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Would You Settle Your Claims on Social Security for 83 Cents on the Dollar? (I Would)

Thursday, April 7, 2011

Here’s a win-win proposition for all involved.

If a debt cannot be paid, it will not be paid—at least not paid in full. In dealing with such debts, the fundamental logic is to settle unpayable debts at a discount, at less than 100 cents on the dollar. This can happen by voluntary agreement when a mortgage loan is settled for less than the amount of the loan through a “short sale,” for example (an increasingly familiar transaction in the wake of the burst housing bubble). It can happen when a troubled company buys back its own bonds from the market at a discount. Of course, it can also happen in a reorganization under the bankruptcy code. In all cases, the point is for the parties to put past mistakes behind them and for life to go on.

Let us consider the Social Security program. The interaction of its design by politicians with the demographic and economic facts has the unavoidable and well-known result that its debt (its “promises,” if you prefer) cannot be paid in full.

Could Social Security’s debt be settled at a discount by voluntary transactions with its creditors, namely American citizens? I propose that it could. Every time this happened, it would reduce Social Security’s net deficit, because its debt would go down by more than its assets, just as with any individual or company in a similar situation. This is basic balance sheet arithmetic: if your debt goes down more than your assets do, your net position improves.

Could Social Security’s debt be settled at a discount by voluntary transactions with its creditors, namely American citizens? I propose that it could.

Would at least some Americans be interested in such a transaction? Large numbers of people, especially young people, do not believe that they will ever fully collect on Social Security’s promises, that is, its debt at par—and they are right. So I believe significant numbers of people would be interested. These might well include the 68 percent of respondents aged 19 to 29 who were “not confident at all” (48 percent), or “not so confident” (20 percent), that they would get their full benefits, according to a 2009 poll.1 In a 2011 poll, the grand total of those aged 25-34 who were “very confident” that they would get Social Security benefits at least equal to today’s value was 2 percent!2

What might be a fair price to settle Social Security’s debt?

To answer this question, we need to focus on that part of Social Security dealing with pensions. This part, called “OASI”—“Old Age and Survivors Insurance” —represents about 85 percent of Social Security and is in large measure designed as a forced savings program. (The other 15 percent or “DI”—“Disability Insurance”—is a program for forced insurance, not savings, and is a different discussion.)

The present value of all future income of the OASI program is $34.5 trillion, according to the Social Security Trustees 2010 Report.3 This is using the Intermediate Assumptions as the best guess estimate. It values all the future cash payments to the government from OASI—these are the real total assets.4

Against the $34.5 trillion in OASI assets, there are liabilities of $41.4 trillion. This is the present value of all the future cash outflows promised by Social Security. The liabilities are obviously $6.9 trillion greater than the assets. If your liabilities exceed your assets, you are by definition insolvent—and your creditors have reason to think about how they might wish to deal with that.

For those who choose to stay fully in the Social Security program, the Social Security net worth deficit becomes smaller every time someone else settles for 83 cents on the dollar.

Putting these numbers together, the $34.5 trillion in assets of Social Security available to pay promised pensions are only about 83 percent of the promises of $41.4 trillion. Since the assets are equal to about 83 percent of the liabilities, this gives us a reasonable estimate of the fair way to settle the debt of Social Security to its creditors (namely, us): 83 cents on the dollar.

The Social Security Trustees also express the finances of Social Security in terms of future cash receipts and future cash outflows as percentages of the total projected taxable payrolls. In the intermediate estimate, OASI cash receipts will be 11.3 percent of future payrolls, and the cash cost will be 13.6 percent,5 so receipts will be 83 percent of costs: another way to say 83 cents on the dollar.

So would you rather have 83 cents of your own, which you could invest to earn interest you would own, or would you prefer 100 cents of future claims on an admittedly insolvent government pension program? Personally, I’d take the 83 cents in a heartbeat, and so would most other people to whom I’ve put the question. But I think the matter should be entirely voluntary.

For those who choose to stay fully in the Social Security program, the Social Security net worth deficit becomes smaller every time someone else settles for 83 cents on the dollar.

