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Happy New Year - and happy new you! If you are taking stock of your wealth know that for the most of us Social Security will be worth more than any other asset we own. And you will probably pay Social Security taxes all year -- most of us do. But some very high income people will stop sometime during New Year’s Day. Who are these people who don’t pay all year long--or in the extreme, who pay their total annual Social Security taxes in less than one day? If they paid more, Social Security would be financially stronger.  

Social Security is Important and Popular

Some background: a 65-year old expected to live 20 years who receives $1300 per month (inflation indexed) from Social Security has a present value Social Security wealth of approximately $350,000 (assuming a conservative return and modest inflation; see Dana Anspach's efficient calculations).  In comparison, the median retirement account balance for an older worker is about $60,000 and the median home equity for people age 65 and over is approximately $120,000.

No wonder the vast majority of Americans of all ages, income levels, and political affiliations oppose Social Security benefit cuts in any form. A National Academy of Social Insurance survey reports that 77% of Americans feel it is critical to preserve Social Security benefits for future generations, even if it means raising taxes.

Social System Is Primarily Short of Funds Because of Unexpected Income Inequality and Sky-High Health Premiums, Not Longevity Increases

Social Security is in good shape and well-funded. However, the program will only have enough money to pay 77% of benefits in 2034 unless the system obtains the equilvalent of about one trillion dollars  Sounds like a lot of money?  Coincidentally, the amount needed is less than the $1.889 trillion of lost revenue (from 2018- 2027)  due to the tax cuts enacted in 2017 that reduced taxes for the wealthiest Americans and the corporate tax rate from 35 to 21%. The fix to Social Security comes from addressing the source of the revenue shortfall, not cutting benefits.

Boomers living longer is not causing the Social Security system to face a revenue shortfall in 2035.  Social Security actuaries can count. They have been anticipating baby boomers’ retirement as longevity increased as a slow-moving, observable and predictable phenomenon.

Social Security taxes aren’t sufficient to pay full benefits mainly because of extreme earnings inequality and diverting wage increases to pay ever-increasing health insurance premiums since back in 1983 when the Social Security tax was last raised by Congress and the President. According to Urban Institute economists Karen Smith and Eric Toder, the inequality of wage income and taxable wages escaping as health insurance premiums are the most salient and unexpected reasons for the shortfall. The Economic Policy Institute has found that most labor earnings growth since 1979 has gone to the top earners; the top 1 percent wages grew 138 percent since 1979, while wages for the bottom 90 percent grew only 15 percent.

The basics of the Social Security system reveals why the unprecedented lopsided growth in earnings is the main reason behind the system’s shortfall. Social Security benefits are paid by the FICA tax, which is 12.4% of pay (split evenly between the employer and the employee) up to a cap. In 2018, the cap was $128,400 (the cap will rise to $132,900 in 2019). Ninety-four percent of American workers pay FICA tax all year long because our annual earnings fall below the cap and 6% stop paying sometime during the year when their earnings reaches $132,900.

But for some very, very wealthy people their earnings will reach the cap hours after midnight strikes on New Year’s Eve. Who are these people who don’t pay all year long--or in the extreme, who pay all of their total annual Social Security taxes after only one day?

People don’t post their salaries, so we don’t know who is the highest salaried  person in America. We know the richest man in the world is Jeff Bezos, but the system doesn’t tax wealth, it taxes wages and salaries. (Social Security could tax wealth, but it never has.) Public companies post the salaries and bonuses for its executives and Brian Duperreault of AIG -- the insurance company bailed out in the 2008 financial crisis -- earns $44 million in salary.  That means he stops paying Social Security tax by about 3 minutes into January 2.

In 2017, over 165 million workers paid a total of $836 billion into the Social Security system. I don’t know the names of all the 1143 people in 2017 who earned over $20 million although 205 employees earned over $50 million each, with an average salary of $97 million.  But these extremely wealthy people only paid Social Security taxes on the first $128,400 they earned in 2018. On average, those 205  people at the top will stop paying Social Security tax 12 working hours into 2019, about the time you may be reading this blog.

