Doylestown Wealth Management - LPL

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Monthly Budget Review – November 2016

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“Reform?  Reform?  Aren’t things bad enough already?”

–Baron Eldon, Lord Chancellor of England, 1801-27

No subject is so dear to the heart of so-called fiscal conservatives and self-appointed financial watchdogs as the tsunami of debt which will allegedly overwhelm the public purse in the coming years due to the retirement of the baby boomers.  Social Security, we are told, will doom the budget and threaten the solvency of the United States if Something is Not Done Immediately.  Payments to retirees will cause the deficit to skyrocket and will force benefit cuts, tax increases, or both.

In reality, Social Security is perhaps on the soundest footing of any major government program.  The deficit the program runs accounts for a tiny fraction of the federal government’s debt increase every year.  The fact of the matter is that the debt and deficit are already skyrocketing for expenditures that have nothing to do with Social Security—an inconvenient truth which the anti-pensioner crowd is able to ignore while insisting that the one program which arguably provides the greatest benefit to ordinary working Americans must be “reformed.”

Let’s look at the numbers.  Over the last ten years, the Old Age, Survivors, and Disability Insurance Fund (OASDI)—what we usually refer to as Social Security—has run a cash deficit (the difference between contributions and distributions) of $ 454 billion.  Let us set aside for the moment that $224 billion of that occurred in 2010-12 when the government temporarily reduced the rate of employee contributions from 6.2 to 4.2 per cent, as well as the fact that the shortfall has been narrowing in recent years.  $454 billion may sound like a great deal of money, but the reported federal deficit over the last ten years was over $8 trillion, and the increase in the debt was over $11 trillion.  The OASDI shortfall looks like a rounding error compared to the rest of the government’s operations.

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Those with bad eyes like me might need to squint to see the grey portion of the chart.  What does seem pretty clear is that if we do have a debt problem, it’s not being caused by Social Security.

But what about the future?  What about the horde of retiring baby boomers who will pick the Treasury clean like a swarm of locusts?  Put it this way: with a consistent annual increase of $1 trillion (and that’s before the promised Trumpian “stimulus” and expansion of military operations), the National Debt is currently trending to be well north of $35 trillion by the time the OASDI Trust Fund is scheduled to “run out of money” sometime in the early 2030’s.  If the deficit hasn’t caused any problems by that point it seems implausible that a couple hundred billion per year for Social Security will push us over the edge.  It is said that effective leaders focus on what’s important while bad ones seek out scapegoats; the reader is left to draw his or her own conclusions.

A Tale of Two Indices

Much of the federal tax code is adjusted for inflation each year, and Social Security is no exception.  Both the maximum contribution threshold, referred to as the tax max (the amount above which FICA taxes are not assessed) and the benefit payment amounts are increased each year to account for inflation.  However, the tax max is indexed to the Average Wage Index (AWI) while the benefit payments are adjusted based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).  You would be forgiven for thinking that these two inflation measures were roughly equal; instead, the maximum contribution amount will increase 7.34% next year while benefits will increase a mere 0.3%.

The outsized jump in the maximum limit is due to a quirk in the rules: The AWI has increased by roughly 3.5% in each of the last two years.  However, a little known rule (hat tip Ed B.) prevents the max tax limit from rising if there is no increase in the CPI benefit adjustment for a given year.  Since there was no increase in Social Security benefits due to inflation in 2015, the 3.5% wage index increase was suspended.  However, a tiny 0.3% bump in benefits scheduled for 2017 will allow both last year’s and this year’s wage index percentages to move the maximum limit for contributions up from $118,500 to $127,200   The unfortunate earners caught by this mismatch must console themselves with the thin gruel of knowing that they are helping to prolong the solvency of the Social Security Trust Fund.  The question of why the CPI-W seems to run a few percent below the more familiar CPI is left for another time.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  All performance referenced is historical and is no guarantee of future results.  All indices are unmanaged and cannot be invested into directly. 

 Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Doylestown Wealth Management, Inc. are separate entities from LPL Financial.