Funding Social Security vs. Public Pensions

In a previous post “Social Security vs. Public Pensions,” source data is presented to document the following reality in America today: Given a similar salary history, a non-safety public sector employee will collect a defined benefit pension approximately triple what they would have collected under social security, and a “safety” public sector employee will collect a defined benefit pension approximately 4.5 times what they would have collected under social security. This post is to explore how feasible it is to fund social security vs. public sector pensions.

As will be shown, the notion that social security is on the verge of insolvency, or will ever be on the verge of insolvency, is complete nonsense. In stark contrast, however, based on quantitative facts that are relatively easy to extract and analyze, public sector pensions are glaringly unsustainable and they are already grossly insolvent. To compare public sector pensions to social security in order to justify federal deficit spending to bail out public sector pension funds – rather than dramatically reduce their benefit formulas – is entirely fraudulent. Here’s how we get to these sweeping conclusions:

The social security fund has been described as a “ponzi scheme,” suggesting that it can only remain solvent if the new entrants who work and pay into the system fund the retiring beneficiaries who collect payments from the system. But this ponzi scheme metaphor quickly breaks down. First of all, a ponzi scheme typically implies an eventual return of principal to the investors, whereas social security only promises a defined – albeit modest – retirement annuity. Therefore if the people entering the system as workers can provide sufficient cash to fund the retirees who are collecting from the system, there is no danger of insolvency. You can call this a virtuous ponzi scheme, or abandon the metaphor altogether. It isn’t really a valid metaphor.

The valid concern about social security is based on the possibility that as the American population ages, the ratio of workers to retirees will inevitably drop, as baby boomers age and as average lifespans increase. But if the data is examined critically, this concern, at least in America, is overstated.

According to information found on the U.S. Census Bureau’s table “National Population Age Estimates,” summarized on the above table, there is clearly a large number of Americans who are about to become senior citizens, and consequently the number of senior citizens in America is going to nearly double over the next twenty years. But this data shows something else quite encouraging – the American age demographic is not about to invert, wherein the number of old people begins to significantly outnumber the number of young people. Remarkably, when examining each five year age group in America, nearly every one of them, from those under five years old through those in the 55 to 59 year age category, have almost exactly twenty million people. This not only demonstrates conclusively that America’s age demographic is simply transitioning from a pyramid to a column, and not inverting, but that it is easy to project retirement populations well into America’s future. Such an even stream of population age groups ascending America’s age continuum is a serendipitous reality – our age demographic is not inverting, it is normalizing – we are achieving a stable and sustainable population. To understand what this means for social security and public sector pensions, examine the next table (numbers are in thousands):

Using information from the U.S. Census Bureau’s table “Projections of the Population by Selected Age Groups for the United States: 2010 to 2050” (ref. 2nd link), and making some assumptions based on the earlier data that indicates an even stream of aging Americans – i.e., about 20 million people in each five year age group – it is reasonable to infer the above projections. That is, there are currently about 93 million Americans who have not yet entered the workforce, there are 137 million Americans between 22 and 54 years old, 40 million between 55 and 64 years old, and 40 million who are 65 years old or older. Using the same data, inferences can also be made for 2030 and 2050. As the table indicates, the population of all age groups increases over the next 20 to 40 years, with the largest increase among the 65 and older group. But the table also shows the number of people over 65 remains relatively stable between the years 2030 and 2050, which reflects the encouraging fact that Americans are replacing themselves, unlike many other developed nations.

The data to project the total number of full-time workers in America is derived from the U.S. Bureau of Labor Statistics “Occupational Employment Projections 2008” table, indicating there are 151 million workers in the U.S. currently, or about 85% of the working age population. The number of government workers in America is derived from U.S. Census Bureau data, adding up their reported Federal, State, and Local tallies, and indicates there are 19 million public sector workers in the U.S. today. Using subtraction, the above table infers there are 132 million private sector workers in the U.S. today. It is important to note that in the context of calculating the solvency of social security vs. public sector pensions, 19 million public sector workers is a very conservative number, because it doesn’t include career military personnel, nor does it include millions of public utility workers who often enjoy retirements outside of social security, calculated instead using the same formulas as public sector pensions.

