Social Security

At least once a week I get an e-mail with claims about the Social Security System.  Almost invariably the claims are so far from reality as to be ludicrous.  But people believe the claims because they don't know any better.  With that thought in mind, here are some pertinent facts about "Social Security."

Social Security is, and always has been, a wealth transfer system.  It takes wealth from the working young and transfers it to old farts like you and me.  There is no investment aspect to Social Security; whatever taxes are taken in from FICA are immediately paid out to all the old farts (and some not so old farts).

The Social Security Trust Fund is an accounting gimmick.  It is a myth.  The Social Security Trust Fund was created to justify increasing the FICA tax rate to, allegedly, fund expected future shortfalls in Social Security funding.  That's a crock.  The federal government did a simple trick:  The Treasury issued a special issue of bonds to the Social Security Administration to account for the extra FICA revenues not used by the Social Security Administration and added the excess tax collected to the general fund.  That, of course, was spent.  That special issue of Treasury bonds is nothing but IOUs.

Contrary to common belief, Social Security is not just the Old Age benefit that is usually referred to.  There are four components to Social Security:  (1) The Old Age Benefit; (2) The Disability Benefit; (3) The Survivors Benefit; (4) Medicare.  The FICA taxes collected go out as payments to all four of those components.  The main problem is that over time the federal government, SPECIFICALLY, THE US CONGRESS, has gotten more and more generous (but then that's what happens when you're spending other peoples' money).  Worse than that, the number of recipients of the Disability Benefit has ballooned as lawyers have gotten into the business of suing on behalf of people who don't really qualify for the benefit.  The simple definition for the Disability Benefit used to be that the disabled person was unable to do ANY USEFUL WORK.  Lawyers and judges have corrupted that and driven the system deeper into insolvency.

The FICA tax rate has not always been 15%; it used to be much lower.  It has crept up over the decades as THE US CONGRESS has gotten more and more generous with other peoples' money.  In addition to that, since Social Security payments are based employment, the employers pony up another 15% payment into FICA.  If you happen to be self employed you get to pay BOTH sides of FICA.

Comments about Social Security payment not being benefits are totally false; the claim is being made by people who knows nothing factual about the Social Security System.  Social Security payments are technically indemnification because they were originally intended to be part of an insurance scheme.  Ever wonder what the acronym FICA stands for?  It stands for Federal Insurance Contributions Act.  Note that second word:  Insurance.  The system was designed from the start to be indemnification for the risk of growing too old to work.  The other components came later to cover the risks of becoming permanently disabled and dying during one's working years.  The justification for Medicare is a lot more murky, but politicians being what they are, in 1965 (when Lyndon Johnson was president and Democrats ruled Congress) the US CONGRESS came up with the justification that most medical care goes to those who are old and not very capable of working.

Note that indemnifications are not supposed to be taxed.  Indemnifications restore one to an economic position before a loss occurred.  Therefore they are not taxed.  Note that you don't pay tax on any insurance payments made to you after you suffer a loss., whether the indemnification is from an auto policy, a homeonwers policy, a life insurance policy, or any other kind of private insurance.  The Old Age Benefit of Social Security used to be that way.  Politicians, Democrats in particular but some Republicans also, decided in the 1980s that the Old Age Benefit should be taxed.  That action may have started the notion that Old Age Benefits are earned income.  They are not.

Finally, the Social Security System, in case you missed it before, is a pay-as-you-go system.  The FICA revenues collected go right back out again as benefit payments of Social Security recipients (except for whatever excess goes to the Treasury general fund).  If this were a private plan, THE US CONGRESS would demand that it be FULLY FUNDED.  The term FULLY FUNDED means that there must be sufficient funds available at all times to be able to pay the present value of all legitimate claims on the system.  Not so the Social Security System.  The justification for the initial setup was that, first, the federal government can use its taxing power to cover any shortfalls, and, second, there were a lot more workers than beneficiaries of the Social Security System.  That is no longer the case.  The UNFUNDED part of Social Security grows larger every day.

Once, during the ten years or so that I taught the subject of Social Security at University of Nebraska, Lincoln, one of the former chief actuaries of the Social Security Administration came on campus and gave an hour long discussion on the Social Security System.  He focused on how it originated and how it was set up.  A lot of actuaries from the insurance companies in/around Lincoln Nebraska were in attendance.  The revelations made in that hour stunned those actuaries.  When they walked out of the hall I heard several actuaries talking among themselves.  They kept saying, "It's pay-as-you-go!"  They were stunned because to them a pay-as-you-go system was not only not acceptable under government rules, it was unthinkable from an actuarial point of view.

That is what THE US CONGRESS has bestowed on us.

