How to Save Social Security and Medicare

To summarize the 2012 Medicare and Social Security Trustee reports:

If Congress fails to change the senior entitlement laws, Medicare will be unable to pay full benefits beginning in 2024 and Social Security will only have the resources to pay three quarters of its scheduled benefits starting in 2033.

The Trustees are telling us, just as they have been telling us for years, that Congress has promised but neglected to pay for over $63 trillion worth of senior benefits.[1]

Our chronic failure to resolve this decades old problem is a measure of how incompetent our federal government has become. But perhaps equally as distressing is how suboptimal, short sighted and narrow minded are the proposed solutions being bandied about.

To solve our senior entitlement funding problems, the Democrats propose raising taxes. The Republicans counter that the nation can no longer afford to pay the ever escalating benefits and that raising taxes will further damage our already fragile economy. Because of this, the Republicans propose reducing the senior benefits that have been promised to millions of American voters for decades – good luck with that.

Most experts agree that on the brink of economic collapse Congress will reluctantly reach a poorly reasoned, ill advised compromise that incorporates some combination of both raising taxes and reducing benefits. The ultimate effect of this last minute deal will be to subject our economy to slower than necessary growth; higher than necessary unemployment and the continued erosion of our standard of living.[2]

There is a better way!

We can restore our senior entitlement programs to solvency simply by changing how we fund them. For a fraction of what it costs our economy today, a sensible funding approach would place our senior programs on a glide path toward permanent fiscal soundness without the need to increase anyone’s taxes or reduce anyone’s benefits. Does all that sound a little too good to be true? Read on.

Albert Einstein, perhaps America’s most renowned physicist and certainly one of the world’s most brilliant historical figures is often credited with saying that the most powerful force in the universe is compound interest. Whether Professor Einstein actually expressed that sentiment is not important; what is important is the fact that the basis of capitalism and the foundation for the U.S. economy is predicated on the notion that private capital, invested in a profit motivated enterprise, may grow over time. The reason why people lend their money to, or invest their money in an enterprise is because the lender/investor expects to get more money back in the future. Without this fundamental principle of private capital appreciation, capitalism could not exist.

Our senior programs would have served America’s interests better had they been designed from the outset as investments in our seniors’ futures and taken full advantage of capital appreciation and the time value of money for the life of the beneficiary. Instead, they were designed as insurance programs where the premiums paid today are used to pay today’s beneficiaries. This type of funding is referred to as Pay-As-You-Go. When you consider that people will have to live at least 62 years before they receive their first benefit, pay-as-you-go is perhaps the most inefficient money management strategy conceivable.

Saving our senior safety net is as simple as fully utilizing the power of compounding for the life of the beneficiary. We call this whole-life investing strategy Pre-funding at Birth.

Let’s use an analogy to explain the approach.

Yesterday your first child, Jane was born and today you want to do something nice for Jane’s future. After some research and a little planning, you’re satisfied that you’ll be able to take care of baby Jane’s daily needs including her education and health care. But now you would like to do a little something for Jane’s old age – say when she reaches 70 years old. What a good daddy.

After selling your baseball card collection and the banged up old Harley-Davidson your wife affectionately refers to as the coffin, you were able to scrounge up another $2000 to help fund baby Jane’s retirement. But what should you do with the money?

You could do what our government does and spend the $2000 today and promise little Janey through an IOU that someone else will provide for her when she retires. Of course since you are a good daddy and possess a modicum of common sense, you immediately reject that idea as irresponsible.

You could decide to put the money in a safety deposit box and set up a trust fund with a law firm stipulating that baby Jane receives the $2000 when she reaches age 70. But you also know that inflation will eat away at the purchasing power of the money. You’re worried that after 70 years, $2000 might only buy little Jane a loaf of bread or two. You don’t know much about investing so you decide to consult a lawyer friend of yours for some free advice.

After reviewing a list of investment alternatives, your lawyer friend Loretta recommends that you invest the $2000 in the stock market. In particular she suggests an index fund that tracks the S&P 500.

You express grave concern over the safety of the stock market. Seeing your concern, a patient Loretta provides you with the following facts.

  • Since 1915, U.S. equities have returned an average annual return of 10.4%. That time frame includes the two deepest and longest economic downturns in U.S. history; the Great Depression and the Great Recession.[3]
  • In all that time, the worst 70 year period still managed to return a very respectable 9.85% average per year. In other words, pick any 70 year period since 1915, and the worst average return on your investment would have been 9.85% per year.
  • The best average annual rate of return over any 70 year period since 1915 was 11.92%.
  • The U.S. Senate Special Committee on Aging report entitled “Social Security Modernization Options to Address Solvency and Benefit Adequacy” dated May 13th, 2010 concluded that over the long term a government controlled broad based equity fund would average 9.4% annual returns on investment after accounting for fees and expenses.[4]
Even after considering what Loretta just told you, you’re still feeling a little uneasy. You don’t trust the stock market. You tried it a couple times and always got burned. You tell Loretta, “The market is too risky. What are you not telling me?”

Loretta tells you “The stock market is risky over the short term such as a year, five years or even fifteen years. It is also very risky if you’re not an expert and try to conduct your own research and invest in individual companies. On the other hand, the secret to growing rich in the stock market is investing over the long term in a well diversified portfolio and never trying to time the market.”

Loretta continues, “Consider this fact: If you were to invest the same way as the average of all investors then your returns have to be identical to the market’s average returns for that period. It’s that simple. That’s exactly what investing in broad indexed funds like the S&P 500 is all about. They are designed to track with the market”

Loretta hands you a glossy tri-fold pamphlet entitled “Financial Planning: Birth to Retirement” and dives into her firm’s new Pre-Funding at Birth Trust Fund sales pitch.

“We believe that average stock market returns over the long-term, say thirty years or more, will always trend toward their 10.4% historic average. Because of that belief, we are able to guarantee you a fixed 9.4% return per year. This allows us to keep any amounts above the 9.4% rate.”

“How this works is; my firm will invest your $2000 in a trust fund that we set up for Janey. At the end of each year we automatically add 9.4% to her beginning of the year balance regardless of how the stock market performed for that year. We assume all the risk for the 9.4%. Our reward for assuming that risk is we keep any growth over the 9.4. In other words, if the market averages 10.4% like we believe, then we will on average profit 1% per year and as your balance grows over time so will our 1%.

“However, and this is very important. The money is not available to you or Janey or anyone else until she reaches age 70.”

You interrupt Loretta “How much will $2000 at 9.4% per year be in 70 years?”

“Excellent question, let’s see.” Your lawyer pulls up a Microsoft Excel spreadsheet. In an open cell she employs the standard future value of a single-sum investment formula. But since you’re not interested in how she gets the number you stare out her window and wait for her answer.

=FV(Rate, Nper, PMT, PV, Type) where

FV = Future value which is what we are trying to obtain.

Rate = Growth rate so she enters 9.4% per year (0.094)

Nper = The number of periods so she enters 70 years (70)

PMT = Payment Amount each period or since there are none she enters 0

PV = Present Value of the lump sum amount. Since it is rcvd now it’s -$2000

Loretta reclaims your attention and points to the answer she bolded on her monitor:          $1,077,067

Your eyes bug-out of your head as you blurt out “One million dollars; are you kidding me?”

“I’m not kidding you” says your new best friend Loretta the Lawyer. “But be careful because in 70 years a million dollars won’t buy nearly as much as it does today. What we need to find out now is just how much $1 million will buy in 70 years.”

