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Old 10-28-2011, 08:17 PM
cragger cragger is offline
Join Date: Aug 2007
Posts: 632
Default Re: Maybe this bit of income equalization...

I'm not sure that the majority of your coments conflict with my statement that I think the terminology in use depends on the agenda of the user at that time. You point to people excluding FICA to make a claim about the poor not paying taxes or make taxation appear more progressive. I suspect many of the same people include FICA as a tax when they are complaining about how much of people's income the feds take in taxes. Much the same as people who are all about state's rights on one issue, but when the issue changes to something like states recognizing gay marriage, for example, they want a federal ban and/or a constitutional ammendment to stop it.

But that's all about perception and imputed intentions and I think I've belabored it past any semblance of a point I may have had. Onward to pension (vs. 401k's) plans and social security. Math is fun!

Lets consider a somewhat simplified first-order model of a retirement system such as a defined benefit pension plan or social security. Look at it from an individual basis. Further, lets consider the system in operation, say 75 years or so on, at which time we can ignore questions of startup such as how we want to deal with, or exclude, people already at or near retirement when we begin and whether we need to make external funds available if so.

People make an annual contribution C to the plan. Eventually they retire and recieve an annual payout R. At the end of each year, the plan holds some sum of money S. While money is in the plan, it is invested, perhaps in treasuries, with a rate of return of P, such as 1.05 if the rate is 5%. Since I'm too lazy to figure out how to do subscripts on this forum, (n) and (n - 1) are indices indicating a sum S at the end of a given year (n) or at the end of the previous year (n - 1).

At the end of each year, the accumulated account from contributions is:
S(n) = C +[ P x S(n - 1) ]

This iterates recursively each year until the worker retires, after some 40 years or so, at which time the account holds S(40) dollars. On retirement, payouts begin and the account is described at the end of each year by:
S(n) = [ P x S(n - 1) ] - R

Now contributions and payments aren't annual, so the interest works slightly differently but like I said, it's a simplified model that illustrates the basics. Assuming a retiree lives and collects for 20 years or so, the sum of the payouts in a balanced system will be such that S(61) goes to zero. At equilibrium, the sum of the payouts equals the sum of the contributions plus the contribution of 60 years of interest on the sum. It's really pretty simple. The pension or SS system is just the sum of this formula for each worker superimposed across time.

A couple things should stand out. Due to the compounded interest return and the fact that the contribution period is greater than the payout period, annual payouts R are much larger than annual contributions C. It is absolutely impossible to run the aggregate system of many workers on a pay-as-you-go basis unless there are many times the number of workers entering the system and paying C then folks retiring and collecting R. The number of new workers would have to increase rapidly and infinitly. It would be a Ponzi scheme that collapses instaneously. The accumulated "trust fund" surplus would never exist unless such a continuous and rapid explosion of new workers existed, and existed in excess of that necessary to cover the payouts R>>C.

What you can get is a situation in which the system goes out of balance due to actuarial changes such as people living and collecting for a longer period of time than expected when setting the payout R, changes in the interest rate P, or assorted other things getting glommed onto the program such as the addition of payouts for people who become disabled, and so on. If the program isn't monitored and tweaked as needed, you can end up in the situation we are in now, in which S(40) isn't quite enough to support the payout R over the life expectancy of the retirees. If adjustment requires recourse to the unfortunate political process I alluded to previously, politicians can simply ignore the problem and effectively draw funding from current workers to cover the shortfall for current retirees. These workers will no longer have S(40) in their accounts when they retire, the accumulated "trust fund" sum S across the aggregate of workers drives to zero, and the system eventually crashes.

If social security is "fixed", through increasing contributions, changing payouts, or whatever such that it goes back into balance, it will be in fact a saved contribution retirement plan. It's a closed system, there is no other place the money comes from. I contend it is a contributory system now, it is just one that has been allowed to go out of balance.

Corporate pension plans are the same, except that companies typically haven't made ongoing contributions, historically. They have thus basically kept the money for their use over the course of a worker's employment and inflated their balance sheets by doing so. At retirement, they have generally taken that sum S(40) and purchased an annuity from a third party that does the payout just as shown above. My understanding of the relatively recent legal changes requiring ongoing funding at some level for retirement obligations reflects both a desire for more honest accounting and reduction of cases in which a company runs for years then announces it can't afford to honor their pension obligations as workers retire.
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