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Means Testing Your Social Security Payments

Mises Daily: Monday, September 24, 2012 by

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I posted an article on my Tea Party Economist site on the increase in the real debt of the US government over the last year. The increase was $11 trillion.

Impossible? Not at all. The annual increase — the deficit — will be even larger next year, and larger still the year after.

This refers to the unfunded liabilities of the government. These are the price tags of political promises that politicians have made over the years for which there is no money available to fulfill. The expert here is Professor Lawrence Kotlikoff of Boston University. His most recent report says that total unfunded liabilities went from $211 trillion a year ago to $222 trillion this year.

The biggest source of future red ink will be Medicare. In second place is Social Security.

How can the government pay off these obligations? It can't. The possibility does not exist. The government needs a spare $222 trillion to invest in private companies. This investment must make a return of at least 5 percent to provide the money needed to pay meet the government's obligations. There is no $222 trillion available, and no capital markets large enough to absorb $222 trillion.

Conclusion: the US government will default.

"No, no!" you may be thinking. "This cannot be true. Why, the full faith and credit of the government lies behind these obligations." This is the correct verb: lies. It is also the correct noun.

It is all a pile of lies. These lies are IOUs.

Your check will not be in the mail. The Postal Service by then will be long gone.

What about automatic deposits into your bank?

What bank?

The implications of an unfunded liability of $222 trillion are so comprehensive, so stupendous, and so frightening that voters ignore the story. So does Congress.

There is a lot of shadow boxing going on. There is talk of a sequestration of funds in 2013, as the 2011 law requires. There is talk of a fiscal cliff. What is this talk all about? It is about cuts in projected federal spending of about $120 billion a year for ten years.

At $11 trillion a year, we are talking about an increase of $110 trillion over the next ten years. But it will not be this low. Every time Congress kicks the can, the year's unfunded liabilities are added onto the total obligation. As the total obligation grows, the interest payment on the debt grows. It keeps building, like a mortgage after missed payments.

What if rates go back up to 5 percent? Then the unfunded liabilities will really grow.

The government will default.

Social Security

Social Security has been running a deficit ever since 2010. There is no trust fund. The trust fund is a pile of IOUs from the Treasury. Here is the wording from the 2012 report from the Trustees of Social Security. "The Department of the Treasury currently invests all program revenues in special non-marketable securities of the US government which earn a market rate of interest."

Therefore, every time the trust fund sends an IOU back to the Treasury, the Treasury must borrow money to be able to send money to Social Security. The deficit in the general fund rises.

How much in the hole is Social Security? First, there is the red ink from insufficient FICA tax revenues. Here is what the Trustees of Social Security say.

Social Security's expenditures exceeded non-interest income in 2010 and 2011, the first such occurrences since 1983, and the Trustees estimate that these expenditures will remain greater than non-interest income throughout the 75-year projection period. The deficit of non-interest income relative to expenditures was about $49 billion in 2010 and $45 billion in 2011, and the Trustees project that it will average about $66 billion between 2012 and 2018 before rising steeply as the economy slows after the recovery is complete and the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers. Redemption of trust fund assets from the General Fund of the Treasury will provide the resources needed to offset the annual cash-flow deficits.

Second, there are interest payments on the IOUs in the so-called trust fund. These payments go from the Treasury to Social Security. The Trustees failed to mention this in the body of the report. That would make things look a lot worse. To find this figure, you must do some digging. I have done it for you. It is reported in an unnamed table about one-third of the way into the report. Social Security's interest income from the general fund in 2011 was $106.5 billion. Add this to the $45 billion deficit, and we get $151.5 billion. That was the total deficit in the program in 2011.

We can see where this is headed: deeper into the red-ink lake.

At some point, there will be calls in Congress for a tax hike for FICA. My guess is that the earned income subject to the FICA tax will go from $110,000 a year to at least $150,000. This way, the average wage earner will not pay more than what is already scheduled. It will come out of the pockets of the upper middle class. But this is a political issue. Members of Congress will have to test the opposition to any increase. They will make a cost-benefit analysis — for their careers, not the victims' income.

All of this is political. It is short term. It is sound and fury signifying little for the total unfunded liability of all of the federal welfare programs. The relentless growth of the unfunded liabilities dwarfs anything that Congress is willing to discuss.

Who Will Get Stiffed First?

Congress will delay any comprehensive default on Social Security and Medicare. The obvious solutions are to raise the age for eligibility to both programs. But this creates havoc for Medicare's beneficiaries.

The health-insurance industry has received its greatest bonanza from Medicare. As soon as anyone reaches age 65, he loses eligibility for most of the payments from his private health-insurance policy. His company informs him that it will not cover any expenses that Medicare covers. But the premiums do not fall.

Everyone cancels his health insurance on that day. This lowers the risk of illness for everyone remaining in the pool of clients. The risk of insuring sicknesses beyond age 65 is transferred to Uncle Sam in one move. This lets health-insurance companies offer policies far cheaper to those under age 65.

