during the twentieth century, it’s very hard to win a two-front war.

  As we consider an appropriate way forward to reform Social Security, we should remember that other countries are ahead of us in making changes to their pension programs. Australia, New Zealand, Canada, the United Kingdom, and Chile have already taken steps to make their systems more sustainable. Some of their efforts can be used to inform our own reform proposals, while others are more radical and therefore not likely to be politically feasible in the United States.

  We don’t have to change Social Security radically to make it secure and sustainable. The challenge is to make enough adjustments to properly finance it for seventy-five years and beyond. Yes, we need to make changes that recognize demographic realities and that ensure solvency indefinitely. We also need to respect our values of thrift, saving for the future, and passing on a better world to the next generation. Here are a few suggestions for how we can balance Social Security’s promises with enough revenue to pay for them.

  Benefits

  Focus on people who are most in need. Provide a new higher-level floor benefit for Americans who have worked at least thirty years to ensure they will not live in poverty. This will serve to strengthen the social safety net.

  Do not eliminate Social Security benefits for higher-income individuals but reduce the relative benefit for middle-and upper-income persons through progressive wage indexing or otherwise. This would ensure that benefits are better targeted to those in need without allowing Social Security to become a welfare program.

  Trim cost-of-living adjustments. A modest reduction, 0.5 percent or less, in these annual postretirement increases, possibly targeted to certain middle-and upper-income beneficiaries, would boost the reform effort while also helping to ensure that better-off retirees contribute to a sensible Social Security solution.

  Raise the normal and the early retirement eligibility ages on a gradual basis, and require that they keep pace with increases in life expectancy. A relatively modest increase—for example, from sixty-seven to seventy for the normal retirement age, and from sixty-two to sixty-five for the early retirement age—would have a significant impact, and the change could be implemented over a twenty-year period. An allowance could be made for manual laborers who can’t continue to do heavy work as they grow older. These workers could access the disability program until they reach the normal retirement age. In combination, these changes would help to reduce and offset revenue losses caused by the slower growth of the workforce.

  Allow individuals to defer their Social Security benefits to any age they choose and increase their monthly benefit based on life-expectancy tables. This would encourage people to work longer.

  Revenues

  Increase tax revenue. Keep the payroll tax rate at the current level of 6.2 percent but raise the cap on taxable wages from the 2009 level of $106,800 per person to around $150,000. This would be less than the historical dollar level at which 90 percent of total wage income would be subject to the Social Security payroll tax ($171,900 in 2009).

  Savings

  Require supplemental savings accounts. An additional 2 or 3 percent payroll deduction would go into an individual account for each worker. Individuals would have several professionally managed investment options to choose from along the lines of the Federal Thrift Savings Plan, which is used now for federal elected officials and employees. This would help our overall savings rate while providing a meaningful preretirement death benefit and supplemental post-retirement benefits.

  That’s it. None of these ideas is particularly radical or new. The changes could be phased in so that people who have already retired or are nearing retirement—those who are between fifty-five and sixty years old, perhaps—would not be affected in any significant way. Yet these adjustments would result in a solvent, sustainable, secure, and more savings-oriented Social Security program. They would also secure a larger benefit for every generation of Americans than its members might be expecting to receive given the program’s current troubles.

  If reforms like these are necessary, sensible, and feasible, then what are we waiting for? It’s called leadership, and hopefully we’ll get some soon. Achieving Social Security reform would be a solid start toward our nation’s return to a prudent fiscal path and would also help to ensure that the federal government can deliver on the promises that it makes. Should we expect any less from our government? Then why aren’t we demanding that it act?

  To demonstrate how far out of control Washington is
in connection with federal spending, in October 2009, President Obama asked the Congress to authorize an ad-hoc payment of $250 each for Social Security beneficiaries. He did this because the official cost-of-living adjustment formula did not justify any increase in monthly benefits. This was a very troubling $13 billion spending proposal. It represented blatant political pandering that would only serve to further mortgage our future. It also ignored the fact that the poverty level among seniors is lower than in other segments of the population.

  Six

  CURING HEALTH CARE

  If there’s one thing that could bankrupt America, it’s out-of-control health care costs. It’s no coincidence that President Obama chose this as his signature issue, nor that debate about it has dominated the media since he began to push for comprehensive health care reform.

  Health care reform is another of those perennials of American politics. Theodore Roosevelt called for comprehensive health care reform while running for a third term in 1912, and Harry Truman made a big issue of it during his presidency, to no avail. President Truman lived long enough to attend the 1965 ceremony at which President Johnson signed Medicare into law. President Clinton tried to achieve comprehensive health care reform early in his presidency, without success. Most recently, George W. Bush expanded Medicare to include prescription drug coverage but made no attempt to achieve universal coverage.