The Retirement Compact

The problem

The Social Security Trustees publish a date every year. In recent reports the old-age trust fund runs out around 2033, with the combined funds a year or two behind.

Most people hear "runs out" and assume a negotiation follows. It does not. Current law already specifies what happens: benefits are reduced to whatever the incoming payroll tax can cover, which the Trustees put at roughly a 21 to 23 percent across-the-board cut. Not means-tested. Not phased. Applied to a widow of ninety and a retiree of sixty-two alike, on the same day.

That is not a forecast of a crisis. It is a scheduled event, in statute, with a date, affecting about 68 million people.

The arithmetic underneath is not mysterious and has not changed in forty years. In 1960 there were about five workers paying in for each beneficiary. There are now under three, heading toward roughly two. People live longer, which is the good news, and have fewer children, which is the arithmetic. A pay-as-you-go system is a ratio, and the ratio moved.

The 75-year shortfall is about 3.5 percent of taxable payroll, or something over $20 trillion in present value.

Here is the part this catalog is most interested in, and which almost never appears in the debate.

The trust fund's assets, roughly $2.7 trillion and falling, are invested entirely in special-issue Treasury securities. By law it may hold nothing else. So the retirement savings of the American public are lent to the American government at the government's own borrowing rate, and that is the whole return.

Canada faced the same demographics in the 1990s, and did something different. The Canada Pension Plan Investment Board was created in 1997 to invest contributions in global markets, at arm's length from the government, with a statutory duty to beneficiaries alone. It now manages on the order of C$700 billion and its actuary certifies the plan sustainable for 75 years.

Canada's workers own equity. America's own a promise from the Treasury.

The proposal

Close the gap with a package of small, early, phased adjustments, and let a portion of the trust fund own real assets through an independent board that no politician can direct.

How it would work

Closing the gap

1. Lift the cap gradually. Wages above the taxable maximum, around $184,000, currently pay nothing into the system. Phase the cap upward over a decade until roughly 90 percent of national wages are covered, which is where the 1983 reform aimed and where erosion has since taken it to about 82. Credit the additional taxed earnings toward benefits at a reduced rate, so the contributory link survives.

1. A more progressive benefit formula. Hold the bottom two-thirds of the earnings distribution harmless. Slow the growth of initial benefits for the top third by adjusting the highest replacement bend point. This is a reduction in future growth, not a cut to anyone currently receiving a cheque, and we are not going to describe it as anything softer.

1. Index the retirement age to longevity, for the young only. Applied to cohorts at least 20 years from claiming, with a hard carve-out preserving early eligibility for workers in physically demanding occupations and those with long earnings histories starting before age 22. Nobody near retirement has their date moved. That is both fair and the only version that has ever passed.

1. A minimum benefit floor. No one who worked 30 years retires below the poverty line. The current special minimum has withered to near irrelevance through bad indexing. Restore it and index it to wages.

Owning assets

1. An independent investment board. A portion of the trust fund, phased to a cap of 25 percent, invested in a broad global index through a board modelled on Canada's CPPIB and on the Federal Retirement Thrift Investment Board that already runs the federal workforce's own $900 billion savings plan. Statutory duty to beneficiaries alone.

1. Passive, and mute. Index-only holdings, no stock picking, and shares voted by an independent fiduciary under published standing policies, or not voted at all. The government must not become an activist shareholder in American companies, and the design has to make that structurally impossible rather than merely unlikely.

1. Separate from the Fund. This is not the American Permanent Fund of № 001 and must never be merged with it. Social Security's assets belong to its beneficiaries under a contributory promise. The Fund belongs to every citizen by birth. Combining them would put the endowment's payout at the mercy of the retirement system's actuarial cycle, and would let a future Congress raid one by way of the other.

The numbers

The gap is 3.5 percent of taxable payroll. The package roughly covers it:

On the investment half: the historical gap between a global equity index and Treasury yields has run 3 to 4 percentage points a year over long horizons. On a quarter of a $2.7 trillion fund, three points is roughly $20 billion a year, and compounding matters more than the annual figure over a 75-year valuation window.