Every year, the earnings cap means that over $2.3 trillion dollars of earnings--wages and salaries, not capital income-- of an economy-wide $6.7 trillion in taxable earnings escapes Social Security tax.  That's over one-third of total earnings.  This escape happens not by design, but by accident. According to Kathleen Romig of the Center for Budget and Policy Priorities, in 1983, Social Security reformers never imagined we would see such a rapid increase in earnings above the cap, nor did they imagine that the bottom 94% of earnings would experience wage stagnation during the 1990s and 2000s.  Otherwise, they might well have raised the earnings cap, putting more revenue into the system.

How To Fix Social Security

The American Academy of Actuaries Social Security game makes it easy to assess like an expert -- choose revenue and/or benefit cuts to balance the program's long run budget. Since we are approaching an overall retirement crisis as boomers continue to retire and the 401(k) system is inadequate for many workers, it makes no sense to cut Social Security benefits. Revenue increases are the practical solution and two ways to raise revenue can fix the shortfall completely. If we eliminate the earnings cap and assess FICA on currently tax-deductible health care premiums, Social Security is fully solvent for  75 years. Higher income workers will pay more but there is no evidence that increasing revenue to the system is unpopular.  Because raising the cap would mean only a few of the highest earners pay more, it is unlikely to inhibit overall economic activity or cause any meaningful economic harm.

Keep in mind that in 1994, a bipartisan group of politicians eliminated the Medicare earnings cap. Since then, everyone pays Medicare taxes all year long. And since 2016, higher earners pay a surcharge. The Medicare tax is only 2.45 percent (combined employer and employee tax - the worker effectively pays the employers’ portion).

We could also collect revenue for Social Security from income that is currently not counted as labor income. Forbes staff writer Noah Kirsch reports the three richest Americans —Bill Gates, Warren Buffett and Jeff Bezos—together hold more wealth than 160 million American households. Taxing unearned income -- income received passively from interest and dividends etc. would be a big change in the system, maybe for the better, but that is for another debate.

If we did nothing to the basic bones of the system and only taxed earnings not wealth and raised the cap (and benefits were not increased), 88% of the short fall would be solved.   Or we could not touch the earnings cap, but increase the FICA tax from 12.4% to 15.23%.  The employee and employer would each pay 7.615% instead of 6.4% to close the entire gap. Really, take a pause. If we raised the FICA and elminated the cap Social Security shortfall would be solved and we would have moved a long way to fixing the next coming retirement crisis.

Even conservative commentators – the Washington Examiner -- urge a close look at removing the cap. Eliminating the Social Security earnings cap is unlike the sugar and spending and fitness resolutions you made New Years Day--  raising the cap is a policy with very little pain and all gain.

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The ongoing government shutdown that began on December 21 is affecting many programs, but it doesn't affect mandatory, entitlement, nondiscretionary spending including all tax breaks, Medicare and Social Security.

That's a good thing for the elderly and for the economy, since over half of seniors depend on Social Security for most of their income and Social Security constitutes over 90% of household income for one-fifth of seniors. That financial dependence is essential when considering the Social Security program's financial and political stability.

Although checks are being sent, the partial shutdown is hurting seniors in other ways.  Sixty-seven million seniors depend on many other government programs besides Social Security. For example, the Department of Agriculture may run out of money for food stamps (Supplemental Nutritional Assistance Program) which means 4.8 million people over 60 will not get full food assistance.

Further, the breakdown in Washington still hurts Social Security.  The unreliability of the federal budget process may weaken public support for the Social Security system. More concretely, the agency’s current fiscal 2019 budget, adopted just two days before the Oct. 1 start of the fiscal year, reduced funding for beneficiary services and administration from their 2018 level.  That’s on top of the fact that, customer service was already suffering from years of administrative budget cutbacks, even as the number of Social Security beneficiaries has been growing with the retirement of the Baby Boomers. (Author’s note: the original version of this article, relying on contingency plans posted by the White House Office of Management and Budget, incorrectly suggested that some Social Security services have been further curtailed and some agency workers furloughed during the partial shutdown.)  

