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Social Security Crisis?

While many believe that Social Security is doomed, new research says otherwise.

Dan Danford, 12/06/2007

Mark Twain's famous retort "The reports of my death have been greatly exaggerated" could apply to the commonly held perception that the Social Security system is in trouble. In his new book, The Social Security Crisis? An Evaluation of Status Quo Social Security, Dr. Jason T. White presents research and analysis that he conducted as a part of his Ph.D. dissertation.

The classic "everybody knows" scenario includes the widely accepted belief that the modern Social Security system faces looming shortfalls and ultimate bankruptcy as baby boomers move into retirement. White makes a compelling argument in his book, saying that it ain't necessarily so. Here's his thinking, as I understand it.

Unlike today, Social Security faced a very real and imminent short-run financial crisis in the early 1980s. At that time, it was projected that the Social Security Trust Fund would be exhausted in mere months if action were not taken to preserve the program. President Reagan appointed the National Commission on Social Security Reform, which became known as the Greenspan Commission, named for its chairman, Alan Greenspan. The commission was charged with restoring short-run and long-run actuarial balance to the Social Security system, which they accomplished through a host of reforms, including an increase in the payroll tax rate that funds the system.

Shortly thereafter, the 1983 Board of Trustees declared the system to be in balance for both the short-run (10 years) and long-run (75 years) actuarial forecast periods, a period well beyond the life expectancy of the baby boom generation popularly believed to be the cause of Social Security's future anticipated insolvency.

So what has gone so terribly wrong since these reforms were enacted? What pending crisis creates the popular notion that Social Security faces insurmountable financial obstacles, and ultimately insolvency? According to White, nothing real.

In the book, White examines the Board of Trustees of the Social Security Trust Fund's recent annually reported estimates of the system's 10-year and 75-year actuarial balance. The trustees prepare three separate assumptive scenarios for analysis: "most optimistic," "most pessimistic," and "most likely." he system is actuarially balanced under all three scenarios for the 10-year period and under the "most optimistic" set of assumptions for the 75-year period. Even under the "most likely" 75-year period, it is now estimated that the Social Security system will still be able to meet more than 70 percent of its current obligations, despite grossly pessimistic assumptions by the trustees about the future of the U.S. economy.

White says that status quo Social Security can and should be preserved for future generations. He argues that the trustees are overly focused on actuarial balance as a measure of the future health of the program. This approach requires the Trustees to make many arbitrary assumptions for the next 75-years regarding the economy, demographics, disability and forecast methodology.

White argues that the pessimism in these assumptions, even under the "most likely" scenario, should give one pause for thought. For example, growth in real gross domestic product, a critical economic variable, is projected at a high of 2% in the early years of the forecast, and declines to an annual rate of just 1.3% by the end of the forecast period. Real wage growth is assumed to fall to less than 1% during the forecast period, despite the fact that we may experience significant labor market shortages from the retirement of the baby-boom generation. Worker productivity forecasts are equally dismal.

Noted economist Robert Eisner has testified that a mere 1% increase in annual worker productivity over the trustees' estimate completely eliminates any trust fund financial crisis or Social Security's bankruptcy in the short- or long-run forecast periods!

In White's analysis, the most important forecast assumption affecting the future health of the program is the rate of economic growth as measured by growth in real gross domestic product. The trustees' anemic long-run forecast for this variable is difficult to understand since the United States has never experienced such a protracted pace of growth, nor do they provide adequate explanation for their pessimism regarding the future.

To White, it appears that those advocating privatization of Social Security are successfully breaking the link between the real economy and the financial economy. They cite the forecast of the trustees and argue that because the real economy will grow interminably slowly in the future, we must invest Social Security taxes into private financial markets to capture what the historical equity premium has averaged. Divorcing the real and financial economies is misguided, in his view. It is incongruent to believe that the magnitude of the historical equity premium will persist in a future where the pace of real economic growth is forecast to be much lower than in the past.

White reminds the reader of the importance of preserving the core promises of the present Social Security system. The program guarantees a minimum safety net retirement income annuity to all who have qualified through accumulated workforce service. It increases national savings by continuing to reduce government borrowing pressure in the private market. The progressive tax and redistribution mechanisms help close the increasing gap between the rich and poor. The program extends universal insurance coverage, rather than means testing as social welfare programs do. Social Security improves generational equity, allowing older Americans to share in the wage growth of today's workforce. Also, total administrative costs of the program rival the best-run insurance company programs in private industry.

In case you are wondering if this guy is credible, I feel compelled to add that White has been a finance professional for almost 15 years. During his business career, he has held positions in both the public and private sector, focusing primarily on financial analysis, business valuations and financial advisory services. For the past 10 years, he has also been teaching at the college level, currently as assistant professor of finance at Northwest Missouri State University in Maryville, Mo.

This book is a thoughtful evaluation of the Social Security system and offers an alternative view to conventional wisdom. It's a good primer for financial professionals of all stripes. You can learn more about White at www.familyinvestmentcenter.com.

Disclosure: White is the chief investment officer of Danford's Family Investment Center.

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