“Saving Social Security” May End in Dollar Devaluation

Fri, Aug 19, 2016 - 2:11pm

As the US presidential election nears, we are doing a series of reports on the differences and agreements of major parties on various economic and financial topics. Last week, we noted one area where the major-party candidates are in agreement: trade. In different ways, the candidates have challenged the free-trade status quo. US multinationals will face an environment in which established free-trade treaties are renegotiated, and treaties that are currently in the works (such as the Trans-Pacific Partnership) are scrapped or drastically revamped, potentially disrupting long-settled plans.

Where the candidates agree, we have some sense of what waits for us after the election. In many areas, though, their visions of the way forward for the US differ substantially. This is certainly true for the approach each would take to retirement and tax issues.

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Both candidates agree that Social Security must be “saved”—that is, something must be done to ensure the solvency of the system, which will exhaust its “trust funds” by 2034. If nothing is changed, at that point Social Security would be financing payments purely with the contributions of those currently paying into the system, and by current estimates would be able to pay only 79% of its obligations. The situation would continue to get worse as the population aged, so politicians on both sides of the aisle are eager to come up with a solution that will keep the system intact and solvent.

Bi-partisan deals made changes in the past—such as the one made in 1983 under Republican President Ronald Reagan and Democratic Speaker of the House Tip O’Neill. Such bi-partisan agreements have been tougher to come by a more polarized environment that has prevailed recently.

The Republican Party platform says that “all options should be considered” and leaves open the possibility of further rises in the retirement age, and of changes to the system of cost-of-living adjustments, as well as more radical reforms such as privatization. However, on the campaign trail, Donald Trump has consistently made comments such as “We’re going to save your Social Security without any cuts.” (This is one of the areas where his populism has departed from Republican orthodoxy.)

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Hillary Clinton likewise was brought around to a forthright rejection of the old bipartisan consensus by the challenge of Bernie Sanders on her left, and now rejects any reforms that could be construed as “cuts,” especially changes to cost-of-living adjustments and changes to the retirement age.

Then what do the candidates propose to keep the system solid?

In a nutshell, the Clinton campaign proposes that Social Security taxes be raised: “There is no way to accomplish [the goal of protecting Social Security] without asking the highest-income Americans to pay more, including options to tax some of their income above the current Social Security cap, and taxing some of their income not currently taken into account by the Social Security system.”

On the other hand, the Trump campaign looks to boosting Social Security tax revenue by boosting economic growth and wages: “You do it by bringing jobs back, by being smart, by getting rid of waste, fraud, and abuse.” This prescription is short on detail but refers Social Security concerns essentially to Trump’s economic agenda: reviving economic growth, job creation, and wage growth by reducing corporate taxes, reducing regulatory burdens that discourage small business formation, driving harder bargains with trading partners, and reforming immigration policy.

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The candidates also differ widely on issues surrounding private pension plans. Both the Republican and the Democratic platforms note the problems faced by private pensions; the Republican platform notes the risks posed by inadequately funded plans that are insured by the government’s Pension Benefit Guaranty Corporation. (Many government employee unions fall in this category.) The Democratic platform, on the other hand, straightforwardly promises to protect the benefits paid by such pensions—which could exacerbate fiscal strains on insolvent municipalities or states.

Workers turning 48 this year will be eligible to retire in 2034, the year the system is set to hit insolvency. We do not know all the effects that will follow a Democratic or Republican strategy to “save Social Security.” However, the decisions made by would-be reformers will be affecting retirees long before then.

Investment implications: Both major candidates have pledged to “save Social Security,” which on its current path will exhaust its trust funds in 2034. Commonsense bipartisan solutions like those created in the 80s seem unattainable in the present highly polarized environment. The Democratic solution relies on higher taxes, and the Republican strategy on creating more robust economic and wage growth. The major parties also have differing attitudes towards Federal support for any private pension funds that run into trouble. The policies enacted will affect retirees long before 2034. Both retirees and those preparing for retirement should pay particular attention to the tax consequences of any changes, and make sure they consult with a competent advisor so optimize their retirement strategy as the tax landscape shifts. Many who favor gold as an alternative investment, or those who are concerned about the very high current US debt level, argue that the US government will handle the problems by devaluing the dollar. Devaluation will make pension obligations easier to fund by creating inflation—which will reduce the buying power of the dollar and push Americans into higher tax brackets. As taxpayers move into higher brackets, more taxes can be collected to fund social security. Such a strategy has been used in the past, most recently after WW2—and many believe that it will be attempted once again.

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