Based on the percentage of active public sector workers vs. private sector workers – adding one key assumption, that the ratio of government workers per capita has gone up 50% in the past 40 years – the 2010 retirement populations of government workers and private sector workers are also inferred on the above table. In reality, the 2010 numbers are not crucial, because it is the future solvency that is of concern. In this, the numbers are again quite conservative, because they assume the ratio of public employees vs. private sector employees remains constant, i.e., 11% of the working age population work for the government, and 74% of the working age population work in the private sector. Assuming the public sector workers retire on average at age 55, and the private sector workers at age 65, by 2050, the number of retired private sector workers will double, while the number of public sector workers will nearly triple. This disparity is explained based on two differentiating factors – the increase in government workers as a percent of the total workforce over the past generation, along with the earlier retirement of government workers compared to private sector workers. But when this headcount disparity is combined with the huge financial disparity between public pensions and social security, there is a dramatic compounding effect, as shown on the next table.

Using data from the same sources referenced above, the average annual earnings of private sector workers in the U.S. is currently $29K per year, and for public sector workers it is $52K per year. If one assumes these averages correspond to wage-earners at the mid-point of their career, which the even-streamed (neither pyramidal nor an inverted pyramid) age demographic of the American workforce does suggest, then the average earnings of someone in their final year of employment can be inferred using the Social Security Administration’s “Benefit Calculator’s” (ref. item 4) “relative growth factor” of 2.0%. That is, the average worker receives an increase to their earnings, after inflation, of 2.0% per year (all figures here are using 2010 dollars, which is to say they are real, or after-inflation figures). To estimate the final salary of a private sector worker, their average salary is multiplied by 1.02^20, implying a 40 year career, and for the public sector worker, their average salary is multiplied by 1.02^15, implying a 30 year career. From these inputs, the conclusions fall out via simple arithmetic, and they are staggering.

Right now, using these assumptions, our 5.8 million public sector retirees, representing 14% of the retired population, collect $245 billion in retirement pensions, whereas social security recipients, representing 86% of the retirement population, collect $553 billion in social security payments. The average social security payout is based on the Social Security Administration’s “Estimated Retirement Payments Chart,” applied to the projected average final salary of a private sector worker – using the average final salary (social security formulas are progressive, unlike public sector pensions, meaning the less you make, the higher percentage of your final salary you will receive in social security), this equates to $15K per year, or 34% of their final salary. The average public sector employee’s retirement pension payout is based on 2% per year times a 30 year career, applied to their projected average final salary – this is $42K per year, or 60% of their final salary.

Adding this all up, the ratio of total private sector payroll to total social security payouts is quite interesting in 2010 – at 14%, it suggests that social security today is breaking even, since 14% is what employers and employees together are currently contributing to social security. In turn, when looking at 2030 and 2050, the ratio of total social security payments to total private sector payroll does go up – but only to 22%, and it stabilizes there, reaching that level in 2030 and not increasing at all between 2030 and 2050. For social security to remain solvent in 2030 and beyond, the employer and employee contributions to social security will need to increase by 4% each, from 7% to 11%. Alternatively, the $104K cap on social security withholding can be raised, or there can be means testing, or other slight reductions to social security benefits, or there can be a slight increase to the age at which a worker becomes eligible for social security. Or a combination of all of these. The point is this: Social security can remain solvent with relatively minor and incremental tweaks. Social security is not about to go insolvent, and it never will.

When one examines public sector pensions, however, the opposite is painfully evident. Estimated total public sector pension payouts already are 25% of total public sector payrolls. By 2030 they will be 57%, and by 2050 they will be 62%. Equally dramatic is the projected absolute dollar amount that will be paid out in public sector pensions in comparison to social security – by 2030 social security will pay out $918 billion and public sector pensions will pay out $620 billion – 67% as much money for 24% as many people – and by 2050 social security will pay out $1.1 billion and public sector pensions will pay out $796 billion – 72% as much money for 25% as many people. At the rate we are going, public sector pensions, serving less than 20% of all retired Americans, are going to cost American taxpayers nearly the same amount in absolute dollars per year as social security payments, serving the other 80% of Americans. This is grotesquely unfair and ridiculously unsustainable. To compare social security, which can easily remain solvent, with public sector pensions which are already insolvent and are headed for utter collapse, is completely absurd.

