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Crossing the U.S. Policy Void∗
Aaron M. Careaga+
This Draft: December 16, 2014
Abstract
The United States of America is in the midst of an enormous demographic and economic transformation; effects are witnessed through decreased labor force participation, stagnant economic growth, and financially strained government programs. Layered within the demographic change is a system morphed through partisan interests and inequitable assumptions. The country’s social insurance programs perpetuate on guarantees that supporters receive similar benefits as needed. Academics and government officials have warned of the coming population wave for decades, yet little action has been taken to mitigate associated problems. Safety nets are critical for developed nations to maintain minimum living standards and some forms are sustainable. U.S. social insurance programs are underfunded by $39.698 trillion dollars, net of assets and future tax revenue, if continued under the current structure. The following research is provided to raise awareness of the existing system’s insolvency, generational inequity, and long-‐term costs in hope of instigating the necessary discussion of realigning economic, fiscal, and social policies onto a sustainable trajectory. Keywords: Social Insurance; Aging Demographics; United States; Fiscal Policy; Entitlements; Health Care; Education; Military; Infrastructure; Behavioral Economics
∗The views and opinions expressed in this article are those of the author only, and do not necessarily represent the views and opinions of WealthMark LLC., or any of their affiliates and employees. The author makes no representation or warranty, either expressed or implied, as to the accuracy or completeness of the information contained in this article, nor is he recommending that this article serve as the basis for any investment decision—this article is for information purposes only. I want to thank Benjamin Esget and Asche Rider for helpful comments and discussion. +Research Analyst, WealthMark LLC, 1329 North State Street, Suite 206, Bellingham, WA 98225-‐9998, [email protected] (email).
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Contents
Introduction: The Perfect Storm
o 1.1 Background o 1.2 Demographics o 1.3 Fiscal Environment
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3 6 10
Structural Effects
o 2.1 Social Risks o National Defense o Education o Health Care o Infrastructure o Social Welfare
o 2.2 Economic Risks o Global Reserve Currency o Capital Markets o Consumer Economic o Foreign Direct Investment
o 2.3 Vested Interests
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17 18 19 20 21 22
24 25 27 28 30
Accountability
o 3.1 Social Policy o 3.2 Economic Policy o 3.3 Tax Policy o 3.4 Retirement Policy
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32 36 39 42
Resolution
o 4.1 Realigning Incentives o 4.2 Crossing the Void
o Structural Reforms o Support Growth Drivers o Returning to the Roots: Commonwealth Mentality
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46 48 48 52 54
Conclusion: Starting the Journey 56
Appendix 58
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1. Introduction: The Perfect Storm
“Those who cannot remember the past are condemned to repeat it.” – Santayana Social insurance programs are necessary pillars of modern society that not only benefit recipients, but also the population at large. Governments use these systems as a throttle to mitigate poverty and influence minimum living standards by providing a safety net to those who otherwise cannot support themselves financially. At a national level, it is the responsibility of elected officials to allocate tax revenue and manage these programs in a sustainable manner. Social insurance programs in the United States include Social Security, Medicare, Medicaid, Veterans Administration, federal employee and military retirement plans, unemployment compensation, food stamps, and agricultural related programs.1 These are funded through tax revenue and perpetuate on the guarantee that contributors receive similar benefits as they qualify. Changes in population size across generations greatly influence a country’s overall productivity and social demands. When a large percent of the population is younger, healthier, and working, there is a significant tax base to draw from with lower demand on social insurance programs. When population size fluctuates between cohorts and relatively more individuals draw from the system, benefits can only be funded through other means. Governments can either increase tax rates to generate more revenue or redirect funds from other programs and finance the shortfalls through deficits, indirectly borrowing money to bridge the gap. Increased borrowing and higher taxes are necessary to sustain government programs and social insurance benefit levels as entitlement demand grows. This reality not only favors older generations who paid relatively lower tax rates in higher growth periods but leaves unfunded legacy obligations to current and future generations and further disincentives personal and professional growth. Total costs of U.S. social insurance programs extend far beyond unfunded benefit obligations. Increasing tax rates or cutting benefits can be quantified with reasonable accuracy. The economic drag from diverting discretionary funding to mandatory programs inhibits maintenance and improvements to fundamental systems. Losses in economic competiveness, deteriorating infrastructure, a failing education system, the polarization of politics, and many other issues are all indirect costs. Even though not all of these can be quantified, evidence of the effects is visible today. Running deficits to finance shortfalls will continue to exacerbate government programs as compounding debt grows exponentially. Political choices will also become harder as the tug of war between discretionary and non-‐discretionary programs sculpts the future of the country. Warning signs have sounded for decades but election cycles leave policy makers with little courage to take action or even convey the severity to the masses. Remedies will not happen overnight, but action taken now will prevent current and future generations from major heartache. The following research explores the historical foundations of social insurance programs to provide an understanding of original structures and their modern adaptations. After this 1 Auburn University. “A Glossary of Political Economy Terms: Entitlement Program.” Accessed June 12, 2014. http://www.auburn.edu/~johnspm/gloss/entitlement_program.
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background, fiscal imbalances and political and social drivers stemming from these programs will become apparent and lead to a discussion of current and forecasted long-‐term effects. The scope of research centers on the United States, but successful and flawed international systems will be examined to discover strengths, weaknesses, and potential improvements. In conclusion, points of resolution and courses of action that can be taken to realign the country’s unsustainable fiscal and political trajectory will be reviewed.
1.1 Background
pen·sion·er (noun) pen(t)-‐sh(əә-‐)nəәr\
A 15th century word defined by Merriam Webster as a person who receives or lives on a pension; especially: a person who receives a government pension. Origins trace to mid 1600 German widows’ and teachers’ funds, established in good faith to protect those who could not support themselves. These eventually grew into funds for veterans, elderly, poor, and disabled citizens who otherwise didn’t have a safety net to insulate against adverse financial shocks.
Individuals often supported each other by living in extended families and working in agriculture or other craftsmen-‐type jobs prior to the industrial revolution. This structure began to shift as new economic demands drove jobs to factories and populations to major cities. Higher density societies demanded better health care and public services that, amongst other reasons, drastically increased life expectancies. The U.S. population age 65 years and older was over seven times larger in 1940 relative to the older group in 1870, an increase from 1.15 million to 9.02 million people.2 Increases in longevity and population size have supported the growth of economic and government structures that attempt to better mediate social demands.
Although limited military pensions were started in the late 17th century by English colonies in the United States, widespread universal social insurance was not formed until the early 20th century.3 The earliest pension programs were for disabled settlers who fought Native Americans. The country’s first pension law was enacted during the American Revolution to promote military enlistment, with benefits paid by each state until the U.S. Constitution was put into effect in 1778.
The Pension Act of 1818 reshaped military safety nets by extending coverage to all service members, not only the disabled, and bestowed lifetime benefits. Various other legislation extended coverage and benefits to military members and their families throughout the Mexican, Civil, Indian, Spanish American Wars and World War I. But nonmilitary citizens could not access widespread federal safety nets until the 1930s.
Everything changed when the Great Depression left millions unemployed, homeless, and hungry, encouraging both individuals and governments to institute national programs that assured minimum levels of living standards. President Franklin D. Roosevelt signed the Social Security Act into law in 1935, creating the Social Security Board that encompasses seven programs. These programs include old-‐age assistance, federal old-‐age benefits, unemployment insurance, aid to dependent children, grants to states for maternal and child welfare, public health work, and aid to the blind. Its structure was established independent from other government agencies, but
2 U.S. Census Bureau. “Historical Statistics of the United States: Colonial Times to 1957, part 1, series A 199–134, p. 15.” 3 U.S. Department of Veterans Affairs. “Military Pension History.” Accessed June 12, 2014. http://www.va.gov/opa/publications/archives/docs/history_in_brief.pdf.
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transitioned into a sub-‐cabinet agency in 1939 and then regained independence in 1995.4 In description of the Social Security Act, President Roosevelt stated that, “We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-‐ridden old age.” Sustainability of this goal has become questionable due to growing imbalances across program structures.
Largely maintained through a payroll tax on the working population, those who pay into the fund are entitled to receive benefits after defined thresholds are met. Significant portions of Americans were excluded from social security from the start. Minorities, government employees, self-‐employed individuals, and those in low and inconsistent wage jobs, or who otherwise had employer-‐based pensions, were excluded. Most of the unqualified persons gained eligibility to participate as social insurance programs grew.
Social Security was intended to be a self-‐sustaining advance funded system, but immediately transitioned towards a pay as you go program. Although current policy is not a pure budget neutral pay as you go system, changing the structure allowed elected officials immediate political support by diverting funds earmarked for future retirees into current initiatives as they saw fit. An advance funded system works like a national savings account where money deposited is only withdrawn for its intended purpose.5 Rather, the pay as you go system lies at the other end of the spectrum by using current tax dollars to pay obligations on a revolving basis. With even the slightest interruption in tax collection or miscalculation of benefit levels the system no longer balances.
These programs were developed with good intention, but held serious structural flaws that Government officials recognized from the start based on failed international systems. On November 27, 1944, Chairman Arthur J. Altmeyer of the Social Security Board warned the House Ways and Means Committee:
In this country we are still in a position to avoid these mistakes by getting clearly established now that if our people want social insurance they must be willing to pay for it. The time to obtain the necessary contributions is when people are able to pay for the insurance and are willing to pay for it because they can be shown that they are getting their money's worth. If we should let a situation develop whereby it eventually becomes necessary to charge future beneficiaries rates in excess of the actuarial cost of the protection afforded them, we would be guilty of gross inequity and gross financial mismanagement, bound to imperil our social insurance system.
Initiating a transfer payment scheme with workers varying in age and taxable income, and elder cohorts who never paid but already qualify for benefits, is difficult because one cohort typically gains and policy adjustments are inevitable. The social security payroll tax rate was initially set at two percent and was to be split equally between the employee and employer. The rate was originally scheduled to increase one percent every three years until it reached six percent in 1949, but Congress enacted legislation preventing the increase until 1960.6 The following table displays 4 U.S. Social Security Administration. “Development of Social Security in America.” Accessed June 17, 2014. http://www.ssa.gov/policy/docs/ssb/v70n3/v70n3p1.html. 5 Ibid 6 Congressional Research Service. “Summary of Major Changes in the Social Security Cash Benefits Program: 1935-‐1996.” Accessed June 18, 2014. http://www.ssa.gov/history/pdf/crs9436.pdf.
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the varying tax rates across decades for Social Security's Old Age, Survivors, and Disability Insurance (OASDI) program and the Medicare's Hospital Insurance (HI) program.
*Employer & Employee Combined Rate Source: U.S. Social Security Administration
Tax rates are only one variable in the program’s revenue equation as the Social Security Administration also defines limits on the amount of earnings to be taxed. The maximum amount adjusts based on the national average wage index, the most recent average being $44,321.67 in 2012. Ignoring inconsistencies in growth rates between the national average wage index and real median household income reported by the U.S. Census Bureau, earnings limits are set for the social security (OASDI) payroll tax. The Medicare (HI) program followed a similar structure until 1993 when taxable limits were removed. For example, an individual earning $50,000 a year in 2014 pays a combined $6,200 in social security tax and $1,450 in Medicare tax per year.
Source: U.S. Social Security Administration
Earlier generations were subject to inconsistently favorable taxation both in tax rate and earnings limit terms, which has led to a significant underfunding of program reserves and a mismatch in benefit obligations. As Arthur Altemeyer recognized in the 1940s, a sustainable transfer payment scheme taxes individuals while they are still working by matching current rates and earnings limits with future benefit obligations. For social insurance programs to remain solvent, funding assets and equity held need to be greater than or equal to the liabilities paid.
As with individual budgets, federal finances must also balance:
Year OASDI HI Total OASDI HI Total1940 2.00% - 2.00% - - -1950 3.00% - 3.00% - - -1960 6.00% - 6.00% 4.50% - 4.50%1970 8.40% 1.20% 9.60% 6.30% 0.60% 6.90%1980 10.16% 2.10% 12.26% 7.05% 1.05% 8.10%
1990 - Today 12.40% 2.90% 15.30% 12.40% 2.90% 15.30%
Employer & Employee Self-Employed
Social Insurance Payroll Tax Rate History
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!Earnings!Limit!
Year!
OASDI!Contribu7on!and!Benefit!Base!
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Assets = Liabilities + Equity
Assets generated in the form of tax revenue significantly outpaced benefit obligations leading to fiat equity reserves in the early days of the system. Aging demographics, rising health care costs, benefit adjustments, and decreased labor force participation (resulting in a lower taxable base) are driving program imbalances between revenue and obligations to unsustainable levels. U.S. financial accounts cannot withstand the increases in debt levels necessary to indirectly cover the gap in revenue, nor can payroll taxes be raised beyond levels that disincentives the country’s economic engine. An unbiased review of the facts is critical to establish national priorities.
1.2 Demographics
Modern societies are continuing to learn how to sustain population levels that have never been seen before and which are living much longer. Global population is expected to plateau around 10 billion people as birth and mortality rates stabilize at lower levels over the next century.7 Although fertility and mortality rates are declining across the globe, older groups are increasing in size as existing populations age transforming demographic structures from a pyramid towards a rectangle age profile.8
Life expectancy in the United States was 47.3 years for a person born in 1900, 68.2 years for a person born in 1950, and 78.7 years for a person born in 2010. Remaining life expectancy at age 65 has also greatly increased over the past half-‐century, from 13.9 years in 1965 to 19.1 years in 2010.9 Both statistics are prime examples of the increases in longevity due to advances in health care and social programs, yet over this period the average retirement age has remained largely unchanged. Expecting younger generations to finance unfunded retirement and health care benefits will constrain most developed nations future prosperity.
Source: U.S. Centers for Disease Control and Prevention
7 TED. “Hans Rosling: Religions and babies.” Accessed June 20, 2014. http://www.ted.com/talks/hans_rosling_religions_and_babies#t-‐781676. 8 Gates Foundation. “2014 Annual Letter, Myth Three”. Accessed June 20, 2014. http://annualletter.gatesfoundation.org/#section=myth-‐three. 9 U.S. Centers for Disease Control and Prevention. “2013 Health Statistics, Table 18.” Accessed June 20, 2014 http://www.cdc.gov/nchs/data/hus/2013/018.pdf.
0"
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1950" 1960" 1970" 1980" 1990" 2000" 2010"
Popu
la'on
)(in)thou
sand
s))
Year)
US)Popula'on)by)Age,)1950)?)2010)
85+"
65-74"years"
55-64"years"
45-54"years"
35-44"years"
25-34"years"
15-24"years"
5-14"years"
1-4"years"
Under"1"year"
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A country’s economic productivity is greatly influenced by each generation’s education, health care, and social demands as they transition through life. Age groups are classified to better understand and track their characteristics across time. Recent cohorts in the United States include the Lost Generation from 1883 to 1900, the GI Generation from 1901 to 1924, the Silent Generation from 1925 to 1945, the Baby Boom Generation from 1946 to 1964, Generation X from 1965 to 1979, the Millennial Generation from 1980 to 2001, and the New Silent Generation from 2001 to the present.
Current demographic and policy discussion revolves mostly around the Baby Boom Generation because of their influx in size and overall influence held across economic, political, and social dynamics in the United States. Increases in fertility rates after major wars are common, but the period following WWII was unique because levels remained elevated for nearly two decades spurring a population wave. Generation X, the group between Baby Boomers and the Millennial Generation, is smaller in size creating a relative gap in the workforce.
