Rodney Johnson | Thursday, November 29, 2012 >>


To be entitled is to have the legal right or just claim to something. And when we talk about entitlements from the U.S. government, we’re usually talking about money.

Social Security is an entitlement program, as is Medicare. In this sense, recipients have a legal right to receive benefits from these programs because that is how the law is written.

But what everyone knows is that these programs contain… nothing. If these programs hold a big bucket of air, then what exactly are recipients entitled to? As it turns out, they’re entitled to a share of the productive ability of current workers.

Because of the way we fund these programs, the law states that retirees get a share of each worker’s paycheck. And that’s what causes the problem…

For obvious reasons entitlement programs do not expand and contract, or at least not too much. There are cost of living adjustments in Social Security benefits and the government is always trying to trim around the edges of benefits by taxing them or changing enrollment requirements.

But every change to what people receive requires a change in the law. For Social Security, there is a huge, growing amount of benefits to which recipients have a legal claim. For Medicare, there is a bigger, but unknown pool of benefits to which recipients have a legal claim.

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As we all know, the unknown part of Medicare is how much bigger will the liability be, not whether it will shrink. Now compare these known and growing payments with the flip side, meaning how they are funded.

We take from workers and their employers 12.4% of their first $110,000 for Social Security. Medicare charges 2.9% on all W-2 income. This 15.3% is a steady percentage, no question, but the payroll itself is not.

What happens when our economy goes through a tremendous setback and millions of people lose their jobs? Obviously 15.3% of nothing is nothing, so these people are not contributing as long as they are unemployed. And when they return to the workforce with a lower salary? They are contributing less.

What happens when there are fewer workers in the workforce? Well, the percentage of 15.3% remains, but just like the example above it is charged on fewer people.

Of course the big question is, “What happens when both of these things occur?”

Well, this is where we are today. There are fewer people working, as noted by the falling labor force participation rate. And earnings have fallen. This leads to the entitlement program funding mechanism (the tax) bringing in less revenue. But the recipients are still entitled to their benefits. So the programs go bankrupt faster.

Then what happens?

This is what we as a society have to decide.

There are many ways to go at entitlements. None of them give a feel-good answer.

There has to be a ranking of priorities and some sort of grand compromise. We can raise taxes (taking more of every worker’s earnings), we can lower benefits, or do some combination.

What we cannot afford to do is stick our heads in the sand and ignore this for another year, or two, or ten.

With 80 million Boomers on the edge of retirement, the sooner we make informed, affordable decisions, the sooner everyone finds out the long-term rules of the game.

Until then, we’ll simply have to keep guessing as to what, exactly, people are entitled to.

Rodney

 

 

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Rodney Johnson
Rodney works closely with Harry to study the purchasing power of people as they move through predictable stages of life, how that purchasing power drives our economy and how readers can use this information to invest successfully in the markets. Each month Rodney Johnson works with Harry Dent to uncover the next profitable investment based on demographic and cyclical trends in their flagship newsletter Boom & Bust. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. Along with Boom & Bust, Rodney is also the executive editor of our new service, Fortune Hunter and our Dent Cornerstone Portfolio.