Loretta drones on “The Social Security Administration uses 2.8% per year for all of its long term inflation projections so that’s what we use.”

Reaching for the Excel application again, Loretta tells you that she will “use the Present Value function to compute the present value of a future value.”

“Whoa, whoa wait a minute.” You say. “I have no idea what you just said.”

“Ok” says Loretta, let me show you. “After 70 years, Jane’s account will be worth $1,077,068. But you want to know how much that will purchase 70 years from now. The $1,077,068 is a future amount. To figure out how much it will purchase 70 years in the future, we have to remove the estimated inflation rate of 2.8% per year. We do that by converting the future dollars back to present dollars by merely eliminating the inflation rate.”

“Here’s the formula.” You notice a pale green hummingbird hovering by a red and yellow feeder outside the window.

=PV(Rate, Nper, PMT, FV, Type) where

PV = Present value which is what we are trying to obtain.

Rate = In this case it’s the inflation rate per year of 2.8% (.028)

Nper = The number of periods so she enters 70 years (70)

PMT = Payment Amt each period but since there are none, she enters 0

FV = Future Value amount. $1,077,067

Loretta politely clears her throat to recapture your focus and points to the Excel answer:        $155,856

While pointing to the answer, she explains “This amount means that a one-time investment of $2000 today that grows at 9.4% per year for 70 years will grow to $1,077,067 but will only have the purchasing power equal to $155,856 in today’s dollars. Does that make sense?”

You consider what she said for a moment and say “Yes, I think so. You’re saying that since the price of an average house is about $150,000; that my little $2000 gift to baby Jane today will buy her a retirement house when the time comes. Is that about right?”

“That’s exactly right assuming that housing inflation averages 2.8% per year.”

Loretta adds, “When Janey reaches 70, then the second phase of the plan takes over.”

“The second phase?”

“Yes, on Jane’s 70th birthday, we annuitize her account balance and begin to pay Janey a scheduled monthly income for the rest of her life. The remaining account balance will continue to earn 9.4% growth per year. By scheduled I mean, based on the then current life expectancy for a 70 year old female, we compute the first year’s annual amount and then divide by twelve to get the monthly amount. Each year we add 2.8% to the previous year’s amount to protect Janey from expected inflation. If Janey lives exactly to her expected life at age 70 then her account balance will reach exactly zero. If she outlives her balance, we will still continue to pay her at the scheduled rate, including inflation, for the rest of her life. That guarantee for life is the risk the annuity firm assumes. On the other hand, if there is any balance in her account when she passes, that balance goes to the annuity firm.”

“So how much will she get each month and what’s that worth in today’s dollars?”

“Hey, you’re getting pretty good at this. Let’s see.”

Again, using Excel, Loretta computes the monthly annuity payments in both future and present dollars.

Seeing your confusion, Loretta continues “Your initial $2000 could actually grow to provide lifetime benefits that will exceed Social Security benefits. Do you want to see what I mean?”

“Whoa, whoa, now you’re telling me that my $2000 will be worth more to Janey then than her Social Security benefits?”

“Exactly!”

You agree to see the computations and Loretta shows you the following spreadsheet.
 
 
All amounts  are shown in current dollars

Begin Age
Year
Begin Balance
Annual Payment
Begin Balance
 Less Annual Payment
End Balance= (BegBal-Payment * 1.094) + 1/2 payment * .094
Next year payment = Payment + .028 (Inflation)
70
1
$155,856.00
$14,650.00
$141,206.00
$155,167.91
$15,060.20
71
2
$155,167.91
$15,060.20
$140,107.71
$153,985.67
$15,481.89
72
3
$153,985.67
$15,481.89
$138,503.78
$152,250.79
$15,915.38
73
4
$152,250.79
$15,915.38
$136,335.41
$149,898.96
$16,361.01
74
5
$149,898.96
$16,361.01
$133,537.95
$146,859.49
$16,819.12
75
6
$146,859.49
$16,819.12
$130,040.37
$143,054.66
$17,290.05
76
7
$143,054.66
$17,290.05
$125,764.61
$138,399.11
$17,774.17
77
8
$138,399.11
$17,774.17
$120,624.94
$132,799.07
$18,271.85
78
9
$132,799.07
$18,271.85
$114,527.22
$126,151.56
$18,783.46
79
10
$126,151.56
$18,783.46
$107,368.09
$118,343.52
$19,309.40
80
11
$118,343.52
$19,309.40
$99,034.12
$109,250.87
$19,850.06
81
12
$109,250.87
$19,850.06
$89,400.80
$98,737.43
$20,405.86
82
13
$98,737.43
$20,405.86
$78,331.57
$86,653.81
$20,977.23
83
14
$86,653.81
$20,977.23
$65,676.58
$72,836.11
$21,564.59
84
15
$72,836.11
$21,564.59
$51,271.52
$57,104.58
$22,168.40
85
16
$57,104.58
$22,168.40
$34,936.18
$39,262.09
$22,789.11
86
17
$39,262.09
$22,789.11
$16,472.98
$19,092.53
$23,427.21
87
18
$19,092.53
$23,427.21
-$4,334.68
-$3,641.07
$24,083.17
88
19
-$3,641.07
$24,083.17
-$27,724.24
-$29,198.41
$24,757.50
89
20
-$29,198.41
$24,757.50
-$53,955.91
-$57,864.16
$25,450.71
90
21
-$57,864.16
$25,450.71
-$83,314.87
-$89,950.29
$26,163.33
91
22
-$89,950.29
$26,163.33
-$116,113.62
-$125,798.62
$26,895.90
92
23
-$125,798.62
$26,895.90
-$152,694.52
-$165,783.70
$27,648.99

 

“First of all” Loretta explains, “since we have converted the future amounts to present values, we will continue to work with present values because it’s easier to visualize the purchasing power using today’s dollars then future dollars.”

Reviewing the first line of the chart with you, Loretta explains “When Janey reaches age 70; the plan will automatically convert the $155,856 balance to an annuity. This annuity plan computes Jane’s first annual benefit as 9.4% of the beginning balance. ($155,856 X 9.4%) = $14,650. That’s how much purchasing power Janey will receive her 70th year.”

Loretta is quick to add, “This is slightly more purchasing power then the average Social Security benefit for 2012.”[5]

She continues “The payment will be made in twelve equal monthly installments over the year. The account will continue to grow at 9.4% on any unpaid balances. At the end of the first year after paying the $14,650 to Jane and adding in the 9.4% interest, the ending balance will be $155,167.91.”

“The last column shows how much Janey can expect the following year. It’s just the previous year’s payment amount plus another 2.8% to cover inflation.”

"Each year, payments are increased 2.8% and paid from Little Jane’s annuity balance until the balance is exhausted during her 87th year” Loretta points to the line for age 87 showing that the ending balance goes negative in that year.

Loretta sums the annual payment column until age 87 less the overdraw amount that year to show you that if baby Janey lives until her account balance runs out, she will have received $332,564 in today’s dollars all from your $2000 investment.

“If Jane outlives her balance, the insurance portion of the plan continues to pay the inflation adjusted amount for her entire life.”

“When Janey dies, whenever she dies, if there is any balance in her account, that amount is forfeited to the firm.”

Loretta emphasizes “The purchasing power of the benefit is greater than the average paid by Social Security. She concludes by explaining that $2000 invested today will produce greater benefits for your child then Social Security is projected to do if Social Security had the money to pay its promised benefits; which it doesn’t; and it accomplishes this at a fraction of the cost.