Due to a number of factors ranging from the recent financial crisis, housing market collapse, and underfunded retirement savings, Baby Boomers are remaining in the workforce longer than previous groups. Labor force participation for the age group 55 and older has not been at current levels since the 1960s, while participation amongst the core workforce peaked in 1999 and has decreased since. The core workforce age 25 to 54 also exhibits a higher unemployment rate relative to the older group age 55 and over.10 Older groups waiting to retire benefit social insurance programs through ongoing income taxes and delaying benefits, but also impacts opportunities for younger portions of the workforce.
Source: U.S. Department of Labor: Bureau of Labor Statistics
All Baby Boomers will be age 65 or older by 2030, at which time it is expected the Boomer cohort will comprise twenty percent of the population. American’s at age 65 and older are forecasted to 10 U.S. Department of Labor: Bureau of Labor Statistics. “FRED Unemployment Rate, Age 25-‐54, Age 55+.” Accessed June 20, 2014.
0.0#
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90.0#
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As#%#of#C
ohort#
Civilian#Labor#Force#Par6cipa6on#Rate#
25#to#54#years# 55#years#and#over#
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outnumber the population age 18 and under by 2056.11 Permanent shifts are occurring that will influence not only social insurance programs, but also many other aspects of American business and life. Applying traditional logic to systems that rely on a significant base of young workers for support will undoubtedly be challenged in an aging world.
Modern population characteristics are fairly predictable across time. Individuals give birth and those children become adults twenty years later. Around the age of forty, they fully transition into adulthood and a certain percent are likely to have conceived children. About twenty years later, they enter retirement and eventually pass away around the age of eighty. Dependency ratios afford great perspective on population structure over time by comparing the dependent population, children under 18 years old and elderly 65 years or older, to the working age population. Because most government programs are largely financed through payroll taxes on the working population, changes in these ratios reflect the unsustainable nature of their current structure.
Youth dependency in the U.S. has relatively decreased since 1940, but old age dependency continues to grow. Over the next few decades, total dependency as a percent of the workforce will near levels not seen since the 1960s and 1970s. But during this earlier period there were a large group of dependent youth about to enter the workforce. Today there is a large group of the workforce entering retirement and becoming dependent. This shift conforms to the notion raised earlier of the population rebalancing from a pyramid shape to a rectangle age profile across time. Pyramid shaped financing systems, where a continuously growing lower base of supporters is needed to support the top level of beneficiaries, break down under this transformation.
Source: U.S. Census Bureau
Aging demographics is also a global issue. China and India are the only countries to exceed the United States in population age 65 and older in size by 2050.12 This transformation over the next half century will not occur without placing strain on governments and their social insurance programs. Even though the number of Americans age 65 years and older will outnumber similar 11 U.S. Census Bureau. “2012 National Population Projections.” Accessed June 25, 2014. http://www.census.gov/population/projections/data/national/2012.html. 12 U.S. Census Bureau. “An Aging Nation: The Older Population in the United States.” Accessed June 25, 2014. http://www.census.gov/prod/2014pubs/p25-‐1140.pdf.
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groups in all other developed nations, as a percent of the total population, the U.S. will remain younger than much of Europe, Canada, Japan, and Russia.
Source: U.S. Census Bureau
Immigration is another force transforming the U.S. alongside aging demographics. The country is expected to not only become much older, but also more racially and ethnically diverse over the coming decades. Balancing differences in cohort size across generations will provide greater resources to sustain transfer schemes over the long-‐term. But short to intermediate challenges facing social insurance systems resulting from fluctuating group sizes and an inconsistent structure threaten future prosperity.
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1.3 Fiscal Environment
Federal government spending has changed greatly over the United States history. WWI and WWII caused significant amounts of revenue to be directed towards national defense programs but this trend returned to normal levels after wartime. To facilitate the analysis and better understand variations in federal expenditures over time, government programs will be classified into four major categories: entitlements, national defense, infrastructure and services, and net interest.
Entitlements include all social insurance and health care programs, veteran’s benefits, unemployment compensation, job training, and related costs. National defense includes military expenditures such as maintenance of the Air Force and Coast Guard. Net interest covers the ongoing and legacy financing costs resulting from national deficits. Infrastructure and services include transportation and agriculture programs, federal employee compensation, science and technology programs, the judicial system, and all other discretionary spending. These categories are graphed as a percent of GDP below to not only visualize how tax dollars are spent but also to display the changes over time relative to U.S. productivity.
Source: The White House Office of Management and Budget
The government has spent a majority of tax revenue on national defense until the 1970s after which entitlement expenditures overtook all other programs. The traditional function of government is often thought as maintaining the nations infrastructure, overseeing the judicial system, providing national defense, supporting science and technology, and guiding the education system. Yet the largest portion of tax revenue is directed towards the entitlement system. Because entitlements are politically untouchable, it’s easy to see how other federal programs are stagnating relative to international standards.
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Outlays(as(%(of(G
DP(
Federal(Government(Spending(by(Program(
En/tlements# Na/onal#Defense# Infrastructure#&#Services# Net#Interest#
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Government revenue is derived from taxes on individual income, payroll, corporate income, excise, and other activities. Individual income taxes are the main source of revenue that has produced nearly half of all government receipts over the past half century. Payroll taxes are the second largest driver of revenue for the government, increasing from about ten percent in the 1950s to about forty percent of total revenue in recent years. Corporate income taxes and excise taxes have both dropped significantly over this period. As exhibited in the graph below, a growing and prosperous workforce is critical to maintaining the tax base necessary to support most federal programs.
Source: The White House Office of Management and Budget
As individual income and payroll taxes are the largest drivers of government revenue, the workforce is held responsible for the unsustainable costs of social insurance and other government systems unless their funding structure is reformed. Large groups of the population are disconnected from the true cost of these programs and at the same time inequitably benefiting. It is becoming politically impossible to address this fact and will intensify if responsibility is not shared across the country’s elected representatives.
The U.S. President submits an annual budget proposal that reviews the current state of federal programs and compiles historic and forward looking financial activity. The budget proposal is a collection of analysis issued by The Office of Management and Budget and other agencies. Congress either accepts or rejects the President’s budget and, if accepted, it is enacted into law.
Federal budgets are unique because they are compiled on a cash basis, only reflecting income and expenditures that have occurred. In direct comparison, U.S. regulatory bodies require private sector businesses to report on an accrual basis. Accrual accounting is considered a more accurate representation of complex entities financial health because it includes reasonably estimated future income and obligations. Although the government is obligated to maintain federal programs, reasonably accurate unfunded social insurance obligations are not reflected on the annual
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1934# 1939# 1944# 1949# 1954# 1959# 1964# 1969# 1974# 1978# 1983# 1988# 1993# 1998# 2003# 2008# 2013# 2018#es/mate#
Receipts(as(%(of(G
DP(
Sources(of(Federal(Revenue(
Individual#Income#Taxes# Corpora/on#Income#Taxes# Payroll#Taxes# Excise#Taxes# Other#
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budget.13 This leads to an incomplete perspective of the programs and overall country’s financial health.
The fiscal year 2015 budget proposal shows that the government expects to spend 3,651 billion dollars, but only collect 3,002 billion dollars in 2014. The difference between receipts and outlays represents a 649 billion dollar deficit. Although the President expects deficits to decrease or stabilize through 2024, this report does not reflect unfunded social insurance obligations or their indirect cost imposed on other government systems. Elected officials often use these reports as a basis for legislative decisions and their overall understanding of the country’s health.
Table 3 – Presidents 2015 Federal Budget
In coordination with the U.S. Treasury and the Office of Management and Budget, the Government Accountability Office is required to audit the country’s annual financial report. Each department includes a Management Discussion and Analysis section similar to corporate SEC filings. In the most recent audit of fiscal year 2012 and 2013 financial statements, both the Treasury Secretary and Comptroller General of the United States conveyed an urgent need for social insurance reform and described the immediate threats facing the country if action is delayed.
Under the guidance of Secretary Jacob Lew, the Treasury department concedes in the Financial Report of the United States Government:
Persistent growth of health care costs and the aging of the population due to the retirement of the “baby boom” generation and increasing longevity will make it increasingly difficult to fund critical social programs, including Medicare, Medicaid, and Social Security.
Delaying action increases the magnitude of spending reductions and/or revenue increases necessary to stabilize the debt-‐to-‐GDP ratio. Relative to a reform that begins immediately, for example, it is estimated that the magnitude of reforms necessary to close the 75-‐year fiscal gap is more than 20 percent larger if reforms are delayed by just ten years, and more than 50 percent larger if reform is delayed 20 years.
13 U.S. Department of the Treasury. “Financial Report of the U.S. Government, Management’s Discussion.” Accessed June 26, 2014. http://fms.treas.gov/frsummary/FR-‐Summary-‐2013.pdf.
Source: The White House Office of Management and Budget
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Economic costs of delaying social insurance reform grows exponentially due to the compounding nature of unfunded current and legacy benefit obligations. As determined by the change in average primary surplus, if reform occurs in 2014 social insurance programs will cost U.S. economic productivity 1.7% of GDP until 2088. This increases to 2.1% of GDP if reform is delayed ten years until 2024 and to 2.6% of GDP if reform is delayed thirty years until 2034.14 A longer delay in addressing the structural imbalances of critical programs that millions of Americans rely upon for assistance not only threatens productivity but also the support of other government programs and the economic incentives for growth.
All social insurance programs have surpassed peak funding levels and most trust funds are paying benefits that exceed current tax revenue, excluding interest on fund assets. Trust fund assets are forecasted to be exhausted much sooner than most Politicians and the American public is aware of. Social Insurance programs qualify benefits as obligations and not liabilities because current law mandates that only the available trust fund assets and incoming tax revenue be used. Unless their structure is reformed, or current laws are adapted, benefits will be cut to match tax revenue levels for each period. The Disability Insurance program is in the worst financial shape with its trust fund’s assets depleted in 2016.
Source: Social Security and Medicare Board of Trustees
In the Financial Report of the United States Government, Comptroller General Gene Dodaro explains:
Over the long term, the imbalance between spending and revenue that is built into current law and policy will lead to continued growth of debt held by the public as a share of GDP. This situation—in which debt grows faster than GDP—means the current federal fiscal path is unsustainable. Further, without legislative action, the Social Security Disability Insurance Trust Fund’s assets are projected to be exhausted in 2016, at which time the Social Security Administration would need to reduce benefits consistent with available funds.
Financial oversight and federal management institutions, established to protect the nation and its people, are calling for reform yet neither the President nor Congress is materially confronting these issues. Millions of Americans are led to believe systems they’ve paid into will provide support even when the U.S. Treasury and Comptroller General, along with numerous other government organizations, are warning of the impending reduction in benefit levels.
Social insurance programs are underfunded by $39.698 trillion dollars, net of assets and future tax revenue, if continued under the current structure. If another model of social insurance were to replace the existing model, either advance funded or a separate financial form, the legacy costs and beneficiary obligations remaining to be funded is a staggering $53.974 trillion dollars. Social Security expenditures in excess of future revenues increased 9% year over year, and will likely
14 U.S. Department of the Treasury. “Financial Report of the U.S. Government.” Figure 3, page 17. Accessed June 26, 2014. http://fms.treas.gov/frsummary/FR-‐Summary-‐2013.pdf.
Key Dates for Trust Funds OASI DI OASDI HIYear of peak trust fund ratio 2011 2003 2008 2003First year outgo exceeds income excluding interest 2010 2005 2010 2018First year outgo exceeds income including interest 2022 2009 2021 2021Year trust funds are depleted 2035 2016 2033 2026
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continue as program assumptions are revised and the Baby Boom cohort fully transitions into retirement.
Social insurance benefits are critical to maintaining stability across a large portion of the population for all countries. It is difficult to comprehend the magnitude of the unfunded liabilities facing the United States without context. For example, global pension funds assets totaled $31.980 trillion dollars in 2013 with a mere $18.9 trillion held by US pension funds.15 Net worth of every households and non-‐profit organization in the United States is $81.763 trillion dollars.16 Net worth is the value of country’s real assets (car, house, etc.), savings, investment accounts, and other assets minus its debts like mortgages, student loans, and credit cards.
To fully fund social insurance obligations, in attempt to replace the current unsustainable system, would take 168% of global pension fund assets or 66% of US household and nonprofit wealth.
Social Insurance Future Expenditures in Excess of Future Revenues
Source: U.S. Department of Treasury
A majority of the unfunded obligations can be attributed to health care expenditures for retirees, elderly, and the poor. Health care in the United States is multitrillion-‐dollar industry that, as a whole, charges far higher rates for similar or relatively worse results when compared to all other developed countries in the world. Some argue that health care expenditures are high because Americans have a greater per capita income relative to other developed countries, neglecting the fact it also has the highest level of income inequality. Uneven wealth distributions result in a greater portion of the population reliant upon safety net programs to subsidize or cover the costs.
Major federal health programs in the U.S. include Medicare, Medicaid, CHIP, TRICARE, and Obamacare. Medicare is a federal insurance program funded through payroll taxes and provides support for the older population and disabled individuals. Medicaid is a health assistance program for low-‐income individuals regardless of age. The program is financed through federal, state, and local taxes, and its structure varies by state. CHIP is also a quasi federal and state health care
15 Towers Watson. “Global Pensions Asset Study – 2014.” Accessed June 26, 2014. http://www.towerswatson.com/en-‐US/Insights/IC-‐Types/Survey-‐Research-‐Results/2014/02/Global-‐Pensions-‐Asset-‐Study-‐2014. 16 U.S. Federal Reserve. “Economic Data: Household and Nonprofit Net Worth. Accessed June 27, 2014. http://research.stlouisfed.org/fred2/series/TNWBSHNO.
$ %Open Group (Net): Social Security (OASDI) (12,294.00)$ (11,278.00)$ 1,016.00$ 9.00% Medicare (Parts A, B, & D) (27,302.00)$ (27,174.00)$ 128.00$ 0.50% Other (102.00)$ (102.00)$ -$ 0.00%
Total Social Insurance Expenditures, Net (Open Group)
Total Social Insurance Expenditures, Net (Closed Group)
Social Insurance Net Expenditures as a % of Gross Domestic Product (GDP)*Open Group 2013 2012 Social Security (OASDI) -1.20% -1.20% Medicare (Parts A, B, & D) -2.90% -3.00% Other 0.00% 0.00%Total (Open Group) -4.20% -4.20%Total (Closed Group) -5.50% -5.60%
(53,974.00)$ (51,604.00)$ 2,370.00$ 4.60%
Dollars in Billions 2013 2012 Increase / (Decrease)
(39,698.00)$ (38,554.00)$ 1,144.00$ 3.00%
15
program that provides insurance for children of families who cannot afford private insurance but do not qualify for Medicaid. The federal government matches benefits that are also determined by the states. TRICARE is the civilian health program for service members, retirees, and their families and is funded through the Defense Department.
The Affordable Care Act, otherwise known as Obamacare, is a federal mandate that all citizens hold insurance either through private carriers or public programs. It created a national insurance exchange to provide the uncovered population with insurance, and to shift other health program costs in hope of avoiding their respective insolvency. Subsidies in Obamacare are funded through taxes on individuals and businesses.
It is tough to see how federal health care spending is sustainable alongside the passage of a mandated national health insurance program. Similar to other social insurance programs, Obamacare should have been evenly implemented years ago when a majority of current high cost beneficiaries were still working. This poses another drag on the workforce and younger generations who are left to subsidize health care expenses for retirees that were never held to such standard but who now benefit.