Defenders of public sector pensions point out the fact that public sector pensions are invested, and therefore yield investment returns, which therefore compensates for what would otherwise be their financial shortcomings. Problems with this argument abound – first because pension funds will not generate the returns in the future that they generated in the past – read Pension Funding and Rates of Return, The Razor’s Edge – Inflation vs. Deflation, Pension Rhetoric vs. Pension Reality, Sustainable Pension Fund Returns, California’s Personnel Costs, Maintaining Pension Solvency, and Real Rates of Return, to name a few, to understand why the public employee pension funds have been overestimating how much they can earn on their funds. But more fundamentally, why are public employees entitled to see their pension fund contributions invested into the private sector, when private sector employees see their social security contributions held in a zero-interest trust? You can argue which is better or worse – I would suggest it is dangerous, for a variety of reasons, to throw this much money into passive private sector investments and that all taxpayer supported retirement annuities should be self-funded via current collections (the virtuous ponzi scheme) – but whatever one may conclude, there is no reason taxpayer funded retirement accounts should not be managed in the same manner for all Americans.

If you have waded through all these numbers, it is important not to miss the point. Social security and public sector pensions are not similar at all. The challenges facing social security are easy to address, whereas the challenges facing public sector pensions are dire, and cannot be solved unless either dramatic benefit cuts are implemented or massive tax increases are enacted. In the interests of the financial security and economic future of America, if not in the interests of equity in retirement for all American workers, the choice between benefit cuts vs. tax increases should be obvious.

Who Are The Carbon Criminals?

At first glance, one might think “Carbon Criminals” is meant to describe the people who extract carbon-based fuel, sell it to the public at a competitive price, and in the process, allegedly edge the planet towards a catastrophic environmental collapse. But perhaps one would be wrong.

There’s nothing wrong with questioning our inordinate dependence on fossil fuel, or taking measures to improve the process of extracting and burning fossil fuel in order to protect our environment. To fail to regularly and scrupulously upgrade safety procedures from top to bottom, throughout the fossil fuel industry, may indeed be considered criminal. And as our technology improves and our prosperity enables us to do more, it is arguably criminal to fail to make the burning of fossil fuel a cleaner proposition each and every decade. But the real criminals are not the industrialists who have made carbon based fossil fuel the engine of civilization – the real criminals are the faceless bureaucrats and cynical opportunists who have convinced us we have to auction and trade carbon emissions allowances and carbon offset credits.

Most people still haven’t thought about how this entire scheme is going to work. And even those who have given this considerable thought, such as the bureaucrats at the California Air Resources Board, are often still in the dark on the details. Read their “Scoping Plan,” and draw your own conclusions as to their readiness to dramatically transform our economy, our property rights, and our lifestyle. Here’s a few of the concepts that need to be mastered, then applied into law, in order for “carbon trading” to become a reality:

(1) Emission Allowances – this is a permit that will be sold by the government to any business that emits more than 25,000 tons of CO2 per year. This would be all power utilities, large manufacturers, and most large agribusinesses, to name a few. These permits would have an initial price, still to be determined, that the State would collect from these businesses in order for them to continue to emit CO2 “pollution.” How are these emissions calculated? Some variables are relatively straightforward, such as smokestack emissions. But it won’t end there. Dozens of “CO2 equivalents,” such as the methane emitted from dairy farms, other livestock operations, and even the flooded fields of rice growers, and on and on, will also have to be measured and calculated. This becomes a very subjective, and very expensive procedure. But don’t worry, State approved consultants will be available to perform this calculation.

(2) Carbon Trading – this is the procedure whereby businesses that have failed to reduce their CO2 emissions would buy permits from other businesses who have managed to reduce their CO2 emissions by more than necessary. This is supposed to “put the market to work,” and indeed, it will put a lot of brokers and IT professionals to work, along with armies of attorneys and accountants. As the value of an emission allowance drops each year – so we can supposedly ratchet down our collective CO2 emissions to prehistoric levels within a few decades – companies will have the opportunity to purchase emissions allowances and “offsets” from qualified sellers, in order for them to continue to emit CO2. Alternatively, they can invest money in non-CO2 emitting sources of power – wind power, methane digesters, etc.

