The Old Way and the New Way.

Once upon a time, the United States briefly (1945-1965) stood unchallenged atop the world economy.  “What America makes, the world takes.”  A handful of giant companies dominated the American economy.  They were capital-intensive mass production and mass employment manufacturers.  They paid good wages and many offered generous defined-benefit pension plans.[1]  The companies had been created by ruthless, visionary entrepreneurs.  By the Forties, Fifties, and Sixties, they were owned by mere heirs and by a great many upper middle-class stockholders.  Salaried managers with B-School degrees actually ran the increasingly bureaucratized companies.  No one much objected to punitive taxation of the well-off.  This is today’s Democratic Party idea of a “normal” economy.  It has been in decline for 50 years.[2]

Then change happened.  Part of the change came from abroad.  Foreign countries became serious competitors with American industry.  Then the “oil shocks” of the Seventies set off an inflation that disordered many areas of the American economy.  Part of the change was domestic.  New generations of ruthless entrepreneurs pushing new products rose up.  These people weren’t heirs to someone else’s work.  They had built their own businesses and fortunes.  Many of these people got rich without getting stupendously rich.  Therefore, many of them rejected the existing social consensus on soaking the rich.[3]  Reaganism followed and continues to this day.[4]  These changes sent shock waves through America’s economy, society, and politics.

For example, dying old industries and growing new industries faced the same problem of employee compensation.  (For that matter, so did many states and cities that had fobbed off public employee unions by promising them generous benefits in what the Brits call the “Never-Never”).  Neither corporate profits nor the stock market could guarantee adequate returns to support the defined benefit promises.  First, beginning in 1978, the private sector began to shift from “defined benefit” to “defined contribution” retirement plans.  Second, employers shifted a large share of medical insurance costs to employees as a way of holding down labor costs.  Since 1999, inflation has raised prices by 47 percent, but average contributions by workers to individual health insurance premiums have risen 281 percent.

The future well-being of employees came to depend upon their wisdom in choosing suitable retirement plans and on their willingness to divert income into savings.  Other factors also shaped their behavior.  First, we’ve been living with low interest rates for quite a while now.  This both encouraged people to pick up “cheap debt” and—through the magic of compound interest—slowed the rise in value of what people did save.  Second, many people had never thought much about saving and investing because the company’s pension and Social Security allowed them to not learn about it.  People often opted out of savings plans or made poor investment decisions when they opted in.

The median personal income of people aged 55 to 69 leveled off from 2000 (before the Great Recession) to the present.  This did not stop people from spending more.  On average, people approaching retirement these days have heavy debts (some for college for their kids, but also for other stuff).[5]  They also have been mining their savings, rather than building them.  The Great Recession both reduced contributions to 401k plans and caused many people to withdraw from them to make ends meet.

The long-term results of this huge change in the social contract are just now beginning to be felt.[6]  More than 40 percent of households headed by people aged 55 to 70 will not have the resources to maintain the standard of living they enjoyed while working once they hit retirement.  Households with at least one worker aged 55 to 64 had a median savings of $135,000 in their 401k plans.   The median annual income from their 401K plans is $8,000.  This should yield a paltry $675 a month in income.

Worse still, the Social Security Trust Fund will have to reduce payments at some point in the future as it is depleted or exhausted.

Undoubtedly, the disaster that is emerging renders a severe judgement on many of the “Baby Boomers.”  Not all of the human-interest stories included in journalists’ stories arouse the same degree of sympathy.  Faced with the need to save for the future and to be self-reliant, many of them delayed saving, stinted saving in favor of consumption[7] until too late, and then did too little.

Still, as a matter of public policy, there are going to be powerful and compelling arguments made in favor of a government response.  If the government expands benefits to the worst off retirees, then either taxes or deficits will rise or benefits for the better-off will be decreased.  Perhaps all three will form the basis of a compromise.

[1] By the 1980s, almost half (46 percent) of workers belonged to an employer pension plan.

[2] Without Democrats being willing to notice the changes.  JMO.