She shows you a chart from the Urban.org that indicates that the average wage earner contributes over $299,000 in payroll taxes over the course of their working career just for Social Security but only gets $200,000 back in benefits.[6] Compare that to the $2000 you could invest today to return $332,564 in today dollar benefits.

Loretta says “For Social Security they’ll take out $299,000 over your career and you’ll only get back two thirds of what you put in. Sounds like a lousy deal to me. What an incredible waste of money compared to pre-funding with $2000 for life. That’s the power of compounding.”

“Well yes” you say “But the government couldn’t do that for everyone. It would cost a fortune; right?”

“Not at all” Loretta says. “In fact, it would be much cheaper and would be a huge shot in the arm for our struggling economy.”

“How so?”

Loretta pulls out some stats. “According to the Bureau of Labor Statistics, about four million Americans are born each year. If the Fed invested $2000 for each newborn it would cost about $8 billion a year.  That’s about how much we spend a month in Afghanistan. We would still have to figure out how to pay the shortfall for those of us alive today under the old system but all future generations would be secured and as current system beneficiaries start to pass-on, the problem would start to shrink instead of continuing to grow.”

“Want more? Back in 2009, the last year everyone paid all their Social Security taxes, the system collected $805 billion. Half of that came from our employers and the other half from the employees. That year, Social Security paid out $680 billion in benefits. That left $125 billion in surplus that was supposed to be used to pay the future Social Security shortages. Today, surpluses that have been accumulated over the years total $2.6 trillion in the Social Security Trust Fund. This $2.6 trillion Trust Fund represents money that workers and their employers have paid into Social Security to help pay future Social Security benefits. But Congress has spent the entire $2.6 trillion on stuff not related to Social Security. Now, Congress will have to borrow another $2.6 trillion or raise more taxes to pay for the Social Security benefits that have already been paid.”

Loretta continues “If Congress had just taken the $125 billion from 2009 and invested it at an average of 9.4% per year, then the gain in an average year would be $11.75 billion ($125 billion X .094). That would be enough to fund a national pre-funding Social Security program for the next 75 years even with expected inflation and population growth. In bad stock market years, the excess in the fund would cover the shortfall. In good stock market years, the fund could be replenished.”

“Want still more? If we started today, the pre-funded accounts wouldn’t have any obligations for 70 years and by definition the first account couldn’t go negative for 87 years. During that time, some people with accounts will die youg. What should happen with the balances in their account? Well we know we have to keep some of the surplus to pay for those folks who will live past their 87th year beginning in 87 years from now. But the money needed for that obligation will be a tiny fraction of the total surplus available, what should we do with all the rest?”

“I give up, tell me” you say.

“Assuming that the taxpayer funded the initial account, when the beneficiary dies, we can dedicate the surplus to the shortfall estimated for the beneficiaries under the current Social Security program. In so doing, we could eliminate the entire $20.5 trillion Social Security shortfall in less than 40 years. Unfortunately, because our government has waited so long to fix the problem, Congress would still need to borrow for several years in order to pay full benefits – but not nearly as much and only for a few years.”

“Over the long term, pre-funding would eliminate the current Social Security shortfall; allow Social Security to become self-funding; eliminate payroll taxes for Social Security and cover all Americans equally regardless of work history.”

“To the extent we can approximate how much the average American will need in 70 years to cover their medical expenses, which CMS.gov does all the time, we can do the exact same thing for funding Medicare with roughly another $2000 per birth.”

“That’s how Congress should solve our Senior Entitlement problems.”

“Now let me get to work and set up this trust for baby Jane.”

[1] November 26th, 2012 Wall Street Journal
http://online.wsj.com/article/SB10001424127887323353204578127374039087636.html
 
As of the most recent Trustees' report in April, the net present value of the unfunded liability of Medicare was $42.8 trillion. The comparable balance sheet liability for Social Security is $20.5 trillion.
 
[2] Americans United Party: Job Policy – Eliminate the Job Burden. http://americansunitedparty.blogspot.com/2011/06/eliminate-job-burden-and-they-will-come.html
 
[3] http://www.econ.yale.edu/~shiller/data.htm Robert Shiller: The data collection effort about investor attitudes that I have been conducting since 1989 has now resulted in a group of Stock Market Confidence Indexes produced by the Yale School of Management. These data are collected in collaboration with Fumiko Kon-Ya and Yoshiro Tsutsui of Japan. Some of our earlier results are also noteworthy.

Stock market data used in [Robert Shiller] book, Irrational Exuberance [Princeton University Press 2000, Broadway Books 2001, 2nd ed., 2005] are available for download, Excel file (xls). This data set consists of monthly stock price, dividends, and earnings data and the consumer price index (to allow conversion to real values), all starting January 1871. The price, dividend, and earnings series are from the same sources as described in Chapter 26 of my earlier book (Market Volatility [Cambridge, MA: MIT Press, 1989]), although now I use monthly data, rather than annual data. Monthly dividend and earnings data are computed from the S&P four-quarter tools for the quarter since 1926, with linear interpolation to monthly figures. Dividend and earnings data before 1926 are from Cowles and associates (Common Stock Indexes, 2nd ed. [Bloomington, Ind.: Principia Press, 1939]), interpolated from annual data. Stock price data are monthly averages of daily closing prices through January 2000, the last month available as this book goes to press. The CPI-U (Consumer Price Index-All Urban Consumers) published by the U.S. Bureau of Labor Statistics begins in 1913; for years before 1913 1 spliced to the CPI Warren and Pearson's price index, by multiplying it by the ratio of the indexes in January 1913. December 1999 and January 2000 values for the CPI-Uare extrapolated. See George F. Warren and Frank A. Pearson, Gold and Prices (New York: John Wiley and Sons, 1935). Data are from their Table 1, pp. 11–14. For the Plots, I have multiplied the inflation-corrected series by a constant so that their value in january 2000 equals their nominal value, i.e., so that all prices are effectively in January 2000 dollars.
 
[4] http://www.aging.senate.gov/ss/ssreport2010.pdf
Page 50 of the report states: Gradually Invest 15 percent of Trust Fund Assets in Equities.
The government could gradually invest Trust Fund assets in a broad index of equity market securities, such as the Wilshire 5000.If the Trust Funds’ investments in equities increased by 1.5 percent a year for 10 years and equity investments were maintained at 15 percent thereafter, it would reduce the long-range deficit by about 14 percent, or 0.27 percent of taxable payroll. These calculations assume that Trust Funds invested in equities earn a constant nominal 9.4 percent return (or 6.4 percent real return over 2.8 percent inflation) this is 3.5 percentage points over the expected average yield on long-term Treasury bonds.
 
[5] http://ssa-custhelp.ssa.gov/app/answers/detail/a_id/13/~/average-monthly-social-security-benefit-for-a-retired-worker
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America's Get Well Plan

America’s political gridlock has hobbled our nation’s economy. What we desperately need is an economic get well plan that will actually solve our nation’s economic problems not merely tiptoe around the edges.

Our economic problems are extensive. To resolve them our plan must be comprehensive. But in today’s divisive political climate and in the absence of effective leadership, no plan can succeed without the support of the American people.