With the significant amount spent on health care in the United States it should be reasonably expected that Americans are living longer and are healthier as a result. Life expectancy is actually a year less than the OECD average.17 Because the older group of the population spends the most on health care, addressing this cost benefit relationship is critical to the future sustainability of social insurance programs.
Source: Organisation for Economic Co-‐operation and Development
Health care spending is growing faster than most other federal programs and the overall economy, a trend that is expected to continue as the population ages. The CBO projects that by 2024 the U.S. government will spend a net $858 billion on Medicare, $582 billion on Medicaid and CHIP, and $137 billion on exchange subsidies and other items. Of the government expenditures net of tax revenue generated, sixty percent of federal health care spending will only benefit the population
17 Organisation for Economic Co-‐operation and Development. “Society at a Glance 2014 Highlights: United States OECD Social Indicators.” Accessed June 30, 2014. http://www.oecd.org/unitedstates/OECD-‐SocietyAtaGlance2014-‐Highlights-‐UnitedStates.pdf.
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16
age 65 and older.18 With about one in four Medicare dollars spent during the beneficiary’s final year of life.19 Again, social insurance programs are unsustainable under their current financing structure of taxing the working population in an aging environment.
America outspends most OECD countries on health care per capita. In 1970 the U.S. was spending an average of 7.1 percent of GDP on health care while the OECD average excluding the U.S. and Italy was 5 percent of GDP. Forty years later, spending has risen to 18 percent of GDP while OECD countries average 10.6 percent of GDP. Savings are estimated to be 1.05 trillion dollars per year if the country matched average OECD spending on health care.20 Addressing domestic cost and current benefit levels are necessary to realign social insurance programs onto a sustainable path.
Federal health care spending has increased faster than GDP, and at a pace consistently above OECD peers, while the taxable wage base supporting the social insurance system has shrunk. A trend largely driven by aging demographics (lower level of labor force participation) has resulted in a smaller workforce whose real wages have stagnated. Effects stemming from policies are visible across numerous aspects of society and felt by all population cohorts. A national discussion is critical to addressing the economic and fiscal imbalances stemming from aging populations.
18 U.S. Congressional Budget Office. “Shifting Priorities in the Federal Budget.” Slide 19. Accessed June 30, 2014. https://www.cbo.gov/sites/default/files/cbofiles/attachments/45342-‐StanfordEconomicPolicyResearch.pdf. 19 U.S. National Library of Medicine. “Long-‐Term Trends in Medicare Payments in the Last Year of Life.” Accessed June 30, 2014. http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2838161. 20 The Brookings Institute. “Growth in Health Consumption and its Implications for the Financing of the OASDI Program: An International Perspective.” Accessed July 1, 2014. http://www.nber.org/programs/ag/rrc/rrc2012/summaries/1.2%20Bosworth,%20Burtless.pdf.
17
2. Structural Effects “Compound interest is the eighth wonder of the world.
He who understands it, earns it… he who doesn’t… pays it.” – Einstein The disability insurance trust fund is forecasted to be exhausted in 2016, hospital insurance in 2026, and the old age and survivor’s insurance in 2035. Recipients and the population at large will experience some combination of forced reform, benefit level cuts or payroll tax increases, if these structures remain unchanged. Effects stemming from legacy and unfunded obligations continue to compound under the current social insurance system, negatively influencing the United States economic, political, and social opportunities. Mitigating this reality before action is forced will lessen the burden.
Entitlement programs have surpassed the inflection point where benefits paid outpace the underlying tax revenue generated, with obligations growing at a faster rate than the economy. Some academics and investment professionals attribute the current environment as to being “in the eye of a storm.”21 Revenue momentum under existing legislation supports forward movement over the short-‐term. But like the roadrunner continuing off a cliff, gravity of unfunded obligations will exhaust remaining fund assets and eventually catch monthly benefit payments.
Growth is the underlying driver of revenue for most business and government programs. It incentivizes future generations, creates opportunity for the workforce, and provides leaders with the ability to meet overall populations needs. Balancing current demands, while laying the groundwork for growth for the next generation, is the difficult but necessary role of contemporary leaders. A lapse between focuses sows the seeds of instability.
2.1 Social Risks
Social insurance programs are considered to be one of the most successful government systems ever implemented in the United States. A national focus on old age health, poverty, and financial security has supported many social trends that are visible through fewer associated negative effects, while other causes have suffered as priority is given to these issues.
It’s important to keep in mind the second derivative impacts while considering the proceeding risks. A question posed by Hoover Institute fellow Peter Robinson in an interview between Harvard political economics professor David Wise and Stanford’s Dean John Shoven is worth considering in light of these impacts.22
My next question is, in general terms, how bad is this for folks in the next generation? But let me get to this question in this way. There's an article in the current Forbes magazine in which Peter Drucker, the management guru, is interviewed. And Drucker points to a couple of fascinating population statistics. Italy, which has a population of 60 million today, is projected to go down below 40 million in 2050. Japan, which has a population of about 125 million, projected to be cut in half within a century on current birthrates. Interesting? What's going on?
Here's what Drucker says what's going on. The main reason for the decline in births is the enormous burden on people of working age supporting older people in retirement who are
21 Milken Institute. “A Conversation with Ken Griffin and Steve Schwarzman.” Accessed July 1, 2014. http://www.milkeninstitute.org/events/conferences/global-‐conference/2014/panel-‐detail/4863. 22 Stanford University Hoover Institute. “Aging: From Baby Boom to Bust.” Accessed July 1, 2014. http://www.hoover.org/research/aging-‐baby-‐boom-‐bust.
18
hail and hearty. You cannot cut the social security payments of older people because that's the law, so they cut where they have control, which is having babies. Now this is a kind of Blade Runner nightmare vision in which the older people in effect prey on the younger people. Give me medical care, give me income. It's not quite that bad in this country, is it? Or is it?
Individuals act out of their own best self-‐interest in making economic decisions. Financial resources are managed prudently when the environment hardly supports living standards. Population growth through higher birth rates is harder to achieve in economic stagnation. Like much of the developed world, China’s demographic environment is evolving similar to Japan’s aging demographics and falling birth rates. The Chinese government has lifted its one child policy in attempt to influence population growth, but less than 3% of the eligible parent base has elected to have another child. Policy analysts observe that, “confidence of couples in their ability to provide for a second child may also be waning as China’s economic growth slows.”23 Growth occurs in an environment that supports increased wealth and economic stability. Policy changes cannot immediately reverse long-‐term trends driving lower real incomes and stagnant economies.
The following section discusses how public policies on defense, education, health care, infrastructure, and human welfare have been indirectly affected as national priorities fluctuate with the election cycle and voting bloc. With relatively less tax revenue and slower growth to bridge obligations, a conscious review of social, economic, and political systems is necessary in influencing the country’s future.
2.1.1 National Defense
National security financing over the United State’s history has expectedly increased in times of war and decreased during times of peace. But in recent and forecasted federal budgets, as exhibited in the following graph, spending on defense is trending towards levels lower than the peace dividend period of the 1990s. This is thought to be the result of cost cutting measures in an attempt to slow the growth of federal debt and spread tax revenue shortfalls across all systems.
Source: The White House Office of Management and Budget
23 Bloomberg. “China Baby Boom Wagers Go Bust on Child Cost Burden.” Accessed August 21, 2014. http://www.bloomberg.com/news/2014-‐08-‐20/china-‐baby-‐boom-‐wagers-‐go-‐bust-‐on-‐child-‐cost-‐burden.html.
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19
Recent wars in the Middle East have strained both national security finances and public support to raise taxes to increase program funding. Continuous engagement in the region over the past decade has negatively influenced domestic productivity, geopolitical stability, and the international economy.24 Exhausting critical financial and political resources has left the country in a more fragile state to address unforeseen defense issues as they might arise.
Legacy and ongoing costs of war, paired with the impending strain on social insurance programs, should stand as a warning to elected officials to allocate available resources prudently before reform restricts the country’s ability to support domestic and international security. Although direct transfers cannot be made from defense programs to social insurance because of how the systems are structured, indirect costs of fiscal tightening do influence national priorities. With an increasing older age population who are traditionally predisposed to vote, a natural disconnect between certain government benefits and underlying costs exists.
2.1.2 Education
Another pillar of society influenced by competing federal interests is the country’s education system. Education is financed primarily through local and state taxes but is also subsidized by federal tax provisions. Management of the system is left to each state to implement, but the federal government, overall population, and media significantly influence academic standards. The foundation of a competitive workforce and prosperous economy is directly affected by the economic, social, and political support given to education programs.
Once a leader in K-‐12 and higher education, U.S. standards across subjects such as math, reading, and science have lagged international peers for decades. A recent Organization for Economic Co-‐operation and Development (OECD) study found the country spends significantly more per student, yet ranks 17th in reading and 27th in math skills relative to all other developed nations.25 Overarching ideologies around learning in the United States have changed very little in decades. Applying the same structure that led global education standards nearly a century ago in the current economic environment is obviously failing.
Higher education is slightly better than elementary in terms of efficiency, but some aspects do inhibit the competiveness of future generations. A majority of the world’s top universities can be found in the U.S. yet college graduates age sixteen to twenty-‐nine, that hold a bachelor’s degree, rank below the OECD average in math skills.26 27 Without a certain level of technical ability, the domestic workforce cannot compete with global peers even if a relatively significant portion has attained secondary degrees.
Tuition inflation has also impacted opportunities for current and future generations. The cost of higher education has outpaced the cost of books and supplies, housing prices, the consumer price index, and average hourly wages since the mid 1970s. To advance in a competitive and recently depressed job market, many students are forced to take on debt. This restricts the flexibility and
24 Stiglitz, Joseph E., and Linda J. Bilmes. "Estimating the Costs of War: Methodological Issues, with Applications to Iraq and Afghanistan." Accessed July 10, 2014. http://www.socsci.uci.edu/~mrgarfin/OUP/papers/Bilmes.pdf. 25 Organisation for Economic Co-‐operation and Development. “PSIA U.S. Education Study 2012.” Accessed July 10, 2014. http://www.oecd.org/pisa/keyfindings/PISA-‐2012-‐results-‐US.pdf. 26 The New York Times: The Upshot. “Americans Think We Have the World’s Best Colleges. We Don’t.” Accessed July 12, 2014. http://www.nytimes.com/2014/06/29/upshot/americans-‐think-‐we-‐have-‐the-‐worlds-‐best-‐colleges-‐we-‐dont.html?_r=0. 27 Organisation for Economic Co-‐operation and Development. “United States Adult skills (Survey of Adult Skills, PIAAC).” Accessed July 12, 2014. http://gpseducation.oecd.org/CountryProfile?primaryCountry=USA&treshold=10&topic=AS.
20
entrepreneurialism of the workforce as once an individual graduates they are less likely to take risks when debt must be serviced.
Source: The Economist
Responsibility falls upon every citizen to support initiatives that improve education standards and provide the skills necessary for meaningful employment across all trades. The U.S. can re-‐establish a solid economic foundation by addressing shortfalls in academic attainment and standards alongside the rapidly increasing cost of higher education. Programs that support growth in national productivity will ease the financial burden across all government programs.
2.1.3 Health Care
Developed nations have come to expect and rely upon access to quality health care at all stages of life. As discussed earlier, U.S. social insurance has provided the disabled, poor, and older age groups with health care subsidies in hope of influencing minimum living standards across the population. Access to health care from entitlement programs and the Affordable Care Act has resulted in a majority of the population holding some form of insurance. Even though health care costs in the United States are significantly higher than most developed nations and outcomes in terms of life expectancy, infant mortality, and other indicators are generally worse, the goal of nearly universal coverage is being achieved.28
Similar to the education system, applying traditional ideologies to modern health demands is proving inadequate. Nationalizing what many consider should be entitled conflicts with the for-‐profit structure of the current health care system. Overtreatment of symptoms and unnecessary procedures drive provider revenue and increase costs to the consumer and general public. Preventative measures on risks such as diet, exercise, and mental health gather negligible support on the health care scene.
Seventy-‐five percent of national health care spending comes from chronic disease. Yet, the World Health Organization estimates that if preventative measures were taken, eighty percent of heart disease, stroke, and type two diabetes cases would be prevented and more than forty percent of
28 U.S. Department of Health and Human Services. “National Prevention Strategy.” Accessed July 12, 2014. http://www.surgeongeneral.gov/initiatives/prevention/strategy/report.pdf.
21
cancer cases would be prevented.29 Even if preventative medical care costs as much as treatment, the country would be healthier and more productive by supporting offensive and defensive health policies. Government, industry, and society need to address the unsustainable nature of the current system to be able to provide adequate universal health care.
Because entitlement revenue is redistributed from payroll taxes to qualified recipients, relying predominantly on the workforce to support these indifferences is inequitable in an aging society. Mandated health insurance spreads the cost burden from unhealthy older groups to healthy younger groups. Both structures negatively impact the more competitive and already less productive economy. Bridging this reality could prove arduous because of the competing interests and lobbying reach of big health and the aging population. Priority needs to be given not only to access to universal health care but also to addressing inadequacies of the current system.
2.1.4 Infrastructure
Infrastructure is another luxury that modern societies have come to expect. But with fewer tax dollars to support competing demands, American infrastructure has fallen as a national priority. Resulting out of military necessity and existing structural disparities following World War I and II, the interstate highway system connects over forty-‐seven thousand miles and took thirty-‐five years to build. A majority of financing to build and maintain the system is derived from fuel taxes in addition to bridge and highway tolls. Expenditures on maintenance and improvements relative to usage have fallen in recent years, threatening the system’s efficiency and safety.
President Obama proposed creating the National Infrastructure Bank (NIB) to support the nation’s highways, bridges, and other public infrastructure. This bank was proposed to lend half of the total cost of a publicly beneficial and revenue generating infrastructure project. Local governments and private investors are expected to cover the remaining financing. The US Department of Agriculture announced a related program, the $10 billion dollar Rural Infrastructure Opportunity Fund, to connect institutional investors with wastewater projects, energy development, and infrastructure development in rural areas. Whether the NIB or other programs are enacted, continued support is necessary to realign infrastructure as a national priority.
As some existing infrastructure has already failed, like the Skagit River Bridge in Washington State, the majority of United States infrastructure is in need of additional maintenance or repair. The American Society of Civil Engineers estimates that one in every nine bridges in the country are structurally deficient and about $76 billion dollars in additional funding is needed to repair the bridges alone.30 State and federal programs to support such activity are strained. Rethinking the structure of domestic public investment needs to be addressed if traditional tax revenues continue to fall short of system needs.
29 National Center for Chronic Disease Prevention. “The Power of Prevention: Chronic Disease.” Accessed July 20, 2014. http://www.cdc.gov/chronicdisease/pdf/2009-‐power-‐of-‐prevention.pdf. 30 American Society of Civil Engineers. “2013 Report Card for American Infrastructure.” Accessed July 20, 2014. http://www.infrastructurereportcard.org/a/#p/bridges/overview.
22
Source: Federal Reserve Economic Data, The U.S. Census Bureau,
and The Bureau of Economic Analysis
Construction spending on roads, bridges, sewer systems, and other public projects has dropped significantly relative to economic productivity over the past two decades. The U.S. Census Bureau started reporting data in 1993, and spending levels have never been lower. It is evident that infrastructure has been impacted by competing national priorities and tax revenue shortfalls. Addressing this economic and safety threat is not important just for public use but also as a significant driver of American job growth. Since the housing collapse and financial recession, many laborers with existing skill-‐sets have remained unemployed or underemployed.