If Medicare's age of eligibility were raised, the premiums of all health-insurance policy owners would rise. This will be fought by the insurance industry. It will also be fought by the geezer lobbies. These are powerful lobbies. The biggest one is the AARP, formerly the American Association of Retired People. When the AARP says no, Congress listens.

The budget killer is Medicare. This is because the subsidy is the largest: almost $12,000 a year. As the baby boomers start getting added to the rolls, the cost to the government will become unsustainable. Then what?

Congress will start looking for politically acceptable sacrificial lambs. This means rich people.

Means Testing

At some point, there will be means-testing. The politicians will decide that anyone with an income above a certain rate will have his payments reduced. The more his income, the greater the reductions. At first, this cap will apply to earned income. Then it will be applied to all income.

We are already seeing this in other federal welfare programs. The means testing has not begun, but politicians are discussing it.

The most recent case is unemployment insurance. This is a sacred cow in Congress. The payments now extend to 99 weeks. About 7 million people are "99ers."

Rich people are eligible for unemployment insurance payments. Rich people do get fired. In 2009, about $20 million was paid to 2,362 millionaires.

This story is great for news sites. It is all over the Web. Search for millionaires, unemployment benefits, 2009.

Someone in Congress requested that the Congressional Research Service produce a report. It was released on August 2, 2012. Title: Receipt of Unemployment Insurance by Higher-Income Unemployed Workers ("Millionaires").Download PDF That gets right to the point, politically speaking. The law does not distinguish between rich fired workers and non-rich fired workers, any more than it distinguishes rich Social Security recipients and not-rich. But the very existence of $20 million in payouts in a $3.5 trillion federal budget (2009) annoys people who are envy-driven.

In the introduction to the CRS report, we read this.

Several other bills have been introduced in the 112th Congress that would restrict unemployment benefit receipt based on income (i.e., they would change the current requirement to provide unemployment benefits to all workers without income restrictions). S. 1944 would impose an income tax on unemployment benefit income for certain high-income tax filers, among other provisions. S. 1931 includes the same provisions for a tax on unemployment benefits received by high-income individuals as H.R. 3630. H.R. 235 and S. 310 would prohibit the use of federal funds to pay UI benefits to certain high-income individuals, among other provisions. While the recent debate in Congress commonly referred to restricting "millionaires" from receiving UI benefits, the various proposals specify different income thresholds at which the restrictions would apply (i.e., they vary in how they define high-income individuals).

To inform the policy debate, this report provides information relevant to proposals that would restrict the payment of unemployment benefits to individuals with high incomes. Three primary areas that may be of interest to lawmakers are addressed: (1) the current US Department of Labor (DOL) opinion on means-testing UI benefits; (2) the potential number of people who would be affected by such proposals; and (3) policy considerations such as the potential savings associated with such proposals, particularly in terms of federal expenditures. The latter two issues are discussed because a small percentage (approximately 0.02%) of tax filers receiving unemployment benefit income had AGI of $1 million or more in tax year 2009 based on Internal Revenue Service (IRS) data.

There is no question what the motivation of such legislation is: envy. No one imagines that $20 million a year will affect the deficit. In all of the cabinet-level bureaucracies, it is not possible to detect an error of $20 million. So, this legislation is symbolic. It is a way to cut the rich down to size.

It is clear what will happen when the expenditures are far more than $20 million a year. When it is clear that rich people who have paid into Social Security are costing the taxpayers billions of dollars, there will be bills introduced into Congress similar to the ones introduced on unemployment insurance payments to millionaires. At some point, one of them will be signed into law.

Most voters will not know of this. Of those who know, most will cheer silently: "Serves them right!"

Congress will start at the top and work down. That will be more acceptable politically. This will keep most voters unaware of what is happening.

The effect on total payments will not be much. There are not enough people at the top to stiff.

Medicare is the program that offers the great challenge to Congress. How will the rich be cut off, when the healthcare industry has no provision for them? If the industry begins to offer special policies for the rich, the premiums will be high, unless they have million-dollar deductibles.

Will Medicare offer high-deductible policies? That would be economically attainable, but would it be politically acceptable? I doubt it.

The rich will be sacrificed first. Then, income quintile by income quintile, the means-testing will be applied until the voters rebel.

Conclusions

The US government has promised more than it can deliver. There will come a point when it will have to renege. It will start at the top of the income brackets and work down. Politicians will seek to delay an across-the-board reduction of payments. But the magnitude of the unfunded liabilities is so vast that Congress will be trapped. It will default in stages, but it will default.

The welfare state's Ponzi scheme economics will catch up with the politicians. It will catch up with everyone who is dependent on the welfare state. All over the Western world, this is statistically inevitable.

We wonder why people begin Ponzi schemes. The schemes always blow up. They cannot survive. The numbers tell us that. Why don't the initiators see what must inevitably hit them?

The financial world was amazed at Bernie Madoff. How did he fool smart rich people for so long, and for so much money?

Simple. He copied Congress.