Not until enough Americans understand and support the details of such a plan can it hope to withstand the attacks from the special interest groups who prefer the status quo of a sinking ship rather than working together to restore our nation’s economic future. To counter their anticipated assaults, the plan must be acceptable to the members the leaders of those groups purport to represent. For example:

Seniors: Our plan must appeal to seniors by not just protecting current benefits but by enhancing Social Security and Medicare benefits while stabilizing the long-term fiscal soundness of both programs for future generations.

Labor: Our plan must appeal to organized and unorganized workers by demonstrating how it will grow our economy; produce good-paying U.S. based jobs; improve pension and healthcare benefits, begin to close the income gap and offer affordable education designed to increase marketable skills.

Investors: Our plan must entice capital investors and entrepreneurs to set up or expand their operations in the U.S. by showing that our state and federal governments are committed to restoring America to the world’s friendliest business climate with the greatest profit potential and the least amount of risk.

Our plan must stress how the U.S. education system will be reengineered to continuously provide the world’s most skilled and most productive labor force; how the U.S. transportation system and the other components of our commerce supporting infrastructure will be upgraded and maintained as the world’s finest; and how our energy policies will ensure a reliable energy supply at stable and predictable prices.

Is such a plan even possible? Of course it is. Not only is it possible but it is a little disconcerting that we didn’t put forth a globally competitive plan when globalization was seriously contemplated back in the early 1970’s. But here we are. Instead of moving forward with real solutions our leaders took us to the brink of a self-imposed fiscal cliff and at the last possible moment agreed to an increase in taxes to fund our bloated government for an additional 5 days a year with the promise of another cliff in two months time – remarkable.

Where is America’s political leadership? Where are the statespersons- the men and woman who want to solve our fiscal problems and get Americans back to work? We need leadership that is committed to developing a unifying economic get well plan that crosses ideological lines and brings Americans together in the common cause of righting our floundering economic ship. Unfortunately, it appears that the leadership we need will not materialize unless and until the American people demand it.

In light of this need for a vision and real solutions, we present our plan for a unifying economic objective and the comprehensive set of policies designed to achieve it. But before presenting our economic objective, it may be useful to answer the following question. What is America’s current economic objective? Here’s a clue: We don’t have one – remarkable.

Economic Objective:
Continuously improve the standard of living of all U.S. citizens.

That’s it! That’s as complicated as our federal government’s economic objective needs to be. Given this simple yet powerful objective to guide our focus, what policies should our government enact to reach this objective?

Job Policy:
The most effective way for an individual to improve their standard of living as well as increase their sense of worth and well being is through a job. The best way for our economy to grow and generate jobs is through a vibrant private sector offering goods and services that people want at prices they can afford.

A private sector employer offers someone a job for the simple reason that the employer believes the company will generate more profits with the employee than without. Our job policy is therefore straightforward, easy to understand and consists of two parts.

1. Identify and then reduce or remove any restrictions that inhibit U.S. based private sector jobs.
2. Monitor global trends and continuously improve the conditions that will maximize the likelihood that the global private sector will want to hire American citizens to work in America.

Please review our Job Policy for more details.

Tax Policy:
In fiscal year 2010, the federal government received 91% of its revenue from Federal Income Taxes (51%) and Payroll Taxes (40%). It’s important to note that corporate income taxes accounted for only 9% of total federal revenue.

With its massive complexity and seemingly endless array of political preferences that manifest themselves as credits, deductions and other loopholes, the Federal Income Tax system causes individuals and businesses to engage in a wide array of sub-optimal economic transactions. The accumulation of these transactions has a chronic negative impact on our economic growth and each year Congress makes it worse.

As economically damaging as our federal income tax system is, our payroll tax system is even worse. With half its high cost added to the cost of U.S. labor – the business paid portion, the Payroll Tax system frequently drives businesses to seek less expensive labor solutions offshore.

With these two economically damaging tax systems in mind, there are only two words Congress should consider when addressing tax reform… Start Over.

Before summarizing our tax proposal, we recommend that you read our Jobs proposal because it explains how government imposed costs on U.S. businesses reduces U.S. based private sector jobs, slows down our economy and reduces our overall standard or living. Below we’ve excerpted some of the tax facts revealed in our Job proposal.

Fact 1:
Businesses do not pay taxes their customer’s do. Business taxes are always paid by the business’s customers. Businesses must increase their prices in order to cover all their costs including their taxes and any other government imposed cost of regulation.

Fact 2:
Business paid taxes are a regressive tax that disproportionately hurts the poor. Whereas the prices for goods and services do not change based on a person’s income, the lower a person’s income the greater the percentage of that income the poor must spend per purchase to cover the business tax. People who advocate for a progressive tax structure to protect the poor should advocate against any type of business tax and they should judiciously scrutinize the costs of any business regulations because those costs must always be passed along to the consumer.

Fact 3:
Business paid taxes are hidden. Because taxes and other government imposed costs are buried in the price of the goods and services they buy, consumers do not know how much of their purchase price is government imposed. Governments should not be permitted to hide their costs from their people.

Fact 4:
Business taxes cost jobs. The cost for business paid payroll taxes, health care premiums and pension plans add 30% to base labor costs and Congress is under pressure to increase that percentage each year. A thirty percent, and rising, labor premium is an unsustainable handicap for American based employers to overcome in a global market that continuously improves its production quality, process efficiency and the education of its labor force. Each new Job Burden makes it increasingly more difficult for U.S. based labor to compete for private sector jobs.

Fact 5:
Business paid taxes slow economic growth. The U.S. Job Burden makes the U.S. private sector less competitive in a global economy. This forces businesses to outsource or relocate, which reduces U.S. employment, which reduces the demand for goods and services which slows down the economy and increases the cost of government.

Fact 6:
There is rarely a valid economic or social reason to impose taxes on US labor or their employers; there is only a political reason which can be expressed in a four step logical progression. 1. Politicians can always justify the need for more tax money to spend. 2. But voters don’t want their taxes to increase. 3. Ah – Businesses have access to lots of money and they don’t vote and. 4. Voters don’t realize that they pay those costs through their purchases. We must break this cycle.

These facts lead us to one very important tax policy guideline: U.S. based labor should not be taxed – ever.

To follow this guideline, the Payroll Tax system would need to be eliminated. That is not to say that the programs the payroll tax system supports are not necessary – they are. What it states is that since these programs are necessary, they must be funded via some other mechanism. In a global economy we simply can no longer afford to pay for these programs through our jobs.

With our tax facts and tax guidelines in mind, the AUP tax plan divides Federal expenditures into two categories.
1. Safety Net costs and
2. All other federal government expenditures

It is with this in mind that our tax proposal replaces our economically harmful Income Tax and Payroll Tax systems with the more job friendly Safety Net Tax and Personal Income Tax Systems.

The key to sustaining the benefits from any proposed tax system is to restrict the politically motivated favors that invariably creep into any tax scheme. Ideally, any tax proposal should be accompanied by laws that require a citizen majority vote or a Congressional supermajority to approve any tax increases or national debt that exceeds certain GDP thresholds.

Safety Net Tax:
To cover the costs of our safety net, we propose a new tax aptly named the Safety Net Tax (SNT). The SNT is a national retail consumption sales tax that includes a refund, paid monthly, in advance, for the estimated amount of tax paid to purchase a minimum standard of living (MSOL) basket of goods and services.