Refocusing national infrastructure programs towards public and private partnerships, in addition to reviewing their current revenue structures, will support economic growth. It is estimated that every dollar directed towards public construction programs will double the initial spending in economic output over the short run. That initial dollar results in about three dollars and twenty-‐cent increase in economic output over periods of twenty years and more.31 In addition to increases in economic output and jobs from public construction spending, local, state, and federal tax revenue also grows. Growth provides policy makers with the tools to lay the groundwork for a prosperous nation. Attention is needed to guide elected officials towards directing more tax revenue into productive national investments. Amongst many other productive causes, public infrastructure spending will produce many benefits in tackling the country’s growing fiscal imbalances.
2.1.5 Social Welfare
The term welfare is sometimes viewed under a negative light. Medicaid, food stamps, the earned income tax credit, supplemental security income, and housing assistance are some of the largest welfare programs, by federal expenditure, in the United States. Significant portions of the 31 Cohen, Isabelle, Thomas Freiling, and Eric Robinson. “The Economic Impact and Financing of Infrastructure Spending.” Accessed July 25, 2014. http://www.wm.edu/as/publicpolicy/documents/prs/aed.pdf.
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23
population rely on their support to survive, while others feel these programs create an economic disincentive. Like Social Security and Medicare, safety net programs are designed to set a floor on national living standards. Modern society would struggle without such support systems to aid such recovery.
Distribution of poverty in the United States has changed greatly over the past half-‐century. Levels are determined by the portion of the population whose gross household income falls below a certain threshold relative to its size. The Census Bureau’s most recent income threshold for a single individual is $11,702 under the age of 65, $10,788 over the age of 65, and scales up depending on family size and the number of dependents. Breaking down the most recent headline poverty rate of 15% between age groups reveals the effective disparity under current social welfare policies.
Source: The U.S. Census Bureau
The poverty rate for individuals age 65 and older decreased from 28.5% in 1966 to 9.1% in 2012. While over this same period adult and child poverty both increased, from 10.5% to 13.7% and 17.6% to 21.8%, respectively. More than one in every five U.S. children lived in poverty in 2012. Census data conflicts with common perception but exhibits that many groups are relatively worse today than in the mid sixties. Success of entitlement programs such as Social Security and Medicare have greatly influenced old age poverty. Elected officials do not intend to neglect any portion of society but, as budget and poverty statistics convey, resources are largely directed towards the older age group.
Relatively concentrated efforts of social welfare programs have bred instability between generations and negatively impacted current and future economic productivity. Focus should be targeted across all age groups and not disproportionately favor those who hold the largest electoral influence. Poverty decreases economic productivity, national consumption, and social mobility. In a period when tax revenue and economic growth struggle to meet government demands, more support should be given to those who drive the country’s economic engine.
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24
Unemployment insurance and job training programs support individuals transitioning in employment and bridge social classes. Effective communication between industry, academia, and workers, in addition to proper incentives for advancement, will increase growth. Acknowledging the inequities and short falls of the current social welfare structure is necessary in supporting a more prosperous and secure national future.
2.2 Economic Risks
Uncertainty surrounding U.S. fiscal policy tarnishes the perception of opportunity in the country. Effects of fiscal policy are felt throughout the world due to globalization. Government, business, and investor cooperation is critical to the success of networked economies. Lack of synergy inhibits capital markets, employment, productivity, trade, taxation, and many other factors. Aging demographics challenge existing social, economic, and political structures. Public discussion that motivates a response from policy makers is necessary to navigate many of these challenges.
Ray Dalio founded the largest hedge fund in the world, Bridgewater Associates. They manage $150 billion in assets for foreign governments and central banks, corporate and public pension funds, university endowments and charitable foundations. Economic and political affairs influence how the assets are deployed. When asked what keeps him up at night in a 2012 interview with Foreign Affairs, Dalio responded:
“What worries me is there would not be the right mix of fiscal and monetary policy to deal with it [recession]. People are not use to policy makers. They don’t have the historical frame of reference and do not go through calculations on how much monetary policy and how much fiscal policy produces the right mix to pull it out. And it requires it happen globally. There’s European deleveraging, Chinese leaving a bubble and going down, and the United States growing at slow stall speed. If they were to slip together and because they’re self reinforcing they could slip together, there needs to be prudence at that time. My fear would be absence of prudence. With prudence, it could be managed.”
Concern is reasonable given the federal government’s reliance on monetary policy and overall hostility towards fiscal reform, far from a prudent response. Many negative economic side effects are created under the current social insurance structure in the United States. The trajectory of fiscal policies under existing entitlement programs will continue to adversely affect the dollar as global reserve currency, capital markets, consumer economy, foreign direct investment, as well as many other economic factors in the United States.
2.2.1 Global Reserve Currency
Monetization of debt through artificially low interest rates jeopardizes the dollar status as global reserve currency. By trading government securities, monetary policy is used to influence the rate at which depository institutions lend to each other overnight. Relatively cheap credit typically promotes borrowing and capital investment. But the Federal Reserve has maintained a federal funds target rate between zero and 0.25% since 2008 and economic activity continues to stagnate.
Adverse side effects of historically low rates are the deferral and diffusion of government responsibility to address fiscal imbalances. As exhibited in the chart below, refinancing of legacy debt and growth of future liabilities decrease with lower interest rates. Reliance on monetary policy to balance the federal budget is unsustainable though because it eventually discourages use of dollars and treasury securities by market participants. Fortunately the U.S. economy and federal policies hold significant influence and treasury securities remain a financial safe haven.
25
Source: The Congressional Budget Office
Cracks are appearing as alternative currency blocs emerge with international deals denominated in domestic currencies. Brazil, Russia, India, China, and South Africa created a New Development Bank in 2014. Similar to the International Monetary Fund (IMF) and World Bank, it will support infrastructure investment and liquidity pressures in developing nations. The bank will be funded with $100 billion dollars in addition to a $100 billion dollar reserve currency pool headquartered in Shanghai, China. The New Development Bank is one of many examples of shifting power dynamics across current regimes.
As domestic and international deals are mostly transacted in U.S. dollars, China has pushed back by structuring energy and infrastructure investment, currency swaps, and international financing in local currencies. Russia and China recently signed a thirty-‐year natural gas deal worth $400 billion dollars to be settled in domestic currencies, bypassing the dollar, threatening European energy supply and geopolitical alliances. China has also financed $7.5 billion dollars of Argentinean infrastructure development and signed a three-‐year $11 billion dollar currency swap between their central banks. These deals are just a few recent examples of the economic warfare occurring as international actors tire of U.S. fiscal and monetary policy.
Global reserve currency status directly benefits issuers through lower borrowing and transaction cost, monetary seigniorage, international authority, and increased capital market efficiency. In order to remain a dominant global force, U.S. citizens need to reform the unsustainable nondiscretionary programs that are driving federal spending and invest greater amounts of tax revenue into causes that support a more prosperous national future. Monetary policy should no longer allow politicians the luxury of neglecting fiscal reform.
2.2.2 Capital Markets
U.S. capital markets are the deepest and most efficient in the world. Similar to benefits received from the dollar being global reserve currency, robust capital markets provide many economic advantages. Growth in the U.S. financial space over the past half-‐century has largely been driven by the supply of retirement savings from individuals, institutions, and governments. A search for higher return on savings supports a multiplier effect that facilitates greater levels of borrowing and investment, resulting in elevated economic growth. As inconsistent population size across
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cohorts affects the funding of social insurance programs, the reallocation of assets towards safer income generating vehicles as individual’s transition through retirement affects market pricing.
Most retirees hold a basket of equities and fixed income assets. As investor demand for consistent returns and income distributions increases in retirement, they sell riskier stock and bonds for relatively safer dividend paying blue chips, investment grade corporate bonds and safe-‐haven treasuries. Jeffrey Gundlach manages one of the largest and most successful fixed income funds in the world. Pensions and endowments invest with Gundlach because of his ability to navigate uncertainty through crisis and discern trends that others have missed. In a Bloomberg interview discussing future bond yields, he explains:
“Now we have the situation where the funding of retirement benefits and health care benefits will start to worsen the deficit again, starting around 2017, and we don’t really know how we’re going to deal with that… I have a hard time seeing yields accelerate in the near term but ultimately when you deal with some of the financing needs we’re going to have six, eight, ten years from now, I think you can make a legitimate case for higher rates. Part of the yield equation is driven by demand for income from retirees. You have a very high demographic demand for yield.”
Investors act out of their own best self-‐interest. As retirees have rationally done throughout history, its expected the allocation from riskier assets towards safer income generating vehicles will continue under current demographics. Estimating this effect is difficult due to government policy and individual responses to fluctuating income needs across all ages.
Federal Reserve Bank of San Francisco researchers forecast that average equity valuations as measured by share price to earnings (P/E) will fall from 15 in 2010 to 8.4 in 2025 and stabilize around 9.14 in 2030.32 Market participants will react to these changes and pricing of riskier assets will rebalance as holdings are transferred, shielding the market from direct headwinds of Boomer retirement, but valuations and expected rates of return will certainly fluctuate with aging demographics.
Source: Federal Reserve Bank of San Francisco
32 Federal Reserve Bank of San Francisco. “Boomer Retirement: Headwinds for U.S. Equity Markets?” Accessed July 28, 2014. http://www.frbsf.org/economic-‐research/publications/economic-‐letter/2011/august/boomer-‐retirement-‐us-‐equity-‐markets/?utm_source=home.
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Bond yields are difficult to forecast because they will be affected by not only demographics but also market responses to U.S. fiscal and monetary policy. The Yuppie Nerd ratio attempts to forecast treasury yields by comparing population size of 20 to 34 year olds (Yuppies) and 40 to 54 year olds (Nerds). The ratio fluctuates with the central bank’s response to borrowing demand as the size of age groups fluctuate and has a 0.80 correlation with 10-‐year treasury yields in the United States.33 Monetary policy attempts to stabilize prices when large younger groups of consumers increase borrowing demand, and vice versa. Although the ranges of young and old age groups will widen with increased longevity, the behavior and policy relationship will likely hold. The yield on 10-‐year treasuries is forecasted to be 4.5% in 2025 based on United Nation demographic trends.
Source: Credit Suisse
Unpredictability of government policies and market responses make forecasting the affects of aging demographics on asset valuations an imperfect endeavor. The only certainty is that relationships between consumption, demographics, and capital markets in coming years will differ greatly from those of the past century.
2.2.3 Consumer Economy
Consumer spending drives a majority of the United States economy. Personal consumption expenditures have risen from 60% of GDP in 1970 to 69% in 2014. Over this same period, average real incomes have stagnated relative to growth in inflation and income taxation. Increased spending can be attributed to greater use of credit. But households cannot leverage consumption indefinitely. The great recession reinforced the need to pay down liabilities, establish an emergency fund and save for retirement.
Entitlement benefits are necessary to sustain current levels of consumer spending across the dependent population. To maintain benefit levels, taxes will need to increase. Increased taxes will disincentive the workforce and decrease spending across younger groups due to lower disposable income. Either alternative will decrease growth under the current consumer spending driven economy.
33 Credit Suisse. “How Demographics Affect Asset Prices.” Accessed July 29, 2014. https://doc.research-‐and-‐analytics.csfb.com/docView?language=ENG&source=ulg&format=PDF&document_id=946215251&serialid=jQpgCRBd%2FS1%2BAajHhl5pC2S8CtQ0B6JVzDSusM59pK4%3D.
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Increased productivity is the obvious route to sustain current social insurance benefit levels without negatively influencing personal consumption behavior. The U.S. Congressional Budget Office foresees the following economic effects if social insurance structure is left unchanged:
• Higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur.
• Higher marginal tax rates discourage working and saving, which reduces output. • Larger transfer payments to working-‐age people discourage working, which reduces
output. • Increased federal investment in education, infrastructure, and research and development
helps develop a skilled workforce, encourages innovation, and facilitates commerce, all of which increase output.34
If action is taken to realign social insurance system onto a sustainable path and to support pro-‐growth federal programs, the negative effects described above can be reversed. Government spending through federal programs directly influences U.S. productivity and employment. Focusing on areas like education, infrastructure, and many other systems that drive productivity can minimize the economic drag from aging demographics.
Another effect that needs to be considered is the country’s shortfall in retirement savings. About 53% of households do not have enough savings to maintain current living standards through retirement.35 The Employee Benefit Research Institute 2014 retirement survey found that 60% of workers have less than $25,000 saved (not including equity in primary residence) and 36% of workers have less than $1,000.36 The majority of current and future retirees cannot support living and health care expenses through retirement, expecting social security and other safety nets will subsidize the shortfall. Cuts to benefit levels, in light of the underfunded retirement savings, are likely to force the liquidation of property, automobiles, boats, and other real assets. Forced selling will place downward pressure on economy, further exacerbating the need for retirement income and reliance on existing social insurance systems.
2.2.4 Foreign Direct Investment
Foreign direct investment (FDI) supports domestic productivity, employment growth, and the advances in research and development. FDI often involves the acquisition of companies or expansion of business operations by foreigners. Elected officials influence the attractiveness of investing in the country through tax legislation, trade incentives, and other subsidies. Illiquid assets such as factories carry significant political risk, changes in government regulation can turn projects uneconomic and it’s hard to liquidate the factory to recover funds. This is why governments compete to provide equitable terms and assure foreigners that political risk is low.
Rule of law, education and health care, police and fire protection, religious freedom, property rights, and financial reporting standards are some of the many attractive characteristics of the United States. But the country is at risk to losing foreign investment because policies on social and economic issues are lagging relative to international standards. Other nations are improving
34 U.S. Congressional Budget Office. “How Would Various Fiscal Policies Affect Federal Debt and the Economy?” Accessed July 30, 2014. https://www.cbo.gov/publication/45558. 35 Boston University Center for Retirement Research. “1 in 4 Seniors Have Meager Savings.” Accessed July 30, 2014. http://squaredawayblog.bc.edu/squared-‐away/1-‐in-‐4-‐seniors-‐have-‐meager-‐savings. 36 Employee Benefit Research Institute. “The 2014 Retirement Confidence Survey: Confidence Rebounds—for Those With Retirement Plans.” Figure 17. Accessed July 30, 2014. http://www.ebri.org/pdf/briefspdf/EBRI_IB_397_Mar14.RCS.pdf.
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standards across many of these issues at a rapid pace, luring investment from abroad and away from the U.S.
Due to political gridlock, fiscal imbalances and the overall path of current nondiscretionary programs, investors are weary of risking their capital with so much uncertainty in the government’s future policy. Foreign direct investment hit an all time high in the United States during the second quarter of 1999 on the heels of the technology revolution. Political risk and government policy have since driven foreign direct investment to an all time low in the first quarter of 2014.
Reform of lagging programs is necessary to instill confidence in foreign investors. Until then, many of the social and economic effects discussed previously will inhibit foreign direct investment from reaching levels previously achieved.
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2.3 Vested Interest
“We have met the enemy and he is us” – Pogo
Every individual has a personal stake in realigning social insurance programs onto a sustainable path. Risks discussed in prior sections will continue to negatively affect society, the economy, and government efficiency. Accepting that traditional structures of many government programs are not as equitable as first prescribed is necessary in shaping future. Response from the masses is critical, not only to support pro-‐growth initiatives, but also to demand that elected officials reform unsustainable elements of the social insurance system. Continuing down the path of least resistance under current policies might be politically easiest, but only defers responsibility of the long-‐term challenges facing the country.
Negative effects stemming from government programs are visible through the political divergence in the United States. Elected officials have never been more polarized in recent history. A Pew research study found that 92% of Republicans hold views that are right of the median Democrat, and 94% of Democrats hold views that are left of the median Republican.37 Animosity is building across age groups, social classes, and political affiliations. Fewer individuals hold middle of the road views and many feel those that hold opposing views are a threat to the country’s future.