(3) Carbon Offsets – these are projects designed to sequester carbon or reduce carbon. A new forest that sequesters carbon in the wood of the trees. A renewable energy project that emits zero carbon. A methane harvester that captures the methane that bubbles up from a waste water pond at a dairy farm, or out of a landfill. To the extent these projects reduce annual CO2 emissions, they are eligible to sell these “offsets” to people who need more permits to emit CO2.

(4) “Additionality” – oops, don’t try to sell a carbon “offset” if you were going to build that zero CO2 emitting hydroelectric dam anyway, or if you were going to reforest your timber property anyway. For that matter, if the price of electricity gets high enough to justify any non-CO2 emitting source of energy, solar, wind, on strictly financial grounds, meaning that you would have built it anyway, then it no longer qualifies as an “offset” project, because it no longer meets the essential criteria of “additionality.” No subjectivity there.

If you don’t accept the premises being used to justify all this – that CO2 is a deadly gas, that fossil fuel is nearly depleted – than it is easier to see what a magnet this whole scheme is for white collar criminals – and their deadly counterparts in the underworld. But even if you do believe carbon is something we need to wean ourselves of, if you ponder the level of corruption that implementation will breed, you may have second thoughts. And as food for 2nd thoughts, consider these articles – just the tip of the iceberg – that describe the ongoing exploitation of the carbon scare by criminal elements:

Deutsche Bank, RWE Raided In German Carbon Fraud Probe

Carbon Trading Complexity Putting Strains on Market Reputation

Anti-fraud investigators swoop on EU emissions traders

U.N. panel suspends two more carbon emissions auditors

Spain Police Arrest Nine In CO2 Tax Probe

Carbon market chaos strikes again

Scandal brewing in the Euro carbon credits market

CDM crackdown continues as board rejects fresh Chinese wind projects

Carbon Credit fraud causes more than 5 billion euros damage for European Taxpayer

That green energy scandal

British carbon traders charged with money laundering relating to alleged carousel fraud

It is difficult to read these stories, all recent, all from reputable sources, without feeling a tremendous apprehension for our future. There is a Citizen’s Initiative, the California Jobs Act, slated for the November 2010 ballot that will suspend implementation of California’s 2006 Global Warming Act, set to take effect in 2012. When the opponents of this measure pull out all the stops, accusing proponents of being shills for “big oil” (despite the fact that most oil companies have come around, and plainly see the dollar signs inherent in embracing the whole global warming scheme), remember who they are: high-tech moguls who want to build the surveillance devices that will manage every kilowatt we use and every mile we drive, public sector bureaucrats and white collar professionals who see the biggest new source of revenue since the enactment of the federal income tax nearly 100 years ago, and, of course, the Wizards of Wall Street, who will milk this for billions upon billions. For more, read “Implementing California’s Global Warming Act.”

Who are the real carbon criminals?

Social Security Benefits vs. Public Pensions

When discussing the issue of public employee pensions, it is easy to suggest that these pensions are necessary because public employees usually don’t earn a social security benefit. While this is true, it ignores the startling disparity between the value of a social security benefit and the value of the typical public employee pension. And it isn’t hard to make the comparison.

If you go to the Social Security online “Estimated Social Security Retirement Benefit” table, you will see what you may expect to receive from social security when you retire, based on how much you earned in your last year working. A person making $65K per year, retiring on their 66th birthday, will begin to collect a monthly social security benefit of $1,609, or $19,308 per year.

In California, public employee pensions typically are calculated based on how many years the employee works, times a set percentage that usually ranges between 2.0% and 3.0%. As an example of how this would work, here are some apples to apples comparisons with social security, i.e., a public employee who enters the workforce at age 22, works for 44 years, makes $65K per year, and retires on their 66th birthday. At a 2.0% per year pension factor – which is the low end of the scale for public employees – this person will qualify for a pension equivalent to 88% of their final salary, based on 2.0% per year times 44 years worked. This equates to a monthly benefit of $4,766, or $57,200 per year.