The Far Flung Economic Costs of An Unreliable U.S.  Government

President Trump is owning the shutdown, tying it to his insistence that Congress fund a wall on the border.  But the "Trump shutdown" is in part a reflection of a larger, ongoing problem in Washington. The regular budget process has not worked since 1997 (the last time all annual appropriations bills were passed on schedule.)  In its place, temporary and short-term spending authorizations--continuing resolutions--have become the norm, causing uncertainty and imposing direct costs on federal contractors (many are small companies), employees and communities that depend on reliable federal spending.

An unreliable U.S. federal government indirectly imposes costs on the world economy. For all its faults the United States and the dollar was seen as a stable entity – over 30 countries (IMF report Table 5)  peg their currency to the dollar.  The Financial Times reports that the partial government shutdowns and erratic Presidential statements are important factors destabilizing the U.S. economy and  financial markets. A substantial share of older workers and seniors depend on financial markets for their retirement income and the last thing they need is financial uncertainty and volatility.  Regrettably, I foresee a great deal of financial instability for older Americans driven in part by our broken budget process.

Despite the costs and disruption, no further negotiations are scheduled.  The shutdown will become the first order of business when the new Congress begins its session on January 3.

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The stock market is in bear territory the night before Christmas, dropping 19.7% in 3 months from a peak during the day on September 20.  And many blame the President’s slipshod economic management.

Financial markets matter more than ever. Twenty-four million American workers are approaching retirement age, and many will have to retire before their time when the recession hits. Just over a third have no financial assets, so for once not having a 401(k) or IRA may be a relief. But 15.6 million American workers, age 55-64,  have real skin in the game – they had on average $92,000 in retirement assets in 2017.  If it were all in stocks each older American lost an average of over $18,000 this quarter.

Folks are panicking as their retirement income and prospects for work look grimmer than they have in 9 years. Account balances shrink at the same time job prospects shrivel and older workers are often FIFO  – first in and first out – and more vulnerable to recessions. Only near retirees relying on a defined benefit pension plan and Social Security don’t have to follow the S&P500 -- their income is guaranteed.

Other assets, such as bonds, don’t promise much relief – the financial markets and real estate may slump for a while.  However, market volatility is not a culprit; market corrections are expected and even necessary. Erratic government policy is the culprit. The clumsy government shutdown and awkward, ill-advised and seeming impulsive statements from  Treasury Secretary Stephen Mnuchin should not be expected and and they are unecessary.

This week the executive branch hit the wallet hard. First, the government shut down as President Trump insisted Congress fund the Mexican border wall and turned down a budget deal. This caused federal budget authorization to expire, shutting down non-essential government services (the White House Christmas tree closed, and now is open only with private money). The shutdown is forcing many federal employees—including border patrol agents—to work without pay.  As of Christmas Eve no further negotiations are planned.

Second, Treasury Secretary Steve Mnuchin caused a minor panic that helped drive the S&P 500 index down by 2.7% today. He probably didn't mean to. Apparently he actually was trying to calm the markets.  Mnuchin announced he spoke to the CEOs of the six largest banks and reassured us the banks had adequate liquidity.   But since no one had been worrying about liquidity, markets either assumed that the Treasury had some disturbing inside information or that Mnuchin was acting under orders from President Trump. The motive might have been to support Trump's constant tweeting against the Fed and its chairman Jerome Powell (who Trump appointed). It is as if the Treasury, reassuring us we are secure from white rabbit attacks, caused more fear of white rabbits than ever before.

Tim Duy, the economist behind the Fed Watch blog,  agrees with Trump’s discomfort with the Fed’s interest rate hikes.  But he worries about the President and his impulsive policy declarations, writing,  "My guess is that Mnuchin was under pressure from Trump to 'do something' and this half-baked attempt to calm markets is the result.”  Duy added "it is widely believed that Mnuchin’s actions were so poorly conceived that they can’t be taken seriously. But they were so poorly conceived that they imply a worrisome lack of competence for economic policymaking as a whole, and that creates uncertainty that undermines investor confidence."

