Confusion about life expectancy and Social Security

I'm a little late getting around to this, but back on May 6 of this year former Senator Alan Simpson (R-Wyoming) appeared at an Investment Company Institute program, also broadcast on C-SPAN, to discuss the recommendations of the National Debt Commission he co-chaired with Erskine Bowles. During this he made a couple of surprisingly ill-informed assertions about Social Security (along with, to be fair, many accurate ones) despite the fact that Social Security was one of the main subjects considered by the commission in question. These weren't trivial errors about obscure points, they were remarkably major, fundamental mistakes.

The first reflected a surprisingly common misunderstanding about the meaning of the term "life expectancy." Simpson said that the Social Security retirement age was set at 65 because in the late 1930s life expectancy was only 63. Simpson appears to have been talking about life expectancy at birth -- that is, average age of death -- which isn't especially relevant to retirement age. For more of human history, even as recently as the 1930s in the United States, that average was pushed down by the what was the large number of deaths among babies and children. The great increase in the average age of death comes mainly from the drastic reduction in the rate of infant and childhood mortality owing to better sanitation and especially vaccines.

In contrast, while people who reach adulthood today can look forward to a longer lifespan, it's not drastically greater. Even the 90th Psalm, written 25 or 30 centuries ago, says, "The days of our years are threescore years and ten; and if by reason of strength they be fourscore years, yet is their strength labour and sorrow; for it is soon cut off, and we fly away." (Psalm 90:10 KJV). We're not talking here about the vast antediluvian lifespans in Genesis; the Psalmist was addressing the adults of his own day who expected to reach 70 or even 80. Many historical records bear this out. The notion that the human lifespan (as opposed to childhood mortality) has vastly changed is to a large extent a myth.

When Social Security benefits first started being paid, 65-year-old men could expect to live, on average, until nearly 78, and a woman until nearly 80, according to Social Security Administration data. By 1990 the remaining life expectancy for women aged 65 had risen by just under five years and for mean by about half that.

There's a more detailed analysis on this page that points out a troubling fact: High-income people at 65 have seen a much greater improvement in their remaining life expectancy than low-income people have.

When the Huffington Post asked Simpson about this and raised similar points, Simpson at first questioned the accuracy and then apparently misunderstood the meaning of "life expectancy."

During the program broadcast on C-SPAN, Simpson even suggested that Social Security was never meant to be a retirement program but rather a sort of welfare system (then why does it pay higher benefits to those with a higher average income?) and a "Ponzi scheme."

That last is a popular but ridiculous notion that reflects a misunderstanding not only of Social Security but of what constitutes Ponzi scheme.

My guess is that Simpson shares the common erroneous idea that what defines a Ponzi scheme is money flowing from later investors to earlier ones. While that sometimes (but not always) happens in Ponzi schemes, the mere fact of money flowing from newer participants to older ones does not a Ponzi scheme make. If it did, then investing in gold -- or in shares of Apple stock -- would be a Ponzi scheme as well, because the only way to get earn an investment return is to sell the asset to another investor at a higher price than when you bought it, which obviously implies money flowing from a later investor to the earlier one.

What actually does define a Ponzi scheme is falsifying investment returns, either by paying out invested capital -- the investor's own deposits or somebody else’s -- as a pretended dividend or else simply reporting fake gains on statements without paying out anything at all. (In practice it’s often a combination of the two.)

Note that fraud is a key attribute of Ponzi schemes. Legitimate investment vehicles can also involve return of capital, and some redistribute funds among investors in a fashion that’s completely open and agreed-upon. With life annuities, for example, longer-lived investors wind up collecting part of the money paid in by those who died younger than average, but there’s no deception that this is going on -- it’s the whole point of a life annuity -- and hence legitimate life annuities are not Ponzi schemes. Nor is Social Security.

It's also possible that Simpson is confusing a Ponzi scheme with a pyramid scheme, which many people mistakenly think is the same thing. A pyramid scheme involves money flowing from many people to fewer people, and that of course does happen with Social Security. But a pyramid scheme also promises getting back almost immediately vastly more money than you put in, making the scheme unsustainable and a dead loss to all but a lucky (or crooked) handful. That's not true of Social Security.

Another thing that everyone worried about Social Security ought to know is that while the system is indeed headed for financing problems, given current projections, those same projections indicate that even assuming that absolutely nothing is done to address the problems and the Social Security Trust Fund runs completely empty in a quarter century or so, benefits paid after that point will on average not be much different from those today in terms of buying power.

This may seem impossible, but you have to understand that Social Security is and has always been a pay-as-you-go system. That is, benefits paid out this year are supposed to be paid for by Social Security tax receipts this year. The Trust Fund exists to accumulate excess taxes in fat years and make of the difference in lean years.

When the Trust Fund runs out, benefits will be slashed (by an estimated 20 to 30 percent) to whatever can be paid by incoming taxes. But because wager and salaries have grown over time at a rate a tiny bit higher than inflation, future scheduled benefits (which are computed based on average lifetime earnings) will be a bit larger than today even taking into account inflation. Over a quarter century, the cumulative growth is enough that after they're cut, what's left will be similar on average to today's average benefits.

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Confusion about life expectancy and Social Security — 1 Comment

  1. Pingback: Facts about U.S. life expectancy that might surprise you | D Gary Grady

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