[3] Warren Buffett is in no sense a representative figure among this group.

[4] To the Democratic slogan of “tax, spend, elect,” the Republican learned to reply “tax-cut, spend, elect.”  See: William Shakespeare, Romeo and Juliet, Act 3, Scene 1.

[5] The per capita student loan debt of people aged 60 to 69 rose from about $300 to about $1,800 between 2004 and 2017.  Per capita debt for cars for the same group of people rose from about $3,000 to about $4,000 between 2004 and 2017.  It looks like people chose not to choose between guns and butter.

[6] Heather Gillers, Anne Tergesen, and Leslie Scism, “Time Bomb Looms for Aging America,” WSJ, 23-24 June 2018.

[7] Sales of HD televisions soared during the Great Recession.  The graph is for global sales, but may offer an approximation of American behavior.  See: https://www.statista.com/statistics/461114/full-hd-tv-shipments-worldwide/

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Campaign Issues 2016 1.

Currently, Social Security faces two fundamental problems.[1]  One fundamental problem is that Social Security is based on a “pay-as-you-go” model: withholding taxes from people who are working pay for the retirement of people who are no longer working.  Fine.  If there are a lot of people working and a smaller number not working, then the system functions smoothly.  What if the number of people working declines relative to the number of those who are not working?  That’s more of a problem.  Taxes on those still working will have to rise to pay for those no longer working.  That is the situation in which Americans find themselves as the “Baby Boom” generation passes out of the work force and into the work-for-me force.

This problem has been around for a long time and people in authority have been trying to devise a solution for a long time.   In 1983 a bi-partisan commission investigated solutions.  Congress followed the commission’s recommendations by raising taxes and extending the age of full eligibility. That fixed the problem for a while, but—of course–“I’m back!”  In a report of 2015, the trustees reported that the Social Security trust fund will go broke in 2034, with the Social Security Administration able to pay less than 79 cents on the dollar of benefits.  In 2011-2012, President Barack Obama sketched a budget compromise agreement in which Social Security would be continually eroded by inflation.  The Republicans weren’t buying this idea.  Another solution, which could be combined with de-coupling Social Security benefits from the inflation index, would be to raise the cap on with-holding taxes.  Currently, only income below about $134,000 a year is subject to with-holding.  Raising that ceiling would generate a lot of revenue.  Taken together, these proposals probably offer a manageable means to solve the Social Security problem for the immediate future.

A second fundamental problem is that Social Security was never designed to be a full retirement pension.  It was meant to provide a basic income for retirees, who were expected to save from current income to pay for the bulk of their future retirement needs.  However, many members of the “Baby Boom” did not do any significant saving for their retirement.

Now, under the influence of the Bernie Sanders campaign, the Democrats have come out for expanding Social Security to make its benefits more generous.  Hillary Clinton has pledged to increase benefits for widows and for those who stop working to be care providers for children or sick family members; to resist reduction of cost-of-living increases; and to resist increasing the age for full eligibility.  She would pay for these increased benefits through higher taxes on the wealthy.  Still, even these proposals don’t go as far as the left wing of the party wants.  President Obama has remarked that “a lot of Americans don’t have retirement savings [and] fewer people have pensions they can really count on.”  How to make up for this lifetime lack of thrift?

Current proposals include increasing the benefits for all recipients while providing additional benefits for the uncertain number of the “most vulnerable”; and/or increasing cost-of-living adjustments to include medical costs.

Several questions arise out of these problems.  First, which “Baby Boomers” did not save and why did they not save?  Moral recriminations are going to be a part of this debate.  Second, what are these proposals likely to cost?  Third, how large a share of the well-off will have to be taxed more heavily?  Just the “1 percent” or the “5 percent” or anyone who did manage to save?  Fourth, do Americans want to transition Social Security from the current partial pension system to a full-blown national retirement system?   What would a long-term system require?

[1] Robert Pear, “Driven by Campaign Populism, Democrats Unite on Social Security Plan,” NYT, 19 June 2016.