Generational Theft: Some Deficits Hurt Young Workers the Most

What do the national debt, Social Security, and many defined benefit pensions have in common? No one expects the citizens of one generation to pay their own way.

In recent years, only part of current federal spending is covered by current tax collections – the rest is funded from borrowed money that future generations are obliged to pay. Our accrued federal -overspending, now stands near $18 trillion. In theory, tax increases could reduce annual deficits, but more often tax hikes are aimed at the political optics of punishing high income earners and on funding entitlements that earn votes.

There are no surprises in the unfavorable demographics plaguing Social Security. Birth rates have been lower since the mid-1970s than they had been earlier. That resulted in a relatively smaller and younger workforce who through Social Security and other payroll taxes are forced to support benefits for a larger and growing contingent of retirees.

Many of those already retired or approaching retirement are unprepared for financial self-sufficiency. They have been trained to expect government largesse, a new right they will defend at the ballot box.

Social security pays out just 40% of what’s needed for retirement, but it takes in 14% of the 16.4% of income that Americans put away for retirement. Young people should be concerned that by 2033 under current law, Social Security obligations will exceed collections by 30%. That shortfall screams for a steep hike in collections and probably for means-testing of benefits.  Most of the adjustment pain will fall on younger workers.

Social Security did run current surpluses for many years and the surpluses should have been invested in equities and bonds with an investment grade yield – rather than in government promises to repay without meaningful interest. Genuine investments would have built the fund to last longer.  The politicians who chose to replace social security cash with government IOUs did the nation a great disservice.

Pensions of the defined contributions type allow beneficiaries to add more to their nest-egg and steer investments toward higher yields – a consumer benefit of those new pension vehicles. Of “at work” retirement plans only 14% are of the defined benefit type. Defined benefit was the norm a few decades ago and is still prevalent among government employee groups.  The mechanics of a defined benefit pension are straightforward.  The number and age of beneficiaries is well known, as are the benefits promised.  Any actuary can quickly reveal the funding payouts needed in future years.

Defined benefit plans tend to fail in the funding. Contributions from employees and employers need to be invested at diversified sweet spots on the risk-yield curve.  If yields fall short of expectations, then contributions should be increased and/or current and prospective benefits reduced.  Conversely, if yields exceed expectations the surplus can be used to reduce investment risk. More often surpluses are used to justify reduced contributions.  The Dutch have made defined benefit pensions a fine art – one where each generation funds its own payouts and all future pension liabilities are fully funded at $1.05 per $1.00 of obligation. Ironically American unions often reject Dutch-style pensions because they call for higher contributions.

If a pension’s mechanics are so obvious, why do so many municipal and union officials botch employee pensions – invariably on the funding side? At bankruptcy, Detroit had pension liabilities of $3.5 billion and no adequate funding to pay those benefits.  Detroit unilaterally chose to slash its healthcare obligations of $120 million by cutting loose the retirees. The problems did not sneak up on the pension officials.  They knew for years it was a looming disaster.  One gets the distinct impression that they expect a pension fairy to arrive (a federal bailout in a time such as in a “lame duck” period, when it will do the least political damage).  Bailouts are another way to shift cities’ failures onto future generations.

Bankruptcy is just a name for the truth – when money isn’t there it cannot be spent. Bankruptcy forces a renegotiation of pensions and especially of benefit.  Bankruptcy will be the outcome for many pensions regardless of how many years that courts and attorneys are paid to pretend otherwise.  Meanwhile thousands of attorneys will enjoy successful careers litigating the $2 trillion in underfunded pensions.

National debt, Social Security, and defined benefit pensions are prone to the scam of shifting obligations onto younger generations – at least until the scam stops working. The pain in cities like Detroit (MI) and Stockton (CA) will propagate everywhere if we do not halt the mounting liabilities in Social Security and our national debt.  Everyone knows this and yet we allow politicians and fund trustees to pretend that “it will all work out.”

Younger workers have the most to lose. It’s time for them to loudly instruct their representatives on how they want this fixed.

Alan Daley is a retired businessman who writes for The American Consumer Institute Center for Citizen Research

FacebooktwitterredditlinkedinFacebooktwitterredditlinkedin