The Safety Net Tax would be implemented over a three year period in a series of phases. Phase 1 would incorporate the senior entitlement programs of Social Security and Medicare. The SNT tax rate to cover the current business paid portions of those programs is estimated between 4% and 5%. The advance refund to every U.S. domiciled citizen to cover the SNT paid at the MSOL level would be an additional 1% to 1.5%. The total SNT rate for phase 1 is therefore estimated between 5% and 6.5%. Phase 1 is revenue neutral for Social security and Medicare and introduces the funding concept of pre-funding at birth for our senior safety net programs. The immediate benefit for jobs is that the cost of U.S. based labor would be reduced by over 7%.

To learn the details of the SNT including the other phases and how U.S. based labor costs can be reduced by 30% while increasing our overall standard of living for all Americans, please see the Safety Net Tax Plan. To learn about the American Birth Contribution plans, please see ABC-Plans.

Personal Income Tax System:
All other federal expenditures would be funded through the new Personal Income Tax System (PITS).

The formula to compute an individual’s PITS tax is:
Taxable Income – Standard Deduction = Adjusted Income
Adjusted Income X .000001 = Tax Rate
If Tax Rate > 20% then Tax Rate = 20%
Adjusted Income X Tax Rate = Tax Amount.
Amount Due = Tax Amount + Tax Penalties – Tax Prepayments

Taxable Income: The PITS treats all income except tips, other gifts and re sales of non-collectable, non-financial personal property as taxable income and all taxable income is treated the same. E.g. payment for work or services performed including wages, salary, bonus, commission, stock grants, profit sharing, other compensation in like or kind; Interest received; net short-term and net long-term capital gains; dividends; pensions; royalties, rents under contract and all net government transfer receipts.

Standard Deduction: Each year Congress provides the IRS with that year’s standard deduction amount as the greater of the national average minimum standard of living for the year (MSOL) or the income amount for those at the 20 percentile income level. This ensures that those whose income is at or below the 20 percentile are not subject to the PITS. If the MSOL is greater than the 20 percentile than the standard deduction is raised and fewer people become subject to the tax. The MSOL is currently estimated at $18,000. The 20 percentile income is $12,800. The standard deduction would therefore be $18,000. This would excuse from the PITS those with taxable income in the 33% income percentile and below. In other words, only those with taxable income in excess of $18,000 would be subject to the Personal Income Tax system.

MSOL: The minimum standard of living represents the national average amount an individual would need to survive who is an adult (over the age of 18) and is responsible for their housing and is raising 1.25 children under the age of 18. The MSOL includes taxes, housing, utilities, food & incidentals, clothes, work transportation, work and emergency communication and healthcare assuming ACHI.

Example 1: Taxable Income=$50,000
Adjusted Income = $50,000 - $18,000 = $32,000
Tax Rate = $32,000 X .000001 = 3.2%
Tax = $32,000 X 3.2% = $1,024
Effective Tax Rate= $1,024 / $50,000 = 2.048%

Safety Net Policy:
The Safety Net policy should eliminate and then prohibit burdening our jobs and businesses with the cost of our safety net programs. Instead, we should fund our safety net programs exclusively through the Safety Net Tax (SNT). We should consolidate and coordinate the safety net to efficiently ensure a Minimum Standard of Living (MSOL) for each U.S. citizen. The design of all safety net programs should always encourage and reward individuals who seek self-improvement, self-reliance and work for wages – not penalize them by making it more profitable not to work.

The following is a list of what the AUP considers part of the safety net and how our policy would eventually provide for funding by the Safety Net tax. Most of these programs are currently funded in part or in whole by our jobs and our employers. Our policies ensure these costs are removed from our jobs and our employers.
• Social Security: Funding replaced by ABC-Social Security
• Medicare: Funding replaced with ABC-Medicare
• Medicaid: Replaced with the American Catastrophic Health Insurance Plan (ACHI)
• PPACA: Replaced with ACHI
• All employer sponsored Healthcare: Replaced with ACHI
• VA-Healthcare: Replaced with ACHI
• All other government sponsored health plans: Replaced with ACHI
• Federal and State Unemployment: Replaced by ABC-Unemployment
• Employer sponsored Pensions: Replaced with ABC-Pensions
• All other poverty programs: Replaced with MSOL-Stipend
• Minimum Wage: Replaced with MSOL-Labor
• Education: Replaced with PPEPA

Senior Entitlement Policy:
Phase out the “pay-as-you-go” funding mechanism used for Social Security and Medicare and initiate “prefunding at birth” financing for all subsequent generations. See ABC-Social Security for more information.

Healthcare Policy:
Employer sponsored healthcare significantly increases the cost of U.S. based labor and costs Americans their jobs. Our policy will replace employer sponsored health insurance and all government sponsored healthcare programs, except Medicare, with the two-tiered private to public health coverage provided by the American Catastrophic Health Insurance plan. ACHI is a high-deductible health insurance plan in which the annual deductible amount is based on individual or household income. Once the deductible has been met, the ACHI plan funds all medically necessary care and is financed by the Safety Net Tax.

Energy Policy:
Achieve U.S. Energy Independence and U.S. energy price stability within ten years. Complete phase 1 of an economically viable global carbon reduction and renewable energy production program within 25 years.

Education Policy:
Introduce publicly funded and privately owned education networks in which the educator owned firms are compensated from public funds based on the achievement of the individual student as well as all students in a grade-class.

Expand the education grading levels from K through12 to birth through death and link the education system with child development and ACHI healthcare. Fund the education system from the Safety Net Tax and consequently reduce or eliminate the education portion of local property taxes.

We encouraged you to learn the details of our economic objective and each of our policy proposals by following their respective links. Until you and others get involved and demand that our federal government support a unifying economic plan, it will not happen. I hope you will take this opportunity to help America get well.

James W. Schneider

Executive Director

Americans United Party



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What is our nation’s economic objective?


by James Schneider: 8/20/2012

For a nation struggling through the worst economic malaise since the Great Depression, the unfortunate answer is that our Federal Government does not have a stated economic objective.

How can that be?
Anyone who has ever led a group of people on a mission, or been responsible for a complex project of any kind, understands that you cannot develop an effective plan without first understanding and clearly stating your primary objective.

Focus, Focus, Focus:
Whenever a group of people is confronted with a complex problem they want to solve or a worthwhile goal they want to achieve, their logical first step is to determine their primary objective. Communicating the objective to all stakeholders is crucial for maintaining focus and reining in the scope creep that invariably manifests itself as those with alternate objectives and differing priorities develop clever ways to influence decisions and divert resources. If those detours from the primary mission are not addressed quickly then the primary mission becomes obscured and subservient to the multitude of parochial priorities that are allowed to take hold.

What is the objective?
All too often, people in leadership roles believe they know what their strategic objective is without fully vocalizing it to themselves let alone to others. They often assume that everyone else instinctively shares their vision and their priorities without ever formally writing them down and getting buy-in. But until leaders take the time to enlist the stakeholders to help formulate the primary objective and reach acceptance of the mission, you do not have a consensus driven primary objective and your chances of success are greatly diminished.

Less is more:
Your objective should state your goal clearly and succinctly. Less is usually more; frequently a single sentence will suffice even for something as large and complex as our national economic objective.

Measures of Success:
How will you know if you are successful? What baseline will you measure your success against? Your objective should identify the barometer(s) you will use to measure your level of success.

Means vs. Ends:
An objective should not mention anything about how you intend to reach your objective or any other limiting criteria. In terms of “means versus ends”, your objective is your ends, not your means. Once you have your “ends” defined, then and only then should you begin to discuss the various means available to achieve those ends.