Using the same assumptions – the same number of years working, and the same earnings during their years working – the 2.0% per year benefit will provide a public employee with a retirement income that is nearly three times better than what a private sector social security recipient will receive.

The high end of the pension benefit scale for public employees is reserved for those engaged in high-risk occupations such as police officers, correctional officers, and firefighters. While according to CalPERS own actuarial data, these individuals actually, on average, have lifespans slightly longer than the average worker – the theory is they live somewhat longer because they retire earlier and endure less financial stress – there are nonetheless compelling reasons why people who are first responders and take risks to safeguard the rest of us should earn a premium for this. The question is how much of a premium is appropriate.

A public safety employee who enters the workforce at age 22, works for 44 years, makes $65K per year, and retires on their 66th birthday – earning a 3.0% per year pension factor – will qualify for a pension equivalent to 132% of their final salary, based on 3.0% per year times 44 years worked. This equates to a monthly benefit of $7,150, or $85,800 per year, a retirement income 4.5 times better than what a social security recipient would earn after working the same number of years and earning the same amount of money.

There are countless nuances to this – public employees generally retire earlier than age 66, for example, which means they don’t qualify for as high a benefit as the comparisons made here would indicate. But early retirement also means fewer working years to set aside funds for the retirement benefit, and who doesn’t want to retire early? Many retired public employees who are still in their early 50’s collect pension incomes well in excess of social security, and are young enough to embark upon lengthy second careers.

Defenders of the public employee pension benefit – which is between 3.0x and 4.5x better than the social security benefit – claim there is little cost to the public for this disparity because most of the funds necessary to pay for this benefit are proceeds from investments by public employee pension funds, and not the burden of the taxpayer. There are several serious problems with this argument.

As argued in-depth with earlier posts, including Pension Funding and Rates of Return, The Razor’s Edge – Inflation vs. Deflation, Pension Rhetoric vs. Pension Reality, Sustainable Pension Fund Returns, California’s Personnel Costs, Maintaining Pension Solvency, and Real Rates of Return, the public employee pension funds have been overestimating how much they can earn on their funds. CalPERS still has an official projected rate of return of 4.75% after inflation. In the long term, it is unlikely CalPERS, or any other pension fund with hundreds of billions of invested assets, can earn an inflation-adjusted annual return of more than about half that. And if your fund earns half as much per year, without splitting hairs, it is roughly accurate to say your annual contribution rate to that fund has to double, in order for these defined retirement benefit promises to be met. This painful readjustment is happening now, and is one of the primary reasons our cities and counties are sliding into bankruptcy.

Another problem with this argument is the implication that investments of taxpayer sourced funds should yield returns to public employees, but not to taxpayers. Why are public employee pension funds pouring money into speculative investments, and showering the benefits of those investments onto the public sector workforce when the returns are good, then holding the taxpayer accountable to make up the difference when the returns are bad?

There’s more: Why are these quasi-government entities, using taxpayer’s money, being permitted to own shares in private sector corporations in the first place? Why aren’t more restrictions placed on the influence public employee controlled pension funds have on our corporations through becoming major shareholders? Isn’t this just another subtle but significant government encroachment on private property?

It’s important to note that the disparity between public sector pensions and social security is only one glaring example of the disparity in overall compensation between the public sector workforce and the private sector taxpayers. In most cases, public sector employees now make more in base pay than their counterparts in the private sector who have similar skills. They also receive more vacation time, sick leave, personal days, “comp” time, job security, annual cost-of-living increases, medical benefits, retirement medical benefits, auto allowances, low-interest loans, and more. The pension examples cited here, by the way, are conservative – they don’t take into account pension “spiking,” or the commonplace practice of fraudulently claiming additional disability benefits in retirement. There is a staggering cost for all this. The idea that we can continue to increase benefits to government employees, and finance this through increased indebtedness and higher taxes, is utterly unsustainable and morally bereft.

Ultimately the problem with public sector pensions goes beyond issues of financial sustainability, and like the entire compensation package public sector employees enjoy, becomes a question of fairness. For economic reasons, but also to be fair, the solution to government deficits is to lower the base pay and benefits to all public employees across the board.

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