This week the executive branch’s incompetence has caused million of workers to uneccessarily lose thousands of dollars.

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The federal budget process may fail by Friday which means the federal  government will stop all but bare bones, non essential, operations.

Congressional authorization for significant amounts of spending—agriculture, justice, environment, homeland security, and other areas-- runs out on December 21.  Despite the looming deadline Congress and the President are not working around-the-clock to negotiate an agreement.

Before President Trump planned to leave Washington for a 16-day vacation at Mar-a-Lago he held a televised session with the Democratic Congressional leadership that degenerated into an argument. The President took ownership of  the looming shutdown (contrary to most political advice and shocking many of his Republican allies), saying “I am proud to shut down the government for border security” if he can’t get $5 billion for his wall on the Mexican border.

And although Republicans still control the House of Representatives until early January, when the newly-elected Democrats take over, many of them are not even in Washington or showing up for votes.  The outgoing representatives have been moved out of their offices into cubicles, so the new members can move in, and many of November’s losers aren’t working  though they haven’t closed the budget. Republican Congressional leaders admit they have no strategy. Senator John Cornyn (R-TX), the number two Republican leader in the Senate, says “There is no discernible plan — none that’s been disclosed.”

Budget Process Flawed for Decades

Although the current looming shutdown is tied to President Trump’s hard stance on funding the border wall, brinkmanship and short-termism is now the normal federal budget process.  The  regular process described in textbooks says the President submits a budget in February for the fiscal year beginning in the following October.  Congress reviews it, setting an overall budget amount that is then allocated to twelve different appropriations bills in each chamber covering the myriad things government funds—defense, housing, national parks, airport security.

House and Senate committees then are to negotiate internally among the political parties, after which each chamber combines its committee decisions, creating an overall spending bill. More negotiations and compromises between the two chambers and with the White House results in the new approved budget being ready for the President to sign before the new fiscal year (FY) starts on October 1.

But this formal process hasn’t been the real budget process in Washington for decades.  Congress hasn’t passed all of its spending bills on time since 1997, almost twenty years ago.  For six years in a row, FY2011 through FY2016, not one appropriations bill was passed on time.  In fact, as the Pew Trusts sadly document, ever since the 1974 Congressional Budget Act put current procedures into place, “Congress has managed to pass all its required appropriations measures on time only four times: in fiscal 1977 (the first full fiscal year under the current system), 1989, 1995 and 1997.”

The real process instead involves passing some individual spending bills when possible, and enacting a “continuing resolution” (what the Washington insiders call a “CR”) for the remainder that continues previous spending levels for a fixed period of time—anywhere from a few weeks to the remainder of the fiscal year.  Of course, negotiations about what goes into the CR, at what levels and for what time period, are themselves contentious and complex.  (Some members further disrupt the process by trying to put pet projects or controversial policy issues like restrictions on abortion spending in the CR, which is seen as a “must-pass” bill that might carry divisive policy positions into law.)  Forbes contributor Stan Collender, the “budget guy” and one of the best guides to these dysfunctional procedures and politics, writes “the federal budget process is not broken: it’s dead.”

Political Failure Imposes Costs

Failing to pass the budget on time is costly.  It causes uncertainty about whether national parks will be open; problems for many federal contractors (including small companies) in planning their business; volatility and speculation in financial markets; increased economic uncertainty that inhibits long-term private investment; confusion for  state and local programs and budgets (given their reliance on many federal spending streams), and weaker  long-term policy and economic strategies that depend on reliable federal spending.

The process can be viewed like a Washington reality TV episode of “The Federal Budget:  Deal or No Deal” featuring colorful characters—the tough Nancy Pelosi, the inscrutable Mitch McConnell, and the unpredictable Donald Trump.  But this systematic fallure is not theater.  As compelling as they are, personalities are by far the least important aspect of the shutdown threat.  The uncertainty and ill will fostered by this chaos hurts the economy and all of us, not just government employees and those that directly rely on federal spending.