Life Cycle:
An objective sentence should address the life cycle of the task at hand. The life cycle of any task, project or system can be identified as either finite or perpetual. Most projects, like building a bridge, are finite in nature and terminate once the objective has been achieved. A perpetual task is a system that is expected to operate indefinitely – such as a national economy. The objective sentence for a perpetual system should acknowledge the perpetual nature of the system. Hallmark examples of objective statements for perpetual systems include phrases like “continuously improve …”

Unite or Divide:
Stating your objective can  be either a unifying or a divisive act depending on how your objective is perceived and how those perceptions align or conflict with the personal objectives of the people your task may affect. From a political standpoint, that may help explain why we don’t have a stated national economic objective.

Is a Unifying National Economic Objective possible?
In this divisive climate of hyper partisanship and political gridlock, is a unifying economic objective even possible? Could anyone construct an economic objective that appealed to the majority of Americans regardless of their political party or ideology?

If we could achieve such an objective would it help unite our nation? Would it allow Americans – the stakeholders – to begin rowing in the same direction instead of pulling our nation apart with paralyzing uncertainty and cross-purpose legislation designed to pit one group of Americans against another and pick winners and punish losers based on the political party in power?

A unifying economic objective would permit us to focus on those "things" that are preventing us from reaching our common objective.

Is such a unifying economic objective even possible?

The Americans United Party believes the answer is a resounding yes!

A unifying national economic objective is the critical first step along our journey to end our political gridlock and restore our economy to maximum vitality. With that as our backdrop, we present our National Economic Objective for your consideration.

National Economic Objective:
Continuously improve the standard of living of all U.S. citizens.

That's it. It's that simple.

The standard of living provides the basis for measuring our success. Investopedia does a good job of defining standard of living.

Definition of 'Standard Of Living'
The level of wealth, comfort, material goods and necessities available to a certain socioeconomic class in a certain geographic area. The standard of living includes factors such as income, quality and availability of employment, class disparity, poverty rate, quality and affordability of housing, hours of work required to purchase necessities, gross domestic product, inflation rate, number of vacation days per year, affordable access to quality healthcare, quality and availability of education, life expectancy, incidence of disease, cost of goods and services, infrastructure, national economic growth, economic and political stability, political and religious freedom, environmental quality, climate and safety. The standard of living is closely related to quality of life.

Investopedia explains 'Standard Of Living'
The standard of living is often used to compare geographic areas, such as the standard of living in the United States versus Canada, or the standard of living in St. Louis versus New York. The standard of living can also be used to compare distinct points in time. For example, compared with a century ago, the standard of living in the United States has improved greatly. The same amount of work buys an increased quantity of goods, and items that were once luxuries, such as refrigerators and automobiles, are now widely available. As well, leisure time and life expectancy have increased, and annual hours worked have decreased.

Read more: http://www.investopedia.com/terms/s/standard-of-living.asp#ixzz23fMNWvzU

Economic Road Map:
With our National Objective to guide our efforts and maintain our focus, the AUP has developed a set of interrelated policy proposals designed to achieve our national objective.

We invite you to read our Economic Roadmap Executive Summary and the detailed policy proposals that stem from it.

We would like to know if you agree with our economic objective or tell us yours if you have a different idea.

Thank you.
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To Outsource or NOT to Outsource

 


The Romney Tax Distraction


Source: http://www.commentarymagazine.com/2012/07/16/the-romney-tax-return-distraction/ Jonathan S. Tobin.


Attempts by some in Congress to shame American business leaders who outsource or relocate to less costly shores as un-American are ridiculous demagoguery. By definition, capital must follow the path of least resistance or risk being lost. It would be a violation of a business leader s fiduciary responsibility not to do everything in their power to maximize the return on any owner s capital investment, even if that means going offshore. It is the responsibility of Congress to ensure that investors, entrepreneurs and business leaders do not perceive their best opportunities lie offshore. Any Congressperson or president who does not understand and accept these fundamental economic truths is not qualified to set economic policy for a country founded on free-market principles. I wish we had a presidential candidate who understood, believed and could articulate this basic American economic truth. http://americansunitedparty.blogspot.com/2011/06/eliminate-job-burden-and-they-will-come.html
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America’s Job Engine is Broken!

"Government stimulus applied to a broken private sector can no more spur job creation than can a jockey's whip applied to a race horse with a broken leg. If you ever expect the horse to run again, fix the leg first."


America's job engine is broken and we have only ourselves to blame. We the people have allowed our elected leaders to heap an ever-expanding array of non-business related costs on our private sector economy year after year ever since President Franklin Roosevelt signed Social Security into law in 1935.

After the ravages of World War II, when the manufacturing capabilities of the rest of the world lay in ruin, the United States transformed its relatively unscathed and vastly expanded wartime production capacity into the world’s sole manufacturing super power. Competing for scarce labor and persuaded by the demands of organized labor, American manufacturing successfully absorbed the incremental costs of new employee benefits such as healthcare and pensions.


As America prospered in the 50's and 60's, she had the luxury to reflect on her historic social injustices and the economic imbalances often attributed to capitalism. During the 1960s, a revitalized Social-Progressive movement returned to power and instituted additional programs that applied their vision of social justice through various employer regulations and wealth redistribution techniques. Most notable of these programs were Medicare (health care for seniors) and Medicaid (health care for the poor). Proponents of these programs, like their predecessors, successfully convinced a naïve public that much of the costs of these programs would be borne by "business" and "your employer; not by you." Again, since America was still the world’s production giant, the increased costs did not materially effect profits and America continued to grow. 

When globalization began rolling out in earnest some forty years ago, the imbalance between the U.S. production costs and those of our foreign competitors was regarded as little more than a nuisance. However, over the last couple of decades that nuisance has not just cost America a handful of manufacturing jobs but the complete loss of our most profitable industries and our best paying jobs. Some of the lost industries that America once dominated include steel, energy, plastics, electronics, white goods, brown goods, computers, automobiles and apparel.

With unemployment in excess of 8% for almost four years, both political parties claim that their primary economic objective is to help the private sector job market. Unfortunately, so far the crux of their proposals has been based on short-term government stimulus programs. Both parties have failed to recognize the fundamental, long-term problems that confront our job market.

The Democrats' solution is to increase taxes and government spending. Their theory assumes that increased government spending would increase the demand for private sector goods and stimulate the economy. This, they believe, would help the private sector rebound.

The Republican solution would lower taxes and reduce government spending. By allowing individuals and businesses to keep more of their money, Republicans assume that the private sector would spend more of their money on the things they need. This, Republicans believe, would help the private sector rebound.

Both approaches have been tried several times over the last dozen years or so with little evidence that either approach works, yet both parties persist in promoting their respective lackluster policies as the Holy Grail of job creation.

The time has come for both parties to recognize that Government stimulus applied to a broken private sector can no more spur job creation than can a jockey's whip applied to a race horse with a broken leg. If you ever expect the horse to run again, fix the leg first.

To make my point, allow me to present an absurd example just to establish a baseline for discussion.

Assume hypothetically, that in order to help cover the projected shortfalls in Social Security and Medicare, Congress passes a new law dubbed the “New Hire Tax”. The new tax is paid by the hiring business and is equal to the new hire’s first year salary. In essence, doubling the cost for a business to hire a new U.S. based employee. How eager do you think employers would be to hire under those terms?

