Unfunded Future Entitlement Costs Not in Debt Debate

The debt service battle in Washington, D.C. has the parties battling over ways to reduce costs and increase taxes. None of the participants are dealing with the real threat to long term survival: unfunded entitlements. This blog compares social security with the transactions of a private pension plan to illustrate my claim.

Assume a person is 55 years old. This person will retire at age 65. This person will live until age 85. The person's employer must put aside this year enough money  to pay for the pension payouts starting at 65.

I assume the earning of the person at age 55 adds $120 to (this is made up)  annual pension payment starting at age 66. I further assume that the dollars put aside to cover the $120 annually payment will earn 4 percent until the person dies (another assumption used to make calculations easier).  

The person's employer must put aside $1,101,74 to pay for the $120 per year the employee is to receive starting at age 66 and receive till death. This $1,101.74 grows to $1,696,07 during the 55-year-old’s working life (4 percent per year growth). The $120 annual payment is deducted from the $1696.07. The amount remaining continues to grow at a 4 percent annual rate. This will provide the $120 per year for the rest of the person's life. This occurs every year the person works.

This one year effect on the person’s pension is illustrated in chart 1.

The pension designed in this example is solvent assuming the assumptions are accurate. If the person is expected to live a shorter life or the interest the pension earns is higher than the 4 percent the amount deposited at age 55 would be smaller. If the person lives longer or the the rate of growth is smaller than 4 percent the amount deposited is higher. The private pension is required to put aside enough money to pay for the future benefits.

The same person at age 55 pays a Social Security Tax. There is no formal relationship between the amount paid and the future payouts. This means there is no plan to ensure the amount you pay in taxes covers your later payments.  

Social Security is not designed this way today and never was. The 55-year-old’s Social Security Tax paid goes directly to recipients. If there is any money left it is given to the federal government in the form of a loan. There is no account set aside tied to you. The private company puts enough money away today to pay for your benefits tomorrow. The federal government assumes there will be enough people paying into the system when the 55-year-old retires to pay his benefits.

This is no longer true. The number of people receiving benefits is increasing faster than those paying taxes and the system is destined to break down.

Medicare works the same way as social security. The taxes paid by people working today does not go into a fund. It pays for the benefits of those retired today. The board of directors of a private plan designed this way would be jailed.

When someone attempts to bring these issues to light they are depicted as throwing grandma off the cliff. Voters reward those who perpetuate a system that cannot continue. The current system will lead to rationing and a system where grandma (grandpa, too) will be allowed to die with “dignity” because it is cost prohibitive to keep her alive another three years. Someone besides grandma, or her family, will determine the value of her life.

Washington has not passed a budget in about two years. If we cannot pass a current budget we will not deal with unfunded future obligations. God help us.