Government shutdowns are economically harmful.  But perhaps their worst effect is to further erode respect for the federal government’s reliability. The President’s combative stance is aggravating our already damaged broken democratic processes while threatening to destabilize the economy, financial markets, and confidence among investors, households, and businesses.

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Last night Olivier Knox of “The Big Picture” SiriusXM interviewed me asking what I was worried about. Answer: “I worry about the coming recession and whether the government has the right tools to fight it.” Yesterday, the Financial Times spooked me (the article is behind a paywall so I can’t link). Michael Mackenzie quoted Mark Tinker of Axa Investment Managers, “The fact that a decade of quantitative easing has produced a lot of products that rely on spread, carry and leverage has left financial markets vulnerable to the unwind of these strategies.”

Ouch.

Tinker is saying that low interest rates caused banks, insurance companies, and firms in the real economy to base their business models on debt and implies little productive activity. And, though debt can be good, it is fragile.

Here are some flashing lights for the next recession. The first is just extrapolation: time’s up! We seem “due”. If this expansion lasts until July 2019 it will be the longest. This expansion is almost twice as long as the average since 1945 -- a little more than 4 1/2 years. The record holder expansion lasted  10 years from March 1991 to March 2001, and the next longest from February 1961 to December 1969. Those were, in part, fueled by large armed conflicts. Armed conflict, though stimulative, not good.

The second concern is the corporate cash-to-debt ratio, which indicates a company's ability to cover its debt with cash flow. The lower the ratio, frankly, the closer a company is to bankruptcy or a takeover. Academics (see Ben Bernake and John Campbell for a standard view) are watching. Other recession flags include the inverted yield curve and oil prices says the St Louis Fed.

Can government help dampen the pain in the next recession?  Government didn’t do all that bad ten years ago, the economics and politics were competent and remarkably bipartisan. The outgoing Bush administration and Republican Fed Chief Ben Bernanke worked with incoming Obama advisors using old and new tools. Both Presidents urged rapid and substantial government spending. Bush passed the bills in 2008 which established the Troubled Assets Relief Program and laid the foundation for the auto bailout . Obama passed the American Recovery and Reinvestment Act (which created about 2 million jobs).

After the dust settles, most economists agree that quiet and effective automatic stabilizers, infrastructure spending, and aid to state and cities work quickly and effectively to counter job loss. Take the progressive tax system, the biggest automatic stabilizer. It stimulates the ecoomy because as the economy worsens households move down a tax bracket and pay less tax leaving more for disposable income to goose the economy. Unemployment insurance, Social Security, and other social safety nets inject money to low and middle class households, which balloon, appropriately, the federal deficits. My worry? President Trump and the Republicans created deficits in a boom, leaving us less wiggle room in a recession.

Sensing I was casting a dak cloud on holiday cheer and a perfectly good Friday night I blurted, “Wait, wait, I can give your listeners some hope.” “Whew” said Knox.

Hope in New Old Ideas-- Job Guarantees

Some politicians are searching for new/old ideas – one is a federal job guarantees – the government would guarantee a job to every adult American who wants one. If pulled off, federal job guarantees would eliminate the worst effects of unemployment. Bard College Economist Pavlina Tcherneva explains how and economists Malcom Sawyer and Scott Fultwiller assess the history and variations. Don't like job guarantees? What do you got? Maybe you like the pro - private sector job matching effort by government -- activist labor market policies including training (see Sweden and others). The bottom line is that quantitative easing, the progressive tax system and deficit spending got more elusive with the tax cuts of 2017 and the unlikely math of even lower interest rates. Doubtless we will rely on garden-variety recession- fighting tools -- automatic stabilizers, adhoc fiscal spending -- but we will need more.

Let’s mobilize the  “Scout Economists” -- our motto "Be Prepared.” Let’s lay out options now (Democrats are pushing Job Guarantees) using history and a creative informed vision for a stable prosperity shared by all.