The purpose of my absurd example is to demonstrate how easy it is to concoct scenarios that reduce the incentives for the private sector to create jobs. It’s so easy in fact that our government has been concocting these types of policies for decades. Instead of our government trying to “stimulate” the economy with short-term gimmicks, they should identify and permanently eliminate those things that impede U.S. based private sector hiring.

Allow me to propose a slightly less but nonetheless still absurd example.

Assume that Congress passes a new law they call “The Business Paid Safety-Net Tax.” The tax mandates that businesses pay a 30% premium on top of every employee’s wages to pay for our national safety net.  Such a tax would not only reduce new hires, it would force many businesses to cut their existing U.S. labor force. As American workers struggle to compete for jobs in this global economy, what are the chances that Americans would support such a law?

Well, apparently most Americans already do support such laws.

  • The business paid portions of Social Security, Medicare and other non-job related payroll taxes amount to a 12% premium on U.S. based jobs.

  • Pensions and 401K type retirement plans paid by employers add another 6% to the cost of U.S. based employees. 

  • Before accounting for the added costs of the PPACA (Obama care), Health care premiums paid by U.S. employers add another 12% to the average cost of every American job.

The above costs amount to a 30% premium on every U.S. based job and unfortunately only represent the tip of our tax and regulation iceberg.

Beginning with Social Security, every burden that has been placed on our jobs has been placed there by the very people we elected to represent our interests in our government. These job-funded safety net programs were enacted with the best of intentions. But, as the saying goes, “The road to Hell is paved with good intentions”.

Our elected representatives, led by our presidents, created these private sector job roadblocks without consideration for the long-term damage to our jobs. To be fair, before globalization, the problems were not material. However, globalization is the new world order.  One principle that the electorate should demand Congress adopt is that it is almost never in any American’s best interest to add non-job related costs to our private sector jobs. There is always a better way to pay for the programs we deem we need.

In addition to endangering our jobs by increasing U.S. based labor costs to pay for our safety net, lawmakers have created several other regulatory restrictions on or threats against private sector job creation incentives.

Regulation Uncertainty:
Excessive uncertainty is devastating to a free market, private capital based system like ours. Uncertainty is risk and decision makers loath any risk they cannot predict, manage or mitigate. Excessive risk of uncertainty paralyzes decision makers and forces them to retrench. They will wait until there is a clearer direction and will hope for a more favorable business climate. Consider the huge amount of private sector risk associated with the unknown regulatory direction of some of our nations most important business policy arenas.

·         National Health Care Policy:
The Supreme Court has ruled that Obama Care is constitutional. Unfortunately, the incremental health care cost estimates are hurting hiring - not helping it . The Secretary of HHS has until 2014 to finalize many of the regulations. When will business be able to estimate the impact of those regulations on their costs?
·         Financial and Banking Regulations:
When will the regulators finalize the Dodd-Frank regulations and what will they mean to our private sector? When will the banks start lending again to small businesses?
·         Tax Policy:
Both parties agree our current tax policy is broken and we desperately need a new one. Will we get a new tax policy and if so, how will it affect the private sector and private sector jobs? What will happen with tax policy issues set to expire by the end of this year and known as “Taxmageddon”?
·         Energy Policy:
We still don’t have an energy policy and still rely too heavily on unstable and unfriendly governments. Energy is the lifeblood of our economy. Wide-ranging energy price and supply fluctuations outside our control add excessive risk, uncertainty and costs to key energy related and energy dependent industries. 

It is inexcusable for Congress and the Administration to allow any one of these major economic areas to languish without a cohesive direction let alone all four. Responsible leadership demands policies that provide our private sector with the certainty and confidence they need to make reasonable business forecasts.

Regulation Inefficiency
Most of the burdens Congress has imposed on our private sector jobs have been implemented with little or no attempt to minimize the compliance costs or other negative affects these regulations will have on U.S. based jobs.

Our government should work with stakeholders in each industry to evaluate how to optimize, replace or eliminate every job inhibiting regulation.

Regulation Inequality vs. foreign competitors
Many of our regulations place U.S. based producers and therefore U.S. based labor at a competitive disadvantage because our laws apply to U.S. based employers but not to foreign competitors. For example, regulations are often designed to protect workers or enhance work life quality. Others are intended to protect, restore or enhance our environment. Unfortunately, the regulatory bodies often fail to consider the affect their regulations will have on our private sector jobs in a global economy. Ultimately, these regulations help foreign enterprises compete in America and around the world. We lose our best jobs to foreign competitors who maintain poor workplace practices and poor environmental controls and thereby negate any anticipated protections to people or planet the legislation was intended to provide. Those nations with high work life and high environmental controls should reconsider free trade arrangements with nations that maintain much lower work life and environmental standards. It is illogical to impose environmental controls on a U.S. based producer but then import the same products from a foreign nation with much less environmental controls.

Our government should compare regulations that restrict a U.S. industry against the regulations of foreign competition and utilize U.S. trade policy and tariffs when necessary to level the playing field.

Americans should expect their government to recognize and then unite against regulations that hurt U.S. based jobs. Yet, instead, Americans must suffer through political gridlock as both parties promote their ineffective economic policies as they hope beyond reason for the brighter days promised after the next election. Regardless of which party wins the presidency or the legislature in our equally divided nation, unless both parties and most Americans can agree to fix our economic racehorse’s broken leg, we will continue to wonder why our economy is not producing good paying private sector jobs.

Americans can have a fair, efficient and affordable safety net. American labor needs and deserves strong workplace safety regulations. Every successive American generation deserves environmental controls that bequeath to them a planet that is at least as safe and pristine as what was left to us. We can have all these benefits but only if we stop trying to do so at the expense of our job engine.

To learn how to restore our private sector job engine and our economy while we simultaneously improve our safety net, please read our position paper entitled Jobs and the Job Burden.


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PreFunding Senior Entitlements


How to Save Social Security and Medicare

The Problem:
Congress has promised that our seniors will have health care coverage and retirement income for the rest of their lives. Unfortunately, Congress has failed to pay for all the benefits they have promised. Now our children must deal with the $61.6 trillion shortfall[1]
 
Pay-As-You-Go Funding:
Social Security and Medicare beneficiaries are primarily paid from the payroll and income taxes that are collected today. This type of funding is called Pay-As-You-Go.

Pre-funding at birth:
The greatest criticism of pay-as-you-go funding is that it ignores the wealth accumulation effects derived from the time-value-of-money. The time value of money is defined as the growth of money over time due to the compounding of interest.

The concept of "Pre-funding at Birth" takes full advantage of the time value of money. Pre-funding involves investing a relatively small amount of money at birth that grows unmolested until the beneficiary reaches a certain age – say 70 years old. The accumulated investment is then used to pay the beneficiary for the rest of their life. If you know how much money you want to receive in the future and you know the rate at which your investment will grow, it's a straightforward calculation to determine how much you'll need to invest today to reach your goal.

Compound Annual Growth Rate (CAGR):
Equity markets do not pay interest.  An investor makes money when the value of his or her equities increases or when the company pays a dividend. Because equity values can decline as well as increase, equity value changes are measured by a computation known as the Compound Annual Growth Rate (CAGR). For purposes of this discussion, CAGR and annual interest rate are synonymous.

CAGR History:
Using stock price and dividend yield data for over 100 years, U.S. equities, including reinvested dividends, have delivered a CAGR of 10.4%. The worst 70-year period since 1915 still returned a very respectable CAGR of 9.85% while the best 70-year period returned a CAGR of 11.92%[2]. The site www.moneychimp.com/features/market_cagr.htm allows you to enter a date range and returns the corresponding CAGR.