The decisive number is not any of these. It is time.

The Trustees have published the same arithmetic annually for three decades. Every year of delay makes the required adjustment larger and the available phase-in shorter. Acting in 2026 means changes measured in single percentage points, phased over twenty years, affecting nobody currently retired. Acting in 2033 means a 23 percent cut arriving on a Tuesday.

The 1983 commission reported when the fund was months from depletion, and the reforms it produced were harsher than they needed to be for exactly that reason.

The honest objections

"Government investment in equities is a route to political control of private companies." The most substantial objection, made forcefully by Alan Greenspan among others, and the reason item 6 is written as a structural prohibition rather than a norm. A $700 billion state shareholder that votes its shares is an industrial policy instrument whether or not anyone intends it to be. The mitigations, index-only, independent fiduciary voting, statutory duty to beneficiaries, a cap at a quarter of assets, are the same ones Canada uses and the same ones already governing the Thrift Savings Plan, which has held equities for federal employees since 1988 without becoming an instrument of policy. The risk is real and it is managed rather than eliminated, and anyone who tells you it is eliminated is selling something.

"You are exposing retirement security to a market crash." Only a quarter of the fund, and the fund itself covers a minority of scheduled benefits, with payroll tax covering the rest. A 40 percent equity drawdown on a quarter of assets is roughly a 10 percent hit to the fund, absorbed over a 75-year horizon by an institution with no liquidity needs, which is the textbook description of the investor who should hold equities. The relevant comparison is not to zero risk. It is to the current portfolio, which guarantees a low return and is therefore guaranteed to require larger tax increases or benefit cuts.

"Raising the cap is a tax increase on people who will never get the money back." Substantially true, and item 1 softens rather than removes it by crediting the extra earnings at a reduced rate. The counterargument is that the cap's coverage has eroded from 90 percent of wages to 82 not by any vote but because earnings above it grew faster, so restoring 90 percent restores the settlement Congress last actually made rather than imposing a new one.

"Raising the retirement age is a benefit cut that falls hardest on people who die younger." The strongest distributional objection, and it is well evidenced: the life-expectancy gap between the top and bottom income deciles has widened substantially, so a uniform age increase transfers from shorter-lived, lower-income workers to longer-lived, higher-income ones. That is why item 3 carries occupational carve-outs and a long-earnings-history exemption, and why item 4's minimum benefit is in the package rather than optional. If the carve-outs cannot be drafted workably, this component should be dropped and the payroll rate raised instead. We would rather lose a fifth of the fix than pass a regressive one.

"No Congress will touch this." The historical record is against us and we know it. But the observation cuts both ways: doing nothing is not a stable equilibrium here, because the alternative is not the status quo, it is a 23 percent automatic cut with a date on it. The politics of this problem get worse every year and then get resolved anyway, badly, in a hurry, the way they were in 1983.

Sources

• Social Security Board of Trustees, Annual Report: OASI trust fund reserve depletion projected in the early 2030s; benefits payable thereafter at roughly 77–79 percent of scheduled (ssa.gov/oact)
• 75-year actuarial deficit of approximately 3.5 percent of taxable payroll; covered-earnings share fallen from 90 percent (1983) to roughly 82 percent
• Worker-to-beneficiary ratio, historical and projected; SSA Office of the Chief Actuary
• Canada Pension Plan Investment Board, established 1997, assets on the order of C$700 billion; Office of the Chief Actuary of Canada sustainability certification (cppinvestments.com)
• Federal Retirement Thrift Investment Board, Thrift Savings Plan, equity holdings for federal employees since 1988 (frtib.gov)
• National Commission on Social Security Reform (Greenspan Commission), 1983
• Widening mortality differentials by lifetime earnings; National Academies, The Growing Gap in Life Expectancy by Income (2015)
• Proposals № 001 (The American Dividend, kept strictly separate); № 023 (The Debt Covenant)