Source: Pew Research Center
37 Pew Research Center. “Political Polarization in the American Public.” Accessed August 1, 2014. http://www.people-‐press.org/2014/06/12/political-‐polarization-‐in-‐the-‐american-‐public.
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Overcoming challenges faced under the current structure of social policy will only be possible when differences can be set aside. Social insurance promotes higher levels of innovation, growth, and living standards but ineffective implementation can disincentives the workforce. Programs have largely expanded under their original structures while social needs have shifted greatly. Because most initiatives evolved independent of one another, some portions of society are left without adequate coverage while others received inequitable benefits. Structural inefficiencies have inhibited adaptation to evolving constituent needs.
To provide effective safety nets and lay the groundwork of economic growth, society must come together in support of program strengths and reform structural weaknesses. Projected benefit cuts and unfunded trust deadlines are the canary warning of imminent danger while political polarization has left the country fragile and less able to respond to crisis. These policies provide too much value to neglect any further.
The Nordic Model of social policy extends coverage beyond traditional safety net issues. These governments are better able to influence inequality and productivity by supporting education and job training, infrastructure and technology investment, property rights, and free market issues.38 Effectiveness of welfare related programs are measured by poverty before and after transfers occur. In the United States poverty is lowered by 40%, while in Denmark poverty is lowered by 75%. Although it might be considered the Nordic Model conflicts with America’s capitalistic economy, relative economic and social measures which are testaments of success.
Source: Jared Bernstein and the OECD
Society’s needs are variable and no single structure embodies all benefits. Strengths from the Nordic Model and other programs should be applied in the United States. Only with proper incentives can society operate at prime levels. Insuring against adverse conditions, promoting opportunity, and limiting burdensome regulations raise everyone’s living standards.
Like auto insurance covering an affected holder’s vehicle damage after an accident, social policy insulates countries from adverse outcomes. Not getting into an accident is the ideal outcome, but when individuals cannot afford to face the out-‐of-‐pocket burden, monthly premiums are the upfront cost to maintaining stability. Social policy is the country’s upfront cost to ensuring
38 Stiglitz, Joseph. “Leaders and Followers: Perspectives on the Nordic Model and the Economics of Innovation”. Accessed September 20, 2014. http://www.nber.org/papers/w20493.
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stability. Every citizen should care because the opportunity created from higher standards far outweighs upfront fiscal costs.
3. Accountability
“It is not a partisan issue; it is more than a political issue; it is a great moral issue. If we condone political theft, if we do not resent the kinds of wrong and injustice that injuriously affect the whole nation, not merely our democratic form of government but our civilization itself cannot endure.”
- Teddy Roosevelt
Continuing under the existing structure of social policy robs the nation. At an individual level, whether an elected official or average citizen, it’s easier to ignore the issues faced until another person addresses them or they’re forced upon us. But the collective diffusion of responsibility leaves society worse off. Inequitable policies that neglect prevalent needs restrain the country from reaching its potential. Political leadership must be held accountable to address social issues that lay a framework for a prosperous nation.
Behavioral economics is a fairly new field of research that attempts to address the psychological, social, cognitive, and emotional drivers of economic decisions. One area of study focuses on decisions that are rational at an individual level but hurt society as a whole. Similar to social policy issues facing the country, decision outcomes between individuals and institutions are not always compatible. In analyzing competition and self-‐interest behavior, one study compared the decision-‐making relationship to elk behavior.39 Bull elk grow large antlers to assert dominance and attract mates. But massive antlers slow elk from escaping wolfs. The inherent desire to grow bigger antlers lowers the individual elk and overall herd’s chances of survival. Like elk that can no longer outrun wolfs, bloated and inefficient social policies threaten the future of the United States.
3.1 Social Policy
From the earliest North American colonies, social policy evolved to insure stability for military personnel and the dependent population. Government leaders carried the responsibility of providing benefits in the form of pensions, disability and other subsidies to smooth the population’s transition through volatile periods of life. Accountability of social policy has since been lost over the past century. Current programs lack a coherent strategy to balance the country’s evolving needs and competing interests.
Entitlement programs such as Social Security and Medicare favor older and past generations who receive benefits far in excess of contributions. Individuals and politicians acting in their own best self-‐interest have led society to a fork in social policy; should the responsibility of unfunded benefit obligations and the unsustainable structure be left to future generations? Most do not intend to leave their children or grandchildren worse off in terms of economic and social benefits than they or their parents received. But that outcome is inevitable if effects continue to be ignored.
The true cost of providing social insurance to the dependent population has consistently surpassed initial program forecasts. Military pensions paid to widow and child dependents are one example of the true costs. Although soldiers who fought in the following wars have passed
39 Frank, Robert. “The Darwin Economy: Liberty, Competition, and the Common Good.” Accessed September 25, 2014. http://press.princeton.edu/titles/9509.html.
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away, one dependent from the Civil War, 16 from the 1898 Spanish-‐American War, and 4,038 from WWI received a combined $16.5 million in VA benefits in 2013.40 These benefits only include pension and health care subsidies paid to dependents and not the legacy cost of fighting. A moral burden falls upon society to support those who have fought for our freedom. Accepting and understanding the true cost of social insurance is critical to regaining accountability.
Consider the future health, retirement, and welfare subsidies that will be paid for those who have fought since WWI. A Harvard research study estimates the total cost of just the recent Iraq and Afghanistan wars to cost between $4 and $6 trillion dollars.41 Again, the true cost of social policy extends far beyond the immediate impact and initial forecasts. Facing aging demographics and slowing economic growth, government debt and taxation are likely financing sources for federal programs and their long-‐term benefit obligations.
Source: Michael Phillips, The Wall Street Journal
Because society is responsible for the liabilities born out of government activity, public influence and program oversight must improve. Structure of social policy has been inconsistent across time and programs. As conveyed in earlier sections, Social Security (OASDI) and Medicare (HI) contribution rates and income caps were held unsustainably low until recent decades. A difficulty in communicating these disparities arises due to competing interests between groups. Paying into the system reinforces the belief that benefits will be available when qualified, regardless of structural sustainability.
Retirees believe they are merely recovering contributions from social insurance programs but research exhibits that older groups have consistently received benefits in excess of their contributions. As rates and income caps were held artificially low over social security’s early years, trust funds never accumulated enough reserves to pay future benefits. Employers and employees contributed a mere $60 combined annual maximum until 1950, $2,631 in 1980, and $14,508 in 2014.42 These numbers only reflect the Social Security payroll tax and do not include
40 The Wall Street Journal. “Still Paying for the Civil War Veterans' Benefits Live On Long After Bullets Stop.” Accessed September 25, 2014. http://online.wsj.com/news/articles/SB10001424052702303603904579493830954152394. 41 Bilmes, Linda. “The Financial Legacy of Iraq and Afghanistan: How Wartime Spending Decisions Will Constrain Future National Security Budgets.” Accessed September 25, 2015. https://research.hks.harvard.edu/publications/workingpapers/citation.aspx?PubId=8956. 42 U.S. Social Security Administration. “Contribution and Benefit Base.” Accessed July 15, 2014. http://www.ssa.gov/oact/cola/cbb.html.
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the Medicare payroll tax as taxable income limits were removed in 1993. Disparity across generations is much greater when the Medicare tax is included.
A 1995 University of Illinois study found that, “after four and one-‐half years, an average-‐wage-‐earning retiree is collecting welfare. That is, all of that worker’s money has been repaid, including the employer’s portion paid on the worker’s behalf.”43 Current structure of social policy is a direct welfare transfer between cohorts with the workforce covering retirees income and health costs for about a decade beyond what they have contributed. This gap continues to widen due to compounding of legacy benefits and increased costs covered with incoming revenue.
In a presentation at the Retirement Research Consortium 2013 Annual Meeting, Social Security Administration funded research found similar inequities.44 A researcher gave the following premise as an example of what an average individual contributes and receives in benefits since birth year, income, and retirement date are variable.
Imagine that you started working at age 20… salary started at around $3,760 in 1968…. around $53,100 by the time you retire. Based on standard tax rates, you would see the following information on the Social Security website:
Total estimated taxes paid for Social Security over your working career through the last year:
You paid: $70,010 Your employers paid: $72,157 Total contributions paid: $142,167
The combined contribution was $142,167 dollars under this scenario. Starting entitlement payments at age 66 results in monthly payments of $1,793 under these assumptions. The cumulative benefits received are listed below by different lifespan.45 Welfare is the benefits received beyond contributions, ranging from $116,000 to $438,000.
• At 78 years old, $258,200 in cumulative benefits ($116,033 in welfare) • At 88 years old, $473,400 in cumulative benefits ($331,233 in welfare) • At 93 years old, $580,900 in cumulative benefits ($438,733 in welfare)
Aging demographics, shifting from a pyramid shape population base of younger cohorts to a more balanced rectangle structure with fluctuating size between age groups, lower real incomes, and a stagnating economy, challenge traditional structures of U.S. social policy. Today’s workers pay relatively higher taxes on larger income caps only to receive a mere fraction of what they contribute over their careers, an amount much less than could otherwise be saved in independent retirement accounts. Society must acknowledge the structural inequity across generations and the impact of unfunded legacy benefits to regain accountability of the system.
The esoteric nature of social benefit policy supports abuse of the programs intended purpose. Similar to military benefits paid to dependents far beyond initial forecasts, elected officials and American society must understand the reach of support in order to reform inefficiencies. Better safeguards are necessary to prevent the dependent population from cyclical poverty. Boston 43 Kaplan, Richard. “Top Ten Myths of Social Security.” Accessed July 14, 2014. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1087367. 44 Payne, John and Suzanne Shu. – “Life Expectations Judgments, Fairness, and Loss Aversion in the Psychology of Social Security Claiming Decisions”. Accessed July 27, 2014. http://www.mrrc.isr.umich.edu/transmit/rrc2013/slides/1B_ShuPayneSlides.pdf. 45 Ibid. Based on prior assumptions.
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University Professor of Economics Larry Kotlikoff has dedicated his academic and professional career to addressing U.S. financial reform, Social Security, Medicare, generational accounting, and pensions amongst other issues. Kotlikoff has written many articles and published research voicing his frustration with Social Security inequities.46 Some of the insane policies that exist under the current system include:
1. You can contribute to Social Security your entire life and get back less in benefits than someone who never worked and never contributed a penny to the system.
2. Thanks to the special disabled-‐worker family benefit maximum, families of very low-‐earning (think minimum wage) workers, who become disabled may lose all their family benefits. This never happens to the families of high-‐earning workers who become disabled.
3. High-‐earners making more than the taxable earnings ceiling over 60 are guaranteed to get higher benefits from working longer. Low-‐earners over 60 are not.
4. The family benefit maximum doesn’t apply to ex-‐spouses. Hence, your ex-‐spouse(s) can receive higher or much higher spousal or widow(er) benefits than your actual spouse.
How can a system where after contributing across a working career, a non-‐disabled individual who never worked or contributed receive more in benefits be sustainable? Or allow for the gaming of benefits, which shift available resources away from the groups who need it most. Another example of the need for increased accountability can be viewed through healthcare fraud in the Affordable Care Act. Government Accountability Office research found that more than half of insurance subsidies paid display inconsistencies.47 Headwinds facing social policy in the United States do not allow for such fraud or gaming of benefits to continue unabated.
U.S. Treasury officials, Social Security Trustees, the Congressional Budget Office, and Government Accountability Office are not the only national leaders warning of social policy’s unsustainable fiscal trajectory. Federal Reserve officials have also voiced concern including Paul Volcker, Alan Greenspan, and Ben Bernanke amongst many others.
The late Federal Reserve Governor Edward Gramlich stated that, “At some point, every country with an aging population has to get off what we might call the tax-‐and-‐spend treadmill… We could respond to this population aging, and attendant rise in payroll tax rates necessary to pay for future benefits, by further increases in payroll tax rates, as was the case throughout most of the twentieth century. Or we could try some new approaches, such as individual accounts, general revenue transfers, or various mechanisms for investing in equities.”48 Since Gramlich’s speech in 2001, the third rail of politics is left unchanged and its fiscal outlook worsened. Elected officials lack the political courage and capacity to address the immanent threat facing society.
Dependent groups of the population who rely upon social insurance, alongside a workforce that currently faces less than prime economic conditions, are at risk of benefit cuts and tax increases. Recipients most in need of safety nets currently benefit less than those who could otherwise independently support retirement and health care expenses, jeopardizing sustainability for the entire population. Fiduciaries must regain accountability of social policy under the country’s
46 Kotlikoff, Laurence. “Calling out Social Security for its awful inequities.” Accessed July 10, 2014. http://www.pbs.org/newshour/making-‐sense/calling-‐out-‐social-‐security-‐for-‐its-‐awful-‐inequities. 47 U.S. Government Accountability Office. “Preliminary Results of Undercover Testing of Enrollment Controls for Health Care Coverage and Consumer Subsidies Provided Under the Act.” Accessed July 25, 2014. http://www.gao.gov/assets/670/664946.pdf. 48 Gramlich, Edward. “Social Security Reform in the Twenty-‐First Century.” Accessed June 12, 2014. http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/gramlich_20010419.pdf.
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democratic influence. In an economic environment desperately in need of pro-‐growth policies, social policy must be reformed.
3.2 Economic Policy
Aging demographics hold significant influence over the nation’s workforce, wealth, and economic productivity. Social policy vis-‐à-‐vis early and higher education, job and skills training, infrastructure investment, and other causes reinforce or undermine economic opportunity. Based on real wage growth and cost of living indices, cohorts that enter the workforce during prime economic conditions accumulate significantly more wealth over their lifetime. But real income growth for a large portion of the population has stagnated since the 1980s, diminishing consumer purchasing power and lowering individual’s ability to meet everyday demands and save for retirement.49 Accountability of United States federal policy must be regained, as repercussions of ineffective policy carry long-‐lasting effects.
With the current political environment stacked against younger voting blocs, policy reform is critical to support education and employment opportunities for all generations. Inequities of existing policy across cohorts by average lifetime net benefits received are exhibited in the following table. The silent generation enjoyed higher levels of economic growth in addition to the largest federal benefit transfer in program history. Encompassing much of the current workforce, generation X and Y face both a weak economy and negative federal benefits. Paradoxically, younger groups are likely to rely upon social safety nets the most.
Source: Gokhale and The Cato Institute
Employment is often an indicator of prosperity in developed economies. Social policy must balance the competing interests between age groups, the dependent population and workforce. For example, healthcare is thought by many to be a universal right. Universal access to healthcare is not a new phenomenon; many developed countries have operated these systems for decades. Why wasn’t universal coverage passed decades ago in the United States? Policy comes down to
49 Reich, Robert. “Inequality for All.” Viewed July 2014. http://www.imdb.com/title/tt2215151.
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economics. Traditional employer sponsored health plans covered the majority of individuals, regardless of whether they were employed or retired. The workforce of past generations did not want to subsidize the health cost of unemployed or uninsured individuals. Legislation was held until the largest voting bloc entered retirement, this is why President Obama was able to pass the Affordable Care Act.
The Philadelphia Federal Reserve noted effects of the Affordable Care Act in a recent business survey.50 The report found that nearly one fifth of the businesses employed fewer people and 18.2% of businesses have increased use of part-‐time workers. Universal coverage forced the modification of existing employer plans, but not for the better. Since the Affordable Care Act was passed:
• 88.2% of the businesses pay higher contributions • 91.2% have higher deductibles • 76.4% have higher out of pocket maximums • 41.2% have a lower range of medical coverage
A significant group of the businesses have also increased prices since legislation was passed. Universal health coverage was withheld until the largest population group in the country’s history entered retirement, passing the cost onto the consumer and workforce in a weak economy.
