Open Letter to Congress to debate Prefunding at Birth:

The purpose of this letter is to request that Congress debate Prefunding at Birth as a viable alternative for funding Social Security and Medicare.

It appears that our nation’s long standing debate over how best to solve our senior entitlement fiscal problems has been restricted to only two approaches. The Democrats advocate for raising taxes as the best solution while the Republicans support reducing program costs by cutting benefits.

There is a third option - one that would prove to be far superior for the long-term health of our economy and one that the voters would demand if they were given the facts - and the choice.

For a fraction of what it costs our economy today, Prefunding at Birth would place our senior entitlement programs on a glide path toward permanent fiscal soundness without the need to increase anyone’s taxes or reduce anyone’s benefits.

At the individual level, Prefunding at Birth involves estimating the future costs of senior benefits for those children born each month and making monthly investments in the equity markets to meet the future need.

From the taxpayer [government] perspective, Prefunding at Birth capitalizes on two of the most successful investment strategies in use today.

1. Time Value of Money and
2. Dollar Cost Averaging

It is widely believed that our current pay-as-you-go taxing method for funding Social Security and Medicare is less risky than investing in the equity markets. While it is true that equity prices can lose value over periods as long as 20 years, it is also true that over the very long-term, markets tend to return to their historical averages. By basing a plan on the perpetuity of the equity markets and by fixing returns at slightly less than historic return averages and offering guaranteed benefits through the full faith and credit of the American taxpayer, a Prefunding at Birth plan could essentially eliminate market risk and perhaps just as importantly, eliminate public fear over the financial safety of their senior plans.

Consider the following.

·       Per Robert Shiller and the Yale School of Management, since 1915, U.S. equities have returned an average annual return at 10.4%.

·       Those same continuously updated Shiller statistics reveal that the worst 70 year period still managed to return a very respectable 9.85% average annual return.

·       The best 70 year period produced an average annual return of 11.92%.

·       The U.S. Senate Special Committee on Aging report entitled “Social Security Modernization Options to Address Solvency and Benefit Adequacy” dated May 13^th, 2010 concluded that over the long term a government controlled broad based equity fund would average 9.4% annual return on investment after accounting for fees and expenses.

·       According to the 2012 Trustees Report, our unfunded liability for Social Security has a net present value of $20.5 trillion while Medicare’s unfunded liability is $42.8 trillion for a total of $63.3 trillion. These future obligations must eventually be paid by the taxpayers or the promises that have been made to our seniors must be broken. How risky will Americans consider their pay-as-you-go senior entitlement programs once Congress starts reducing their benefits?

A fair minded comparison of the risk realities between the long-term equity markets and pay-as-you-go financing for Social Security and Medicare reveals one indisputable fact; namely, that even including the Great Depression and the Great Recession, equity markets have averaged over a 10% per year return on investment while pay-as-you-go financing has left us with a $63.3 trillion unfunded liability. Clearly, pay-as-you-go is the much riskier option. If only the people knew.

Although the plan’s funds would be physically invested in the equity markets, the plan would eliminate market risk because individual benefits would accrue at a government guaranteed fixed rate of return and would be guaranteed by the full faith and credit of the U.S government. The government guaranteed fixed rate of return would equal the long-term market average rate of return less administrative fees and expenses and is currently estimated at 9.4% to coincide with the conclusions reached by the 2010 Senate Special Committee on Aging.

However; in order to maximize the efficiency of the time-value of money, the actual rate of return would more closely approximate the historic equity average rate of return of 10.4% if the only expense paid from the fund were for beneficiary distributions (which would not start for at least 62 years under current Social Security rules). All other fund fees, brokerage commissions, administrative expenses and equity purchases would remain pay-as-you-go expenditures that would be financed from current tax receipts; not the fund. The plan would not need to support any sales charges, load fees or any fees based on a percentage of the fund’s balance. The tax component of the plan designed to pay those fees would be kept separate and managed separately from the benefit portion.

Whatever the fixed rate agreed to by Congress, it would not be subject to annual or perhaps even decades long fluctuations because it would be based on the historic average rate of return and would not change unless and until there was evidence that the long term historic average rate of return had permanently changed.

Pay-as-you-go:

In 1999, the average Social Security benefit was $9,093 per year and the average 65 year old was projected to live another 14.2 years with an average cost of living increase of 2.8% per year for a lifetime benefit payout of $153,269.

Prefunding at Birth:

A one-time investment of $268 in 1935 that grew at 9.4% for 64 years would have grown to $84,187 in 1999. Assuming that all unpaid balances continued to grow at 9.4% per year, the account would be able to pay the same $153,269 in COLA adjusted benefits for the same 14.2 years.