So I propose that Americans be given a choice (imagine that). You could stay in Social Security as it is. Or you could elect to settle for 83 cents, paid in U.S. Treasury inflation-indexed bonds, which you would own outright. These bonds, with all future interest payments on them, would constitute true retirement savings, protected from inflation.6 In exchange, you would forego formula benefits equal to the value of the bonds you received divided by 0.83. You would have made up your own mind about the chances of such promised Social Security benefits actually being paid.

This is clear enough in principle, but how might it work mechanically? Perhaps like this: If you as a creditor of Social Security elect the proposed settlement, each quarter thereafter you would receive a rebate of all the Social Security tax you paid—6.2 percent of your wages is subject to the tax.7 You would receive this in the form of inflation-indexed Treasury bonds deposited in your own tax-deferred retirement savings account. You now have real assets and savings to replace some of the unenforceable, complicated, politicized promises of an insolvent program, and are happy with your choice. Moreover, it is now easy to understand exactly what you have.

You now have real assets and savings to replace some of the unenforceable, complicated, politicized promises of an insolvent program, and are happy with your choice.

As Professor Laurence Kotlikoff rightly said in the Social Security debates of three decades ago, “The perception of Social Security as a savings account has been fostered by every major piece of Social Security legislation since the program’s inception in 1935. Perhaps it is time to make de jure what has long been a de facto relationship.”8 My proposal would achieve just that.

Your rebate would effectively reduce the Social Security portion of your payroll tax to zero. Not bad.

Of course, your employer pays another 6.2 percent Social Security tax, so ordinarily the total tax is 12.4 percent of your wages. The employer’s contribution, like all your past Social Security taxes paid, would continue to be paid and to generate benefits for you. From the government’s point of view, its Social Security income from your wages going forward would have dropped by 50 percent.

But the government would be happy about this. The entire transaction means that its total government liabilities have gone down and its Social Security deficit has been reduced. This is because for every 83 cents in bonds the government issued as rebates, it reduced its Social Security liability by one dollar. In other words, the government bought a dollar for 83 cents and is definitely ahead.

The mechanics of Social Security benefit calculations for those participating in such a Social Security debt settlement, might work like this. The government would calculate your Social Security benefits by the normal formulas, in the normal, convoluted, opaque way. These benefit payments over time would then be reduced by the actuarial equivalent of all the Treasury bonds you received divided by 0.83.

This proposal is a win-win proposition, which improves the financial position of all four parties involved: those who choose to settle the debt of an insolvent debtor at a discount; those who choose to hold the existing Social Security promises; the Social Security program; and the government as a whole.

Alex J. Pollock is a resident fellow at the American Enterprise Institute.

FURTHER READING: Pollock has recently written “Municipal Debt Crises: Some Historical Perspective,” “Can Our Last International Advantage Withstand the Dodd-Frank Act?” and “Living in the Political Wake of the Bubble.” He has discussed “Taking the Government Out of Housing Finance: Principles for Reforming the Housing Finance Market,” explained “The Political Finance of Covered Bonds,” and offered “A Dozen Ideas: What to Do about Fannie and Freddie.”

Image by Rob Green/Bergman Group


1. USABCWASH2009-1086, Table Q24 by AGEBREAK
2. Employee Benefit Research Institute, Matt Greenwald and Associates, 2011, Figure 7.
3. 2010 OASDI Trustees Report, Table IV.B5.
4. These assets do not include the so-called “trust fund,” a debt of the government to itself, since this “fund” disappears as a consolidating elimination in an accounting of the government’s claims on and debt to the citizens. Because it represents zero future cash to the government, the trust fund is, impolitely stated, a convenient political fiction. This is widely, but far from universally, understood.
5. 2010 OASDI Trustees Report, Table IV.B4.
6. This structure is discussed in detail in Alex J. Pollock, “A New Approach to Personal Social Security Accounts,” AEI On the Issues, 2005.
7. Temporarily reduced to 4.2 percent for 2010, returning to 6.2 percent thereafter.
8. Laurence J. Kotlikoff, “Reforming Social Security for the Young: A Framework for Consensus,” Controlling the Cost of Social Security, 1984.

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