The country is at risk of losing the American Dream. Government policy has become bloated and ineffective, failing to provide the resources and guidance necessary to support the opportunity carried by earlier cohorts. A workforce saddled with higher debts, taxes, and lower real wages drives the federal solvency gap wider and inhibits growth in the consumer-‐driven economy. Disparity across policy structure is visible when net worth across age groups is considered. Through the Great Recession, net worth of individuals age 40 years and older experienced a relatively smaller drawdown and has recovered to pre-‐crisis levels. Generation X and Millennial wealth decreased considerably yet remains below pre-‐crisis levels. Long-‐term effects of such wealth destruction in combination with negative federal benefits must be addressed prior to reform being forced so future generations have opportunity to achieve prosperity and success.
Source: Federal Reserve Bank of St. Louis
50 Federal Reserve Bank of Philadelphia. “Business Outlook Survey.” Accessed August 20, 2014. http://www.philadelphiafed.org/research-‐and-‐data/regional-‐economy/business-‐outlook-‐survey/2014/bos0814.pdf.
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Homeownership is a pillar of economic growth and wealth creation. Construction and real estate not only employ a significant portion of society but consumer related expenditures associated with owning a home influence the revenue of many different businesses.
Source: The U.S. Census Bureau
Homeownership by individuals older than 40 years of age, especially those in retirement, is consistently higher than younger generations across recent history. This makes sense because levels of wealth in later periods of life afford such opportunity. Silent Generation homeownership was least affected by the Great Recession because they were not as threatened by mortgage debt or loss of income when the crash occurred.
Ownership rates of individuals younger than 40 years of age are consistently lower across history, but fell significantly during the Great Recession and have yet to recover to pre-‐crisis levels. Homeownership across these groups are likely to remain depressed due to the increased difficulty of purchasing a home in a high debt, low economic growth environment. This allows for even less wealth accumulation as the home is often the largest asset of many household portfolios. Federal policies must consider the effects of recent crisis and inequitable program characteristics that widen the country’s wealth gap. Diffusion of responsibility by elected officials and the public must be reversed before damage becomes irreparable.
Younger generations are less wealthy than older groups, a warning in direct contradiction of cultural beliefs. The Urban Institute cautions that, “if current trends for younger generations are not reversed, within a few decades they may become more dependent than older Americans today, especially in retirement, upon safety net programs less capable of providing basic support. As we grapple with broad issues of budget, tax, and educational reform, we need to be sure that such efforts include a focus now, not at some distant future point, on asset building for
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generations X and Y and successor generations.”51 The long-‐term sustainability of current policy must be questioned as economic growth and living standards slow from historic rates.
Social insurance benefit levels will either have to be cut or taxes increased to cover unfunded program obligations. As the dependent population is unlikely to return to the workforce, even a combination of such efforts disincentivizes the country’s economic engine. Apathetic patriotism has led the country to a critical fork in the policy road. Ignoring the inequitable nature of such reform, politicians need the courage to ignite the intergenerational collaboration necessary to regain accountability of programs that influence the country’s future opportunity.
3.3 Tax Policy
"We don't pay taxes. Only the little people pay taxes."
-‐ Leona Helmsley, billionaire hotelier
Baby Boomers faced many challenges as their population influx transitioned through life but some of these costs have been pushed onto future generations. Although the group may not have directly prescribed unsustainable government policy, they hold significant influence over the future structure of taxation, social insurance and pro-‐growth initiatives. Accepting responsibility of the control is critical for all groups to better understand the true cost of federal programs and to influence policy that shapes a more desirable future. Taxation is the cost of government policy, used as a lever to support a more prosperous future.
The National Endowment for Financial Education recently surveyed over two thousand American’s regarding their financial goals. The main goal for all cohorts was to accumulate enough wealth to support retirement. Retirement is considered by many to be a core element of the American Dream. Reflecting the difficult economic environment, two thirds of the group felt their parents had achieved the American Dream, yet the greatest obstacle preventing them from doing so is ability to save.52 Elected officials must consider these concerns as less opportunity for high paying employment and a relatively stagnant economy inhibit the sustainability of both federal and personal retirement accounts. Near to intermediate social obligations might only reflect the onset of challenges facing society if ineffective policies remain unchanged.
General populous does not fully appreciate the inequities or fiscal gaps that currently exist in social programs. Even though younger groups do not expect to receive full retirement or healthcare benefits, the prospect of receiving only a fraction of what was paid into the system has not discouraged support of social programs. A majority of the population would like to raise taxes in order to support higher benefit levels.53 Even with the country politically divided on almost every issue the public demands sustainable social policy, this sentiment should also encourage lawmakers to realign programs onto a sustainable trajectory.
Federal tax structure has evolved in an inefficient and bloated manner in the United States. Initial legislative aim has been lost in esoteric codifications of activity with many regulations gamed to
51 Urban Institute. “Lost Generations? Wealth Building among Young Americans.” Accessed July 10, 2014. http://www.urban.org/UploadedPDF/412766-‐Lost-‐Generations-‐Wealth-‐Building-‐Among-‐Young-‐Americans.pdf. 52 National Endowment for Financial Education. “Harris Poll Education Survey.” Accessed July 23, 2014. http://www.nefe.org/Portals/0/WhatWeProvide/PrimaryResearch/ConsumerPolls/PDF/2014%20American%20Dream%20Survey%20Summary.pdf. 53 Pew Research Center. “Political Polarization in the American Public.” Accessed June 13, 2014. http://www.people-‐press.org/2014/06/12/political-‐polarization-‐in-‐the-‐american-‐public.
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meet political interests. As displayed previously, the following table reviews the primary sources of government revenue as a percent of GDP. Federal revenue is largely derived from income and payroll taxes. With reduced employment opportunities and lower levels of labor force participation, legislators must assess if there are more effective sources of revenue to balance the country’s competing interests.
Source: The White House Office of Management and Budget
Obligations growing faster than the overall economy threaten the long-‐term sustainability of government programs. Economic growth supports higher levels of federal revenue through an increased tax base. Effective leadership uses taxation as a tool to incentivize pro-‐growth pursuits and discourage harmful activity. For example, more individuals start businesses and fewer consume drugs in an optimal tax environment. Income and payroll taxes were originally thought to be the most equitable sources of revenue when labor force participation was higher and wealth inequality was not as drastic, spreading the burden of government finances across the productive population. Regulations now reward passive behavior by not incentivizing individuals to hold gainful employment or attempt entrepreneurial ventures. Why go to work every day if you can earn more in social benefits by not? This structure limits the country’s economic potential.
Potential areas of resolution are discussed in the following section, but it is important to differentiate between social classes, as income and wealth inequality are at historic levels in the United States. When the top 1% of income earners is discussed, mostly small business owners and working professionals, it is often assumed they’re the wealthiest individuals in the country. Those with significant wealth are efficient enough not to accumulate assets through earned income but rather on investments or other avenues. Berkshire Hathaway CEO Warren Buffett is the third wealthiest individual in the world, with a net worth of $66.9 billion dollars.54 Buffett has stated
54 Bloomberg. “Bloomberg Billionaires: Warren Buffett.” Accessed July 12, 2014. http://www.bloomberg.com/billionaires/2014-‐08-‐27/cya.
0.0#
5.0#
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1934# 1939# 1944# 1949# 1954# 1959# 1964# 1969# 1974# 1978# 1983# 1988# 1993# 1998# 2003# 2008# 2013# 2018#es/mate#
Receipts(as(%(of(G
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that he earns an annual salary of $100,000 and pays a lower taxable rate than his secretary. This is because his real wealth is accumulated through other sources like investments.
Payroll taxes that fund social security and Medicare are only collected on earned income and not investment income. If the public understood the gap in tax structure between professionals in the top 5% or even 1% of income earners versus the uber-‐wealthy, policy would be shaped drastically different. Higher levels of income and payroll taxes discourage the workforce from taking risks, shedding light on the poor incentive structure it provides to businesses and individuals.
Consider the share of federal revenue gained from corporate taxes. As a percent of GDP, levels were much higher in the 1940s and 1950s but have since shrunk to historic lows. Corporate tax rates in the United States have not meaningfully decreased over this time; other countries provide a more competitive and business friendly regulatory environment. Although counterintuitive, higher effective tax rates actually diminish the potential federal revenue.55 It could be considered that going offshore is unpatriotic, but individuals and businesses are merely acting in their own best self-‐interest, similar to social insurance recipients operating in a convoluted state that disincentives support of the domestic economy.
Effectively raising tax revenue to finance government programs will indirectly support economic growth. Because gridlock in the nations capital has prevented meaningful reform of issues that support economic growth, the obvious response to fiscal shortfalls is to raise tax rates through existing channels. Accountability of such behavior begs the question of generational fairness. Raising taxes on a weak labor force in a stagnating economy does not incentivize higher productivity or reduce tensions across social classes.
Stanley Druckenmiller, a legend in the investment space, built a career by trading around modern histories most unsustainable events. Although retired, Druckenmiller commits himself to raising awareness of aging demographics and problems faced under existing social policy – one of the most obvious and unsustainable situations he has ever witnessed. Druckenmiller is amongst a group of academics and professionals that estimate the fiscal gap to be $205 trillion dollars, significantly larger than the CBO, GAO, or U.S. Treasury estimates conveyed in earlier sections.56 The fiscal gap has created instabilities across a number of federal programs including education, health care, social insurance, and taxation structures. Druckenmiller voiced frustration over the country’s political polarization in light of social policies by stating:
I totally disagree with those that say we can wait 20 years to solve this problem. And there are two reasons. The first reason is if you wait 20 years to solve this problem, by the time you're at that time period, the interest payments on the debt alone will start to challenge the entitlements as a problem. It's not unlike climate change. Just because the problem doesn't manifest itself for decades doesn’t mean that you should wait till the 11th hour to solve it because then the conclusion is preordained.
But there's a more important reason for me, and that is the general issue of fairness. Every day we wait, more and more of the burden falls on a future generation. One solution would be to raise the payroll tax from 12 to 15 percent now, and you're done. Another possible
55 Ballard, Charles, Don Fullerton, John Shoven, and John Whalley. “A General Equilibrium Model for Tax Policy Evaluation.” Accessed July 18, 2014. http://www.nber.org/chapters/c11222.pdf. 56 Kotlikoff, Laurence, Mercatus Research. “Assessing Fiscal Sustainability. Accessed July 12, 2014. http://mercatus.org/sites/default/files/Kotlikoff_FiscalSustainability_v2.pdf.
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solution would be to raise the payroll tax in 20 years, but then you'd have to raise it to 16 percent.
So I ask you, is it fair that I and the other boomers get to pay 12 percent through our working career, but these kids who are starting their working career in 2033 have to pay 16 percent? It's ridiculous, and it's wrong.
Increased tax rates are just one of the inequities surrounding policy. How revenue is deployed is another. Older population groups hold significant influence over government policy through their size as a voting bloc, and continue to take a larger share of available resources. Common beliefs around social policy often include the majority of revenue being directed towards younger or unemployed groups. As exhibited in the table below, outlays on the elderly have far outpaced those to children and are growing at a much faster rate across the past half-‐century.
Source: Druckenmiller, The U.S. Census Bureau,
The U.S. Bureau of Economic Analysis, and The Urban Institute
Aging demographics do not provide the economic tailwind of higher growth; rather reinforce the importance of sustainable policy. Accountability over the federal tax structure remains a critical component in realigning the country’s trajectory. The economy will stagnate and wealth inequality will deepen without equitable incentives supporting federal programs. Focus should be on reform that motivates growth in the productive population, rather than redistribution of wealth. The latter will be achieved through increased opportunities for all cohorts.
3.4 Retirement Policy
Modern approaches to retirement are failing. From federal safety nets to individual retirement accounts, society cannot sustain itself while meeting old age obligations under the existing framework. A framework reinforced by cultural beliefs and unrealistic assumptions that discount future growth by spreading obligations across the productive population. Disincentives to employment, stagnant economies, and greater inequality are a few of the many resulting side effects of such policies. Society must address these issues before all groups are left unprepared to fend for themselves.
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Retiring around the age of 65 is a modern concept. Throughout history individuals either saved enough to sustain life through old age or relied upon productive family members for support. People continued to work until it was physically impossible or they could take one of the following routes. Average life spans were not much longer than the minimum age requirements for social security when it was enacted. Social programs were intended to support those who could not sustain themselves, not those who chose not to sustain themselves. Over the past century a belief that retirement is as much a universal right as free speech has become the norm.
The world’s population is aging at rates never seen before. Ignoring effects of such merely delays an inevitable rebalancing. Governments, companies, and individuals have not saved enough for retirement. Standard and Poor’s believes, “the U.S. as a society will soon need to make some hard choices about the cost and timing of retirement, as well as the extent to which the government should be responsible for retirees' income and health care. Unfortunately, we expect Americans to continue to avoid doing so until a crisis occurs.”57 Old age and medical subsidies received through entitlement programs are stretched well beyond their ability to support recipients.
Money is merely a store of value that allows individuals to easily consume goods and services. The beauty of such value is that it can be consumed immediately or stored for future needs. Savings is the sum of delayed consumption accumulated over a productive period. Without savings, future consumption becomes impossible unless subsidized by outside factors. As a government sanctioned Ponzi scheme,58 productivity growth is critical in supporting such entitlement subsidies. A belief that retirement is a universal right detaches responsibility of such costs. This makes sense at the individual level, who wouldn’t maximize consumption without baring the costs? Government cannot support this reality if everyone is living off of the programs.
Similar environments exist at the state, local, corporate, and individual retirement spaces. State administered defined benefit pensions hold a collective $2.7 trillion in assets and $3.6 trillion in obligations; almost a one trillion dollar short fall.59 Savings and investment by current workers is also unsustainably low, with a majority of the population heavily reliant upon social programs as a main source of income in retirement. Researchers have found that 36% of workers have less than $1,000 saved while 60% of workers have less than $25,000 saved. Almost half of the surveyed workers do not have enough to support minimum living standards for a year.60 Consider the repercussions of such given the current economic and social trajectory in the United States.
57 Standard & Poors. “Americans Remain Woefully Unprepared For Retirement”. Accessed July 20, 2014. https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1160170&SctArtId=168525&from=CM&nsl_code=LIME&sourceObjectId=8115287&sourceRevId=1&fee_ind=N&exp_date=20230717-‐00:00:27. 58 With little or no legitimate earnings, Ponzi schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out. U.S. Securities and Exchange Commission. Accessed December 5, 2014. http://www.sec.gov/answers/ponzi.htm. 59 U.S. Census Bureau. “Survey of Public Pensions: State-‐Administered Defined Benefit Data.” Accessed September 26, 2014. http://www.census.gov/govs/retire/state_retire.html. 60 U.S. Department of Health and Human Services. “2014 Poverty Threshold for single person is $11,670.” Accessed September 25, 2014. http://aspe.hhs.gov/poverty/14poverty.cfm.
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Retiree balance sheets are even more shocking especially because currently employed has time to catch up in saving for retirement. Reaffirming society’s dependence on entitlement programs for significant support through old age, the survey found that 29% of current retirees hold less than $1,000 in savings while 58% have less than $25,000 saved.61 Notice the similarity between groups, poor retirement planning transcends cohorts and doesn’t improve in old age.