Risk Mitigation:
There is a widely held but patently false belief that pay-as-you-go-funding for critical programs like Social Security and Medicare is less risky than investing in the stock markets. While it is certainly true that markets can and do fluctuate widely over a five, ten or even a fifteen year period, it is also true that the longer the term, the less the risk in the markets.

Consider a funding plan that was based on the perpetuity of the equity markets. Such a plan could eliminate market risk and beneficiary angst altogether simply by fixing average annual returns for all beneficiaries at a rate that was a few tenths of a percent less than the historic average. The plan could instill confidence further by guaranteeing the benefits through the full faith and credit of the US government.

When you compare the risk realities between Prefunding at birth and pay-as-you-go financing for Social Security and Medicare, the facts are hard to dispute. Even including the Great Depression and the current Great Recession, equity markets have still managed to average a 10.4% return on investment while pay-as-you-go financing has left us with a $61.6 trillion unfunded liability against our children's future. Nice legacy. Which financing strategy would you say is less risky?

A Social Security Example:
In 2007, the average Social Security benefit was $12,972 per year. According to the Bureau of Labor Statistics, a person who turned 70 in 2007 was expected to live another 14 years. Each year Social Security payments were expected to grow 2.8% to cover cost of living increases[3]. The lifetime payout after 14 years was expected to be $218,664[4].

Pre-Funding vs. Pay-As-You-Go:
How would Prefunding at birth compare with Pay-as-you-go financing from an historical perspective? Well, given our 10.4% average return on investment and a 2.8% average annual inflation rate, how much would taxpayers have had to invest one-time in 1937 in order to be able to payout $218,664 over 14 years beginning in 2007? The answer is $121.

You might want to read that last paragraph again – let it sink in.

In other words, if you were born on January 1, 1937 and the Social Security Administration had deposited $121 for you in a fund that grew on average 10.4% per year, at age 70, you could start withdrawing $12,972 per year. Each year you could receive 2.8% more than the year before to cover inflation. You could receive that inflation adjusted payment each year for the rest of your life (estimated at 14 years). At the end of those 14 years, you would have received the same $218,664 that Social Security would have paid you if Social Security had the money, which under current funding law, it would not. Said another way - $121 Pre-Funded at birth is the same as $218,664 Pay-As-You-Go.

Compare the one-time investment of $121 made 70 years ago against the $218,664 that must be taken from workers and employers over the next 14 years. Moreover, that is just one person. Had Social Security and Medicare included pre-funding at their inception, then those programs would be adequately funded today and more importantly, forever.

That's looking at Prefunding from an historical perspective, but what about the future. The BLS.gov forecasts that average life expectancies for a 70 year old will increase from 14 to 18 years. So, how much would it cost today to prefund a newborn’s Social Security account that begins paying benefits 70 years from now? With an average annual growth rate of 10.4%, average annual inflation rate of 2.8% and a life expectancy of 18 years, the answer is $750. 

With roughly 4 million Americans born each year, the cost to fund a program that deposits $750 in an account for every newborn American is about $3 billion per year ($750 X 4 million births).

How much is $3 billion per year? To put it in context, consider that we spend about $2 billion per week in Afghanistan. In other words, the annual cost to prefund Social Security is equivalent to about 10 1/2 days in Afghanistan.

In 2009, Americans paid $805 billion to Social Security. Social Security paid out $680 billion in benefits and Congress spent the remaining $125 billion Social Security surplus on programs unrelated to Social Security. If that surplus had been hidden in a mattress, it could prefund Social Security for the next 40 years ($125 billion / $3 billion per year). But suppose the $125 billion had been invested in non US debt. Any return slightly greater than 2.4% on $125 billion could pay for the prefunding program indefinitely. ($125B x .024 = $3B).

Conclusion:
Pre-funding at birth can resolve the financing problems confronting both Social Security and Medicare. Transitioning from pay-as-you-go to pre-funding would place us on a glide path to eliminate the $61.6 trillion in unfunded liabilities and save Social Security and Medicare from financial crisis. Americans need to be aware of this solution and demand that Congress save our senior safety net and keep the promises they made.

To learn more about how pre-funding can save our Senior Safety-Net programs, please review the position paper ABC – Social Security.



[1] http://www.usatoday.com/news/washington/2011-06-06-us-owes-62-trillion-in-debt_n.htm
[2] http://www.econ.yale.edu/~shiller/data.htm Robert Shiller: The data collection effort about investor attitudes that I have been conducting since 1989 has now resulted in a group of Stock Market Confidence Indexes produced by the Yale School of Management. These data are collected in collaboration with Fumiko Kon-Ya and Yoshiro Tsutsui of Japan. Some of our earlier results are also noteworthy.

Stock market data used in [Robert Shiller] book, Irrational Exuberance [Princeton University Press 2000, Broadway Books 2001, 2nd ed., 2005] are available for download, Excel file (xls). This data set consists of monthly stock price, dividends, and earnings data and the consumer price index (to allow conversion to real values), all starting January 1871. The price, dividend, and earnings series are from the same sources as described in Chapter 26 of my earlier book (Market Volatility [Cambridge, MA: MIT Press, 1989]), although now I use monthly data, rather than annual data. Monthly dividend and earnings data are computed from the S&P four-quarter tools for the quarter since 1926, with linear interpolation to monthly figures. Dividend and earnings data before 1926 are from Cowles and associates (Common Stock Indexes, 2nd ed. [Bloomington, Ind.: Principia Press, 1939]), interpolated from annual data. Stock price data are monthly averages of daily closing prices through January 2000, the last month available as this book goes to press. The CPI-U (Consumer Price Index-All Urban Consumers) published by the U.S. Bureau of Labor Statistics begins in 1913; for years before 1913 1 spliced to the CPI Warren and Pearson's price index, by multiplying it by the ratio of the indexes in January 1913. December 1999 and January 2000 values for the CPI-Uare extrapolated. See George F. Warren and Frank A. Pearson, Gold and Prices (New York: John Wiley and Sons, 1935). Data are from their Table 1, pp. 11–14. For the Plots, I have multiplied the inflation-corrected series by a constant so that their value in january 2000 equals their nominal value, i.e., so that all prices are effectively in January 2000 dollars.
[3] SSA.gov Social Security Administration, Master Beneficiary Record, 100 percent data. SSABenefits2.xls (sheet 2: 12/2007)

If I Wanted America to Fail: Teacher Challenge

On April 20th, 2012, FreeMarketAmerica.org released a four minute video entitled "If I wanted America to Fail"

http://www.youtube.com/watch?feature=player_embedded&v=CZ-4gnNz0vc
I challenge every teacher in America to show this video to their classes and then conduct an open discussion.

But before a teacher can show this video to their students, they should answer the following questions for themselves.

Questions for teachers:
1. Would you be "allowed" to show this in your class?
2. Would you be "concerned" over peer pressure (teachers) to show this in your class?
3. Would you be "worried" about your career if you even asked to show this in your class?
4. Would you "fear" repercussions from the parents?
5. Do you "think" any of the points raised by the video are worthy of discussion?
6. If you belong to a Teacher's Union, do you think your union would support any of the positions raised?

Please submit your answers to these questions and include the zip code where you teach and the grade(s) you teach.

If you know any teachers, please forward this link to them.

Let's have an open and honest discussion for a change.
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James W. Schneider
CEO, Americans United Party
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