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Kotlikoff: Inflation Is a Stealth Social Security Cut

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America is “fundamentally broke”; inflation means “more federal income tax on [Social Security] benefits”; and the Fed is “a paper tiger” when it comes to determining inflation.

Laurence Kotlikoff, economics professor at Boston University, offered these and other candid observations in an interview with ThinkAdvisor on Oct. 15.

“On balance, benefits are being cut due to inflation for recipients in the middle class and upper-income classes, no question,” he says.

Named by The Economist one of the world’s 25 most influential economists, Kotlikoff, 70, is particularly worried about “the enormous amount of money” the Federal Reserve has been “printing” since 2008.

“When countries are broke and printing money, you see inflation,” and at 6% in the U.S. now, this is “the highest inflation we’ve had for decades,” he says.

Kotlikoff is founder and president of the financial planning software firm Economic Security Planning, offering the online tools Maximize My Social Security and MaxiFi to calculate claiming strategies.

Though the 5.9% cost-of-living adjustment for Social Security recipients that’s set for 2022 is the biggest increase in 40 years, it has little muscle, Kotlikoff maintains.

“It’s just keeping people even with inflation. Retirees aren’t going to get a bonanza from this COLA” because prices continue to rise “dramatically,” the Social Security expert argues in the interview.

Further, he explains that because some retirees’ Medicare premiums are increasing, they won’t see the 5.9% increase reflected in their monthly checks.

As for the Fed, no matter what level of inflation the central bank indicates, it has no ability to “determine inflation except by taking a sledgehammer to the economy,” the professor contends.

Kotlikoff, who served on President Ronald Reagan’s Council of Economic Advisers, has been a consultant to the International Monetary Fund, along with Merrill Lynch and Fidelity Investments, among other firms.

His good news is the relative certainty, he says, that once President Joe Biden’s social spending bill is passed, Medicare will expand to cover dental, vision and hearing expenses.

The bestselling author has a new book to be released on Jan. 4, 2022, called “Money Magic: An Economist’s Secrets to More Money, Less Risk and a Better Life” (Little Brown, Spark).

ThinkAdvisor spoke by phone with Kotlikoff, who was calling from Switzerland. He summed up U.S. economic woes succinctly, if not bluntly, when he said: 

“The real issue is whether inflation will stay at 6% or move up to 12% and whether the Fed will try to step on the brakes by raising interest rates significantly and whether that will cause a recession.”

Here are highlights of our conversation:

THINKADVISOR: What concerns you most about the U.S. economy right now?

LAURENCE KOTLIKOFF: Everybody needs to look at the reality that the country is fundamentally broke, that it’s paying money out the wazoo — maybe to be paying its bills; but we’re not quite sure. 

The key thing that troubles me is that the Fed has been printing an enormous amount of money since 2008.  

With our fiscal policy so out of control, it’s very hard to tell how much of this money creation is just making money to spend it.

When countries are broke and printing money, you see inflation. And from last October to this October, [we saw] inflation [rise to] almost 6% — the highest inflation we’ve had for decades. It looks like it’s continuing.

I don’t see the government explaining, “Hey we’ve got a fiscal policy that, over the long term, is going to be sustainable; and therefore we don’t have to do what 22 countries did in the last century, which was to finance their expenditures by printing money.”

What do you think of the 5.9% cost-of-living adjustment [COLA] for Social Security recipients in 2022, the biggest increase in 40 years? Is it meaningful?

No, it’s not. It’s just keeping people even with inflation. Retirees aren’t going to get a bonanza from this COLA. Prices are still going up dramatically. Purchasing power has [dropped] over the last 12 months.

The real issue is whether inflation will stay at 6% or move up to 12% and whether the Fed will try to step on the brakes by raising interest rates significantly and whether that will cause a recession.

Does everything hinge on what the Fed does?

More on this topic

The Fed’s power to influence inflation is largely a bully pulpit: They always say: This is what inflation is going to be, and just believe us, just trust us, and everybody get on the same page.

But when people aren’t on the same page, it becomes clear that the Fed is a paper tiger. It doesn’t really have the ability to determine the price level or inflation except by taking a sledgehammer to the economy.

What will the effect of the 5.9% COLA have on Medicare recipients’ benefits?

There are going to be some people who won’t see a 5.9% increase in their checks because their Medicare premiums are going to go up. 

That has to do with the way in which Medicare premiums are increased: Every monthly check is reduced from one year to the next. They leave in abeyance the ability for them to reduce your income. 

Please elaborate.

There are people who last year received no increase in their check even though there was a COLA.

That’s because these people owed the government premiums that they were never charged for in the past because it doesn’t want to be in the position of cutting their checks.

Why is the Social Security Trust Fund expected to run out of money in 2034? 

The reason the system is in such a terrible state is, in large part, due to the fact that in 1983, the Greenspan Commission [on Social Security Reform] looked out only 75 years. If they had looked at the long run, they could have foreseen the problem that we’re in now.

Children, grandchildren [et al] will be subject to benefits many years into the future. So it makes no sense to put on blinders and look out only 75 years.

The answer is to fundamentally reform the system.

What about the ideas of cutting benefits or increasing payroll taxes, which were put forth a while ago? Do you expect Congress to act on those?

It seems to me that they’re going to do nothing, just kick the can because the last thing the Democrats want is Social Security benefits cut or taxes raised on the middle class. 

Biden would like to raise the payroll tax on people making $400,000 or more. But that’s going to put a lot of high-income workers into the 60% or 70% marginal tax bracket. So I don’t know if that will happen, either.

What are the chances that Congress will move to cover dental, vision and hearing expenses under Medicare?

I think they’re pretty good because that’s part of the $3.5 trillion social spending bill. Biden and the Democrats will get some form of that bill through, and that’s a very important provision for many progressives. 

That there won’t be any Medicare expansion in this bill is hard to believe.

Back to rising inflation: What’s your advice to investors?

People need to protect themselves against inflation. 

They need to consider getting out of long-term government bonds or corporate bonds — any long-term assets that are paying a fixed nominal coupon with a principal payment that could easily get watered down by inflation.

Inflation is going to mean more taxation of [Social Security] benefits under federal income tax. [First 50 and then] 85% of benefits are subject to federal income tax, and those thresholds aren’t indexed.

So, on balance, benefits are being cut due to inflation for recipients in the middle class and upper-income classes, no question.

What’s your expectation for Donald Trump’s becoming president in 2024?

It seems that we have some Republicans in Democratic clothing; namely the senator from West Virginia [Joe Manchin] and the senator from Arizona [Krysten Sinema], who want to take down the whole party and hand Congress back to the Republicans and hand over the presidency to Trump. 

They can do that: Their votes are critical. If they want to restore a Republican majority in the Senate and the House, and reelect Trump, they have that potential. Just those two people.