The reality is that too little was saved when growth was strong and now bills are coming due when the economy is stagnant. Whether public or private retirement systems were misleading, underfunded, gamed, or some combination of the above doesn’t really matter. Current and future retirees are blindly assuming the programs will support retirement, a guaranteed path to crisis.
61 Employee Benefit Research Institute. “The 2014 Retirement Confidence Survey: Confidence Rebounds—for Those With Retirement Plans.” Accessed July 30, 2014. http://www.ebri.org/pdf/briefspdf/EBRI_IB_397_Mar14.RCS.pdf.
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4. Resolution
"Fear is the path to the dark side. Fear leads to anger. Anger leads to hate. Hate leads to suffering." – Yoda
Politics and the democratic process are where the cumulative lack of accountability becomes most noticeable. Legislator’s duty to act in the best interest of the people has been lost to lobbying, short-‐termism, and rhetoric. Social programs are considered the third rail of politics because they are legislatively untouchable, an issue that drives voter support in large part due to inequitable benefit levels and varying population cohort size. In attempt to guide a more prosperous future for all cohorts, the country’s leadership must gain the political courage to confront realities faced under the trajectory of existing policies before crisis forces action.
Change never comes easy, whether for an individual or large institution like government. Top down hierarchies were the most effective structure in managing societies for millennia, dating back to the world’s earliest tribes and civilizations. But the technological revolution has turned traditional ideologies on their head. Younger generations have grown in a highly competitive, hyper-‐connected, transparent environment, while older generations have adapted to this new world. Society now demands accessible resources that are managed in a transparent fashion by leaders who can evolve as part of this new world. Government protests such change on the basis of fear; fear of the unknown, loss of control, a shifting status quo, and of being held accountable. Diverging public and private sector standards in regard to accessibility, transparency, and professional duty continue to polarize issues that drive national interests.
The current U.S. Congress is one of the least productive in recent history. Public approval ratings are at historic lows and the revolving door in Washington has never been more fluid, all testaments to dysfunction. Fewer citizens are understandably choosing to be engaged on national issues or participate in the country’s democratic voting process, allowing more radical groups greater influence over national issues. This negative cycle reinforces dysfunctional leadership and further decreases participation by more moderate groups of the population.
Collaboration between elected officials and mass society has also reached generational lows, validating the need for accessible and transparent government. Some might refer to this collaboration as patriotic duty or the willingness of mass society to band together for a better future. Ronald Reagan raised awareness of the unsustainable traits entitlement programs hold during the 1980 presidential election. Countless academics, professionals, and citizens brought forward ideas to bridge the pitfalls yet little change has occurred in securing the future of social insurance over the past three and a half decades.
Structural reform is necessary to support the economic growth and the government services United States citizens expect. Significant progress in health, technology, and business fields has occurred over the past century yet government structure and destructive political ideologies hold in light of a retirement crisis. The sustainability of federal programs is dependent on such economic growth and effective leadership.
Like elk and antler size, voting bloc interests are often rational at individual level, but harmful at a collective level. Individuals pursue policies that are in ones best self-‐interest. In an aging environment, the democratic structure disproportionately favors older generations who inequitably benefit from entitlements while remaining disconnected from their true costs. Instead
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of continually pushing unsustainable systems onto future generations, why not reform the policies? What is preventing change?
Although it might be politically easier to do nothing, this does not mean that it is the right course of action. The U.S. Treasury and Congressional Budget Office convey that fiscal deficits are shrinking, a positive step in financing the country’s priorities.62 Although deficits may be relatively shrinking the country continues to spend more than it generates in revenue, financing shortfalls and legacy liabilities with debt. This behavior is similar to a family who outspends their income through credit cards, but now overspends slightly less than the previous month. Even if the country stopped spending more than it generates in revenue, the fiscal trajectory remains unsustainable as growing entitlement obligations crowd out discretionary federal programs. The compounding of unfunded obligations is crippling the nation’s opportunity.
4.1 Realigning Incentives
“The only safe ship in a storm is leadership.” - Faye Wattleton
Politics is the root of the threat facing society. It is where the democratic process culminates into collective action or inaction in the case of social programs. Because citizens elect most influential positions in government, the masses hold the ability to remove unqualified leaders and demand a restructuring of failing programs. The United States has the resources and ability to drive opportunity in an evolution similar to the founding fathers; a modern interpretation of the American Dream.
The failures of existing social legislation reveal themselves through education, infrastructure, technology, and research and development programs. Unless trajectory is acknowledged, and consensus on the direction forward occurs, polarization of ideologies will accelerate alongside the aging population and cuts to the discretionary federal programs. Modern politics should not be limited to enforcing laws but also guiding a prosperous environment that provides opportunity and the minimum resources needed to create a floor in living standards across cohorts. Prosperity isn’t just an item on a checklist to running a successful nation. It is the result of a functioning government framework that ties all systems together.
But what is prosperity? An enlightened thinker once described prosperity as financial technology multiplied by the sum of human capital, social capital, and real assets.63 The equations greatest asset is human capital. Humans are the drivers of economic growth, innovation, and national prosperity. The current U.S. political system is restricting prosperity by enforcing destructive legislation that ultimately encourages mass underemployment. Incentives must be realigned to support a functioning, well-‐aimed government that encourages participation.
United States culture rewards risk taking, a critical trait that most societies do not support. It’s okay to fail and try again. The cost of failure far outweighs potential benefits in most countries. It may seem counterintuitive, but without risk taking much of the economic progress over the past century would never have occurred. Risk taking is a major part of the American Dream. In discussing political incentives, the masses need to recognize cultural differences and the risky undertakings that the country has supported across its history, when considering the future of
62 Committee for a Responsible Federal Budget. “Update: Falling Deficit is Not a Sign of Fiscal Sustainability.” Accessed October 20, 2014. http://crfb.org/blogs/update-‐falling-‐deficit-‐not-‐sign-‐fiscal-‐sustainability. 63 Milken Institute. “A Conversation with Ken Griffin and Steve Schwarzman.” Accessed July 1, 2014. http://www.milkeninstitute.org/events/conferences/global-‐conference/2014/panel-‐detail/4863.
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social policies. America must create the proper incentives around risk taking in order to motivate individuals to push the envelope and not to apathetically live off the system. Crisis will drive the country’s path forward unless action is taken.
Action starts with federal leadership. A clear positive vision that supports productive activities needs to be established. In setting the precedent for all citizens, elected officials must end partisan rhetoric in the name of getting things done. Outside lobbying influences such as political action committees have to face greater regulations and the average individual needs to be given access to transparent resources in order to bridge the government’s hierarchal tiers, restoring the voice to the people. Collaboration amongst political parties and government agencies can reignite the country’s patriotic fire.
Structural changes to federal programs can only be taken after the political environment is realigned. Changes will be painful due to excesses accrued across many generations, but a rebalance is critical to regain ownership over existing and future resources. Unless social programs are drastically reduced, benefit levels will need to be cut alongside increased taxes to balance resources on a sustainable path. A well-‐functioning democratic nation can determine the exact details of future social programs, but this only becomes possible with effective leadership.
The masses will shift the country’s direction. Change will not be easy but collective action has forced change countless times throughout history. Developed nations are nearing the end of an incredibly stable period in history, expecting the good times will continue. A collective response will direct how government addresses unsustainable issues, designates priorities, and drives change. The goal should be to decrease polarization of issues. Understanding that it might not be everyone’s cup of tea, larger portions of society need to become engaged in the democratic process. This can range from educating yourself on issues facing the country, to organizing groups in support of a cause and contacting officials in positions of influence. The well being of the country is under immediate threat from the current structure of social programs. Collective understanding and action will transform this reality.
Erik Brynjolfsson, Professor of Management Science at MIT, Andrew McAfee, Principal Research Scientist at MIT Center for Digital Business, and Michael Spence, Professor of Economics and Business at NYU, are scholars who study the drivers and economic shifts happening in the twenty first century. In a recent Foreign Affairs article the group discusses the New World Order of income inequality, technological change, and employment transformation. They provide the following suggestion for government leaders confronting the evolving demands and economic imbalances resulting from aging societies and technological cannibalization.
The basic strategy is intellectually simple, if politically difficult: boost public-‐sector investment over the short and medium term while making such investment more efficient and putting in place a fiscal consolidation plan over the longer term. Public investments are known to yield high returns in basic research in health, science, and technology; in education; and in infrastructure spending on roads, airports, public water and sanitation systems, and energy and communications grids. Increased government spending in these areas would boost economic growth now even as it created real wealth for subsequent generations later.
As developed countries enter a period of transition between stability and the unknown, it becomes critical that a government foundation built on sustainable policies is established before
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crisis directs the outcome. Steps to establish such a foundation are fairly straightforward, but need both the cooperation and collective support of society to progress.
4.2 Crossing the Void
“If you come to a fork in the road, take it.” - Yogi Berra
Two routes of action are needed in order to cross the policy void, address structural reforms and support drivers of economic growth. The following section includes a brief overview of suggested reforms many of which have been discussed and analyzed publicly for decades.
Action will not be easy, the country remains politically ill with a majority of program excesses accrued over generations. Realigning these programs onto a sustainable path and supporting growth drivers that create opportunity for all cohorts is what is needed. Entrenched ideologies must conform to existing social program structures and modern demands until the country’s interests are balanced.
4.2.1 Structural Reform
Although many areas of government can be improved, structural reform of social insurance is critical and must focus on recipient needs and existing sources of revenue. The current benefit structures that are intended to match federal taxes in order to support such programs are severely imbalanced. Solutions are likely to be found through a combination of raising benefit thresholds, offering lump sum payouts, means testing eligibility, providing transparent and accessible social resources, and by removing esoteric codes that support a gaming of systems. Because legacy benefits are unrecoverable, the following areas of reform aim to be equitable choices in that they spread benefits and costs across all groups.
Private industries that intersect with federal social programs are also areas where elected officials should address weak points. For example, healthcare provider incentive structure could be based on quality of service, not billed solely on the number of Medicare procedures or patients rolled through the office during a given period. But because fragmentation across both regulators and industries, in addition to competing interests of elected officials, adapting legislation of the health care industry will take much time.
A potential tool in addressing such gridlock might be found in public-‐private partnerships. In the accounting space, these groups have been quite successful at codifying and improving industry standards through self-‐regulation. The pace of reform to specific industries that intersect with social programs should not discourage elected officials and general society from acting on issues that can be addressed more immediately.
When considering social program reform, it also becomes beneficial to discuss the many social beliefs surrounding retirement and how later periods of life should be addressed. Some of the issues driving unsustainable traits of current programs can be mitigated at micro levels. Retirement is in many ways similar to exercise and personal health. A person who eats poorly and does not exercise will struggle with a list of mental and physical conditions as they age. Compare this to an average individual who eats a balanced diet and exercises a few times a week, they will be much better prepared as they age through life. Taking responsibility over what can be influenced at individual levels can lead to significant differences in social outcomes nationwide.
Many view retirement as an end goal, the ultimate panacea achieved over decades of hard work, and a right that should be subsidized by federal government. But for a good portion of retirees,
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collecting benefits and idly living out the final years of life is not as fulfilling as originally perceived. This is why more American’s are choosing to remain engaged and work later in life, whether in the same career path or learning new skills and volunteering. Robert Levinson is one of the productive retirees remaining active at the age of 89, and who is also trying to kick start an anti-‐retirement movement.64 Although not everyone might desire to work full-‐time into there 90s, Levinson behavior exhibits the power of breaking cultural norms influence on perceived retirement needs. Regardless of aspiration, individuals at all ages of life should have access to the resources necessary to adapt skill sets to modern demands and remain productive.
Another cultural norm surrounding retirement ripe to be challenged is perception of death. Although not a favorite topic to consider, it eventually happens to everyone. People go their entire life making decisions and taking actions to minimize risks while death is the ultimate outcome that has yet to be escaped. Apart from heartache, death should be an experience that highlights character and achievement rather than focused solely on loss. Discussion of how a person wants to die, their expectations of a funeral, burial location, and all other aspects will lead to a more satisfying and less costly experience for everyone.
A small town in the Midwest has set the bar in discussing and planning for death. Ninety-‐six percent of residents in La Crosse, Wisconsin die with advanced directives. This is a massive feat given that only 30% of the population nationwide has established advanced directives. La Crosse’s attitude towards death shifted when a medical ethicist asked local nurses to ask patients, “If you reach a point where treatments will extend your life by a few months and side effects are pretty serious, would you want doctors to stop, or continue to do all that could be done?”65 Surprisingly, a majority requested the doctor stop. People generally avoid questions like this until it is forced, leaving a spouse or kids to make the decision. This allows for outside influences to affect medical treatment rather than what the patient truly desires. Because La Crosse has become comfortable planning final stages of life, patients receive the care they want and the town’s end of life health expense is far less than any other city in the country.
Numerous other cultural norms can be questioned in a similar fashion in an attempt to provide better social support while collectively lowering financial burdens. The combination of holistic initiatives and structural reform can ease this transition across the existing policy void. But citizens cannot better prepare for retirement and the final stages of life without access to effective and transparent resources. In order to achieve this, entitlement programs must be treated as pure safety nets and not primary sources of income for able individuals through life. Realigning the primary role as a safety net will force the structure of eligibility requirements and benefit levels to evolve.
Government, businesses, and individuals have an enormous collective interest in crossing the country’s policy void. The drive to achieve such can be highlighted through academic and corporate research that aims to address the growing imbalances. One of the many financial services firm publishing literature on potential solutions to the retirement crisis is BlackRock. Their focus extends across three pillars of American retirement: social security, employer-‐sponsored plans, and personal savings. The following table provides brief detail of their ideas for improving the retirement system.
64 Boston University Center for Retirement Research. “An Anti-‐Retirement Advocate.” Accessed August 15, 2014. http://squaredawayblog.bc.edu/squared-‐away/an-‐anti-‐retirement-‐advocate/. 65 National Public Radio. “The Town Where Everyone Talks About Death.” Accessed June 14, 2014. http://www.npr.org/blogs/money/2014/03/05/286126451/living-‐wills-‐are-‐the-‐talk-‐of-‐the-‐town-‐in-‐la-‐crosse-‐wis.
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Source: BlackRock
Reforms listed above have great potential in shifting both social behavior and the necessary structural changes to government programs that surround retirement.66 Many visionaries have presented suggestions across the past few decades, exploring strengths and weaknesses of potential reforms in great detail, yet the nation continues to drift toward crisis largely unabated. Social programs are stuck, solutions to the numerous inefficiencies that exist are available but leadership lacks the political courage to enact change. It becomes clear that the country cannot move forward without political courage.
Shifting focus towards the revenue side of the social insurance equation, taxation has followed a similar growth trajectory as benefit levels in the United States. Incentives can be structure to create an extremely powerful framework. As the majority of government revenue vis-‐à-‐vis taxes are generated by the working population, and entitlement programs are dependent on such revenue growing at a pace similar to benefits levels, it becomes clear other sources of revenue, additional economic growth or benefit level cuts are necessary to arrest the growing divergence.67 Aging demographics do not lend themselves to birthing continuously larger population cohorts. Increased taxation on the productive population deters activity that promotes economic growth, and haphazardly cutting benefit levels to match incoming revenue, will lead to immediate social crisis.
66 The University of Michigan, Institute for Social Research. “Conference Papers.” Accessed July 20, 2014. http://www.mrrc.isr.umich.edu/publications/conference/. 67 It might be beneficial to revisit data in section 1.3 regarding the current U.S. fiscal environment.
