WHY ECONOMIC GROWTH WILL NOT HELP SOCIAL SECURITY
©1998 William Larsen
What is economic growth? It is simply the change in goods and
services produced between last year and this year. As more
people enter the work force, more services are provided and
more goods are produced. Similar to having your kids help out
with the dishes. They get done faster so you can do something
else. More help, plain and simple. It also includes a bit of
inflation and productivity improvements. As wages increase
across the board, so does the measurement referred to as
The Old Age Survivors Insurance (OASI) Benefit is based on the average wage in which one turns 62 or in the future, the earliest year you may retire. All previous years wages are adjusted based on this year's average wage. In a way it is adjusting wages you earned thirty and forty years ago to be brought up to today's equivalent. It is better than being adjusted for by inflation because as is stated above, it includes productivity improvements and inflation. The replacement factor for each year is calculated by dividing the average wage at 62 by each of the previous years average wages.
Bend points are used to make the OASI benefit extremely regressive. They act the same as break points between the 15%, 28% and 33% tax brackets. The average monthly indexed wage is less than or equal to the first bend point is replaced at 90%. The amount of the wage exceeding the first bend point and up to the second bend point is replaced at 32%. Any amount above the second bend point is replaced at 15%. Though some think the FICA tax is regressive, the benefit formula more than compensates for this. The bend point is adjusted by the previous years average wage divided by the average wage in 1977 multiplied by the bend point in the previous year.
The indexed wage for each year is found by the product of the OASI wages for each year and the replacement factor for each year.
Once all the indexed wages are determined, the average of the best 35 years is used to determine the OASI benefit.
Once the average indexed wage is calculated, the bend points come into play.
For those who retire early, there is a small price to pay. For each month one retires early, they loose 5/9 of 1% for each month. For a person who retires at 62 versus 65, the benefit will be reduced by 20%. Furthermore, once your benefit has been calculated at 62, it is no longer adjusted by the change in average wages, but by inflation.
In summary, economic growth, which many believe the Social
Security Trustees have underestimated so badly, will not help by
assuming it larger. The simple reason, is as wages go up, so do
the bend points, previous years wages are adjusted upwards, and
ultimately the OASI benefit of future beneficiaries is increased.
Because the unfunded liability is growing by more than the sum
total of all FICA revenues, there is no chance for expenses to
converge with revenues.
To make things even worse, as wages increase and the rate of
return the OASI fund earns each year decreases, the more that is
required to be set aside each year to pay future benefits. Once
the change in rate exceeds the rate of return, the system is
completely out of control. The funds in the OASI trust become
worth less each year instead of growing.
Think of wage growth as inflation. Most people understand the
concept between inflation and rate of return. If you can earn
10% on your money and inflation is 2%, you do not have to set
aside as much each year as you would if you only earned 5%. If
inflation goes to 8% and you only earn 10% return, you must
start saving more. In this case one is trying to maintain a future
cash flow based on the change in inflation. However, Social
Security is trying to maintain future cash flows based on
changes in wages, not inflation. Wage growth is the same as
inflation in the case of Social Security.
Therefore, as the ratio of workers to retirees decreases, the gulf
between what should be saved to replace the reduced revenues
in the future and what is being saved widens.
Now the question is, do you really want to continue paying into
a system that is not only economically bankrupt, but is also
mathematically referred to as a divergent series?
Back to the home page.