Although the benefit payouts would be identical, there would of course be one significant difference between the two approaches. In 1935, had we included Prefunding at Birth for newborns along with pay-as-you-go for those already alive, our unfunded liability today for Social Security would be zero. Ditto if we had adopted a similar approach for Medicare in 1965.

Under the same assumptions, a $2000 investment today will achieve the same purchasing power for a beneficiary 65 years from now. If, on the other hand, we  increase the fixed APR to 10.4% and increase the benefit start age to 70, the one-time investment needed to produce the same purchasing power based on 2.8% inflation per year for a life expectancy extended to 17.4 years is reduced to $750 per newborn.

Given that there are about 4 million births per year, the cost to fund the program at $2000 per birth is roughly $8 billion per year or about the cost to fund our efforts in Afghanistan for a month. At $750 per person, the annual cost to fund the Social Security portion of the plan would be $3 billion or about the amount we plan to provide Egypt and Palestine this year in foreign aid.

Once we completed the transition from pay-as-you-go to Prefunding at Birth, the income redistribution due to Social Security alone would drop from $805 billion per year to $8 billion per year at the 9.4% return rate and $3 billion per year at the 10.4% rate in 2010 dollars.

In 2010, U.S. employers, including the self-employed, paid $252 billion in Social Security taxes and another $78 billion in Medicare taxes. Eliminating the business paid portion of payroll taxes would make U.S. based labor more cost competitive in a global market for labor by about $330 billion per year. How many U.S. based jobs might be created as a result of a $330 billion per year reduction in labor costs?

Another important question that deserves to be answered is what exactly is the main purpose of Social Security? Is it to provide those who earned the most money during their working careers with the most money in their retirement years? That’s what it does. When you consider that those who earned the most also contributed the most, it seems fair that under the present taxing scheme they should receive the most benefits. But getting back to the question, is that the main purpose of Social Security? I submit that it is not. I submit that the main purpose of Social Security is to ensure that every senior has enough income so that he or she can live with a certain level of dignity and independence during their senior years. I further submit that the only reason why a person’s lifetime income is used to determine benefits under the current plan is simply because program revenues originate from a dedicated payroll tax and the amount of the tax is based on a person’s income. By removing the dedicated payroll tax component, we stand a much better chance of satisfying the “real” main purpose of Social Security.

Basing benefits predominately on income has caused the current system designers to adopt several social engineering schemes that may not reflect the social values of the population and in fact may discourage certain behaviors that research has concluded benefit society. For example; the current system penalizes a family when one parent agrees to forego a career and stay at home to raise the children. Similarly, the current system doesn’t value people who accept lower paid jobs or work fewer hours in order to spend more time helping others. In other words, a lifetime of service to family, charity and community are either not valued by Social Security or at least not valued as much as income.

Prefunding at Birth would eliminate the social engineering aspects of the current system. Under Prefunding at Birth, all beneficiaries would be treated the same regardless of their work status or employment history. A person’s [legal] lifelong decisions in their personal pursuit of happiness would not impact their government guaranteed senior benefits.

To those who might wonder if a new moral hazard was being proposed, I would ask them to consider the likelihood that a person would decide to be idle for the first 65 years of their life awaiting the spoils from Prefunding at Birth. For those who were still not convinced, I would argue that a small investment at birth insures our society against the high cost of having to provide for someone who failed to make plans for their senior years.

Recalling Aesop’s fable about the Ant and the Grasshopper, leads to the conclusion that as long as our Supreme Court has ruled that the Ants must provide the basic necessities for the aging grasshoppers then prudence demands that the ants optimize the efficiency of their obligations.

In the past our political leaders have used fear as a tactic. Both parties have threatened that the government might be unable to make senior entitlement payments if for example budget agreements failed and the government was forced to shut down. Prefunding at Birth removes our seniors from the ranks of the political pawns.

In summary, Prefunding at Birth would convert our senior entitlement programs from costly, growth restricting, job limiting, demographically challenged, and political fear mongered pay-as-you-go insurance plans that unethically force future generations to bear the costs of current generation profligacy and mismanagement to one where current generations honorably provide for their children’s future by investing in their nation’s private sector on behalf of their children. Isn’t that how it’s supposed to work?

Clearly Prefunding at Birth deserves a seat at the debate table. I ask every member of Congress to please explain why a plan based on prefunding at birth is not under consideration by Congress as a viable solution to our senior entitlement funding problems?

I look forward to your reply.

Sincerely yours,

James W. Schneider

Concerned Citizen
Twitter: @JimS1
March 1^st 2013