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The United States needs to reform its tax code in a way that promotes innovation and productivity. More effective tax incentives and decreased regulatory burdens will promote domestic competition in the education, health, and technology industries. Higher levels of competition will create employment opportunities for all cohorts and result in better products and services coming to market, raising living standards.
Cries for wealth redistribution due to rising inequality bring into question the effectiveness of the current tax structure. Wealth is becoming extremely concentrated amongst fewer individuals and families, allowing for decreased risk taking amongst the general population. Methods of capturing and redeploying such wealth are heavily debated, but the end result is clear. Similar to the power that taxes hold in motivating or disincentivizing behavior, competition to generate income drives people to better themselves. Competition is healthy at moderate levels, but the current state of inequality ignominiously resembles dynasties past. Hoarding to enrich already divided factions is not as effective as multiplying the resources potential to generate growth.
Older cohorts often demand income taxes be raised to support entitlement levels. Not only would such behavior divide generations further by instilling an inequitable “take all you can” mentality, but it would also decrease the productive populations incentive to become more productive.68 Both environments inhibit the country’s potential. Rather, focus must be directed towards extracting greater value from destructive activities on the individual, private, and public levels instead of increasing personal or corporate taxes, which drive actors to more amiable operating environments.
Government legislation should encourage entrepreneurialism. Because small businesses employ a significant portion of society and are large drivers of economic growth, regulatory burdens that promote outsourcing over hiring domestic workers greatly inhibit current productivity and potential growth. Individuals face disincentives in starting new ventures and growing their business when they do not have the scale to meet compliance or health care regulations. Standards that accommodate varying degrees of businesses can act as a throttle in driving competition.
On a global scale, legislators should focus on improving the nation’s flow of capital. Protectionist policies limit the economy’s scale by inhibiting the nation from maximizing its relative strengths. Flow of physical, financial, and human capital should be more fluid across U.S. allies like Canada, Europe, Japan, and Mexico. Tax and regulatory policies that take into account behavioral aspects will become much more effective in promoting stability. Excess revenue could even potentially be stored in a sovereign wealth fund to be reinvested on national projects in the education, healthcare, infrastructure, and technology spaces. Accrued wealth from human capital should not be treated differently than states or nations that capture and redeploy natural resource wealth for future generations.
Prosperity results from the country’s resources being allocated in the most effective manner. An overarching goal should not only be realigning social programs towards a sustainable path, but also supporting pro-‐growth causes. Matching outlays with revenue will only address the immediate fiscal imbalance. With aging demographics, decreased labor force participation, and vast federal obligations acting as a drag on economic productivity, a focus on growth is just as important as entitlement reform. 68 U.S. Congressional Budget Office. “Answers to Questions From Senator Hatch About Various Options for Payroll Taxes and Social Security.” Accessed July 20, 2014. https://www.cbo.gov/sites/default/files/cbofiles/attachments/45519-‐QFR_Hatch.pdf.
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4.2.2 Support Growth Drivers
The United States must return to the basics in creating opportunity. Focusing on education, research, defense, and the infrastructure space will not only support the country’s domestic level of technical and entrepreneurial activity but also reinforce its position on the global stage. Federal spending in the defense sector led to some of the most important tech innovations to ever exist and led to the creation of private industry opportunity hubs in California and many other states.69 Somewhere over the past century these long-‐term efforts have been lost to short-‐term partisan interests. The following section discusses potential areas of reform in light of countless existing proposals and the main restricting force being a lack of political courage.
Instead of competing as one nation, society has disoriented itself away from its primary objectives, while developed and emerging countries continue to emulate the United States earlier successes. Taking steps to reverse this trend is becoming even more critical in light of aging demographics and growing fiscal imbalances. Americans must demand and support the resources necessary for individuals and businesses to succeed in the current hypercompetitive environment.
Overall, the domestic workforce lacks the skills to compete in today’s global marketplace. As more remedial service and manufacturing jobs are automated or outsourced, capitalizing on the nations technical strengths, while allowing jobs that can be done cheaper to go abroad, will lead to higher levels of prosperity for all. Well-‐employed workforces start with an education system that reinforces an applicable skill set connected to real world demands. Similar to the glacial evolution of government structure, the current structure of education needs to be questioned. Understanding that everyone learns differently, and traditional routes to success might not be as promising today as in the past, is extremely important when applying government resources. Harvey White, co-‐founder of global semi-‐conductor company QUALCOMM, best summarizes the current state of education by conveying:
The US education system does what it was designed to do – the problem is that it was formed over 100 years ago in a different time – for a different need – in a different world economy – to satisfy a different life style – using the then available technology. The US education system has not changed significantly in over 100 years but the world has!
Public and private sectors need to guide the United States education framework into the 21st century by supporting both traditional and alternative paths, revamping public school and university curriculum and supporting technical trade schools. The private sector is far ahead of public systems in translating in demand skills that should be taught, yet the majority of education paths are disconnected in government structures. The majority of college graduates major in generalist studies even though high demand professions such as accountants, software engineers, machinists, and other skilled roles are built off technical educations. Knowledge of in-‐demand skills is failing to reach the next generation of workers. Society must stop repeating this process expecting different results.
Small businesses are where a majority of Americans get started in their first job. Given that the country’s employment participation ratio continues to decrease across core population groups, it seems legislators would focus on supporting these businesses in almost any way possible. But the current regulatory environment and capital requirements prohibit many entrepreneurs from undertaking such risks. In addition, legalization on immigration often times prohibits individuals
69 Hubbard, Glen and Tim Kane. “Balance: The Economics of Great Powers From Ancient Rome to Modern America.”
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who are educated in the U.S. from gaining citizenship and working in the U.S. Government must do all it can to support business by debottlenecking the regulatory environment that limits their economic potential. Small businesses in the United States account for 54% of all sales and employ over half of the workforce, creating a net 66% of all new jobs since the 1970s.70 If these companies faced lower regulations and were able to employ more people, they would sell more goods and services and ultimately increase national productivity across all sectors.
The spectrum of potential reforms ranges from simplifying businesses and individual tax codes to supporting peer-‐to-‐peer or business-‐to-‐business partnerships that encourage intra-‐industry competition. Partnerships such as these would encourage the workforce to rethink processes and provide higher levels of service. Transitioning from the hierarchal structure that inhibits a flow of information through businesses and government towards a modern bottom up distribution of information will present many opportunities.
Although disruptive upon implementation, services such as Uber or Airbnb prove the improvements in efficiency by matching unused capacity with demand and forcing traditional actors to compete on price and service. Like buggy manufacturers fighting adoption of the automobile, slowing or stopping such a transition is futile because the user experiences a higher level of service and ultimately votes with their dollar. Competition forces societal progress. What if local governments had to compete with neighboring cities on quality of service? Constituents would definitely notice an improvement. The potential combination of partnerships and friendly competitions are endless.
Society must also provide a cushion of resources necessary to retrain those displaced by such disruption or face a list of social consequences dragging on living standards. This is why reforming education is critically important because all groups, regardless of age, face disruption and without effective resources the country as a whole will suffer. Although unsustainable traits of social programs will still need to be addressed, the least painful route to bridging the country’s fiscal gap is through higher levels of productivity.
Another area where alternative partnerships should be supported is in the infrastructure and research and development spaces across all industries. As discussed earlier, many governments face fiscal shortfalls and do not have the ability to rebuild an aging infrastructure or fund the next generation of research. Efforts can be undertaken with far less strain on existing systems by opening financing and various other resource sources beyond traditional methods.71 Success of such partnerships is exhibited in the evolution of private space travel. As NASA loses federal funding to non-‐discretionary programs, independent organizations have assumed the role where government left off. Groups such as Space X now contract to transport NASA astronauts and supplies to the international space station.72 Without such efforts, the future of space travel and travel would look drastically different. These are just a few of the potential alternative solutions that are already being utilized in light of fiscal constraints.
70 U.S. Small Business Administration. “Small Business Trends: Small Business, Big Impact!” Accessed November 5, 2014. http://www.sba.gov/offices/headquarters/ocpl/resources/13493. 71 Chatham House, the Royal Institute of International Affairs. “Building Growth in Europe: Innovative Financing for Infrastructure.” Accessed October 5, 2014. http://www.chathamhouse.org/publication/building-‐growth-‐europe-‐innovative-‐financing-‐infrastructure. 72 National Aeronautics and Space Administration. “NASA Chooses American Companies to Transport U.S. Astronauts to International Space Station.” Accessed October 5, 2014. http://www.nasa.gov/press/2014/september/nasa-‐chooses-‐american-‐companies-‐to-‐transport-‐us-‐astronauts-‐to-‐international.
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Natural resources might seem disconnected from the discussion of economic growth drivers but when social processes are distilled, it becomes clear how valuable these inputs are to prosperity. The United States has been endowed with an enormous level of natural resources. Naive exploitation of these resources has been relatively tolerable over the past few centuries due to the sheer amount of available supplies. But many still do not acknowledge or appreciate how gifted the nation is in terms of land and natural resources that have supported such rapid economic growth since the first explorers reached North America.
The global community has entered an era where abuse cannot be tolerated. Shortages of natural resources such as clean water, arable land, and numerous other inputs vital to human survival afflict countries all over the world and are directly proportional to population growth. In order to protect such opportunity for future generations, society must restrict abusive activities and preserve remaining stores of natural wealth. Similar to the taxi industry facing disruption from companies like Uber, businesses that abuse natural resources will have to adapt to the reality of more protective policies. Companies that are pioneering alternative methods of utilizing renewable resources should also be supported through partnerships and competition structures as discussed above.
These suggestions are merely a few of the potential actions the United States can undertake in embracing activities that promote higher levels of prosperity. But without the political courage at federal, state, and local government levels, the county will continue its unsustainable trajectory. America cannot afford to continue to ignore its underutilized human, physical, and financial capital by choosing the path of least resistance.
4.2.3 Returning to the Roots: Commonwealth Mentality
Responsibility of motivating the political action necessary to overcome the structural challenges facing the United States falls upon every citizen. Although elected officials bear great liability in implementing legislation, the democratic process starts with the individual. Without faith in such a process, political gridlock will continue to inhibit prosperity. Americans must reestablish the commonwealth mentality the country was formed upon.
Change starts at the individual local level of society. Harnessing the social drive to make reform happen will come through community involvement, acknowledging and raising awareness of the current state of policy. Local communities can overcome where politicians continually fail to progress. Similar to entitlement reform, many citizens have proposed acts in hope of motivating a collective reform movement. The Intergenerational Financial Obligations Reform Act is one of numerous proposals that are stuck in the political system due to a lack of political courage. Federal entities such as the Congressional Budget Office, Government Accountability Office, Treasury, and the National Commission on Fiscal Responsibility all support financial reform. But elected officials will not take action unless their constituents lead the way.
The United States has gone from the Manhattan Project and putting Astronauts on the moon to an environment of collective gridlock best exhibited by the federal government’s inept implementation of the Affordable Care Act and failure in launching HealthCare.gov.73 74 It’s tough
73 The Wall Street Journal. “ObamaCare’s Failing Cost Control.” Accessed October 24, 2014. http://online.wsj.com/articles/obamacares-‐failing-‐cost-‐control-‐1413758684. 74 Bellovin, Steven. “Why healthcare.gov has so many problems.” Accessed October 20, 2014. http://www.cnn.com/2013/10/14/opinion/bellovin-‐obamacare-‐glitches.
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to even compare the country’s ability between these events, but by acknowledging how far the nation has drifted, citizens should be encouraged that a return to such standards is possible.
When the country was in its infancy, communities understood the value of banding together to survive. Such commonwealth mentality was lost over the country’s numerous successes, all of which lulled citizens into believing the illusion that collective effort was no longer necessary to maintain prosperity. This shift is best seen with voter turnout data across different periods of the country’s history. During the 1860 presidential election, 81.2% of all eligible voters voted. With significant progress in access to the democratic process since 1860, it should be expected more would exercise the right to vote today. But during the 2012 presidential election, which had exceptional turnout from young and minority groups, only 54.87% of eligible voters actually voted.75 Remember these are presidential election years where turnout is consistently higher. Data becomes much worse when local and state elections are considered.
Maybe political courage would return if voting became mandatory. At least if more people voted, radical influences would become diluted. Other mandatory requirements such as taxes could be tied to voting. For example, tax credits could incentivize higher levels of turnout. Or even tying social benefits to the voting process at the federal, state, and local levels would greatly increase participation in the democratic process. Mandatory voting requirements could be considered by many to be un-‐American. But until greater portions of society take part in the democratic process, the country will continue to drift down its current unsustainable path towards crisis.
75 Gerhard Peters, Gerhard and John Woolley. “American Presidency Project.” Accessed November 10, 2014. http://www.presidency.ucsb.edu/data/turnout.php.
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5.1 Conclusion: Starting the Journey
Although many aspects of social insurance in United States have stayed true to their original intents, implementation of a few larger programs has drifted unsustainably far from their intended structures. General old age and healthcare subsidies were never intended to become primary sources of income through retirement. They now threaten the solvency of many other more critical social systems and government programs. If reform is delayed much longer, social insurance trust funds will be depleted forcing benefits cuts to match the amount of tax revenue collected for each period. The Congressional Budget Office estimates this cut to be around 75% of current benefit levels and to occur in little over a decade.
As greater portions of federal tax revenue are diverted to non-‐discretionary social programs and other critical systems that drive prosperity are paired back even further, domestic economic growth is likely to slow. Without policies that support education, defense, health care, infrastructure, and research and development systems, these fiscal imbalances will only be exacerbated with more individuals reliant on government subsidies to get by. Although the cycle created in such a scenario is already in motion, it can be reversed. This reality is not a generational or partisan issue, rather an American issue that will affect all present and future cohorts.
Prosperity starts at the individual. Economic productivity is largely influenced by population growth over time. Developed countries are aging in proportions never seen before and emerging populations are hitting their economic stride. The final graph displayed below illustrates such tectonic trends in working age populations that have and will continue to take place across various regions over the next century. Policies crafted on historic demographic estimates and economic growth rates cannot sustainably be applied to this changing environment. The country must acknowledge and adapt to aging demographics before the weight of unsustainable social programs are forced upon its citizens through crisis.
Source: Drummond, Paulo, Vimal Thakoor and Shu Yu
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As of this writing, the most recent Congressional Budget Office fiscal review remains consistent with social insurance programs continuing to grow at unsustainable rates, but there are areas of hope for the country’s future.76 77 Many industries are positively influenced by the second industrial revolution that is taking place, leading to higher levels of productivity and the creation of entire new industries. Information and the potential to collaborate have never been more accessible in the history of the world. Outsourcing and automation of remedial tasks are allowing more individuals to take risks and pursue opportunities that would have never been possible even a few decades ago. With these advancements comes great responsibility in reforming and crafting policies that support prosperity for all demographic cohorts and promote opportunity for future generations.
Political gridlock at all levels of government threatens such policies. A return to a commonwealth mentality the nation was founded upon, in support of pro-‐growth issues, is critical at the individual level of society. Accountability over the country’s long-‐term fiscal constraints must be shared. Responsibility to motivate the political courage necessary to implement structural reform therefore falls upon all citizens. America has the resources and ability to return to previous trajectories of prosperity, the viscous cycle of apathy must stop. Such change starts with you and me.
76 U.S. Congressional Budget Office. “An Update to the Budget and Economic Outlook: 2014 to 2024.” Accessed September 25, 2014. https://www.cbo.gov/publication/45720. 77 U.S. Congressional Budget Office. “Monthly Budget Review: Summary for Fiscal Year 2014.” Accessed November 12, 2014. https://www.cbo.gov/sites/default/files/cbofiles/attachments/49759-‐MBR.pdf.
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