The Bernie Madoff Ponzi Scheme

The Evil Bernie Madoff got 150 years in prison for running the greatest Ponzi scheme of all time. Actually, it's the second greatest Ponzi scheme of all time. The greatest Ponzi scheme is the Social Security System.

Like all Ponzi schemes Social Security worked pretty well as long as there were a lot of people putting money into the system. All those "contributors," i.e., workers, from CEOs to packing plant employees -- that's 95% of the work force -- have put a Congress-decreed part of their earnings into the system. Most of the money collected goes right back out again in payments to "earlier investors," i.e., people who managed to live until age 65, along with permanently disabled workers, and the survivors of workers who had died. Along the way, politicians promoted the illusion that workers had a pension fund building up in the system, but that was never true.

Fortunately for the politicians the proportion of workers to Social Security recipients was large -- around 40 workers per recipient at the end of WW II. In 2006 that ratio had dropped to 3.3 workers per recipient. Two things happened: advancing medical technology gradually extended life spans, and after the post-war baby boom faded people began having smaller families. The net result is that many fewer workers are having to pay into a system that immediately redistributes their tax payments to a growing number of recipients. Uh-oh.

Of course, Lyndon Johnson wanted to have his shot at a presidential legacy so in 1965 he persuaded Congress to exacerbate the problem by adding Medicare into the Social Security System. Bad idea. Medicare is simply adding to the funding problem. The Ponzi scheme is getting nearer to collapse because the number of people putting money into the system can't keep up with the number of people getting money out of the system. Now that's a legacy.

Some politicians actually have a conscience and have tried to fix -- or propose a fix to -- the funding problem our government-sponsored Ponzi scheme faces: adequate funding. Former Senator Bob Kerrey (D) Nebraska was one. It has been about twelve years ago now, that Kerrey and his RINO compatriot, Chuck Hagel, periodically would come back to Nebraska to pitch his fix for Social Security. Of course, he was only talking about "fixing" the old age benefits, but at least he was on the right track. He wanted to privatize at least a part of Social Security so that workers would have more control over the amount of cash they would have at retirement. It was pretty clear that Kerrey and his aides had at least looked at the problem in proposing partial privatization. Hagel clearly didn't have a clue and was just mouthing politi-speak as a warm up act to Kerrey's ideas. Of course, the idea never took off among Democrats, and when Republicans started proposing privatizing Social Security the Democrats fell on them like a mob of screeching seagulls.

So the problem remains and the Obama administration wants to do more of what Social Security already does: spread the wealth. We already are getting a preview of how well an expanded income redistribution system works: it's running out of funds. Taxation is a dead weight on the economy and smothers economic growth so adding more taxes to pay for more income redistribution is going to be a killer for growth and the jobs growth creates. Most of the "green jobs" we hear about don't really exist, and when they do they are in some other country where specialized knowledge and lower labor costs already exist. Most of the "green jobs" I've heard about are in the administrative bureaucracy, i.e., the unproductive overhead, that will monitor, regulate, and ultimately stifle whatever innovation comes from this move toward a "green economy."

So. Who will take the fall when this, the biggest of all Ponzi schemes collapses? It won't be the politicians, unless voters finally learn the truth about this long-running scam. In truth, the generation now growing up will be taking the fall because, as Margaret Thatcher once said, "The problem with Socialism is that sooner or later you run out of other peoples' money."

Gimme yer Dough

“Gimme yer dough.” That’s a line I recall from a comedy routine Bill Cosby used to do. Congress, not to be outdone by a respected comic, is thinking along the same lines – at least some of them are.

According to a Wall Street Journal editorial (November 6, 2008, subscription required), Representatives George Miller (D) CA and Jim McDermott (D) WA, think that 401(k)s “are a big failure” and want to replace these private retirement fund options with something akin to what the Social Security Administration now pays to those of us who have made it to age 65 alive. With the Social Security facing a looming funding crisis it comes as no surprise that Miller, McDermott, et al, are interested in finding a new source of funding other than raising taxes. There’s a plausible reason why they want to help out 401(k) owners.

Social Security is a pay-as-you-go system. What comes in almost immediately goes out as payments to Social Security beneficiaries. Never mind what you may have heard about the “Social Security Trust Fund;” it’s all accounting hocus-pocus. There is no cash account; the money is spent almost as soon as it is received. If Miller and McDermott get their way the assets from all of those 401(k) accounts would become available to Congress to spend but payments of some kind to the account owners wouldn’t be made for years or decades into the future. It’s a neat way of putting off the looming Social Security funding crisis for a decade or two. How much cash is in all of those 401(k) accounts? Well, Wharton school puts the 2006 value at something like $2.5 trillion. Of course, in the past few months stock values have dropped around 40%, but just roughing it out there is currently around $1.5 trillion in 401(k) accounts.

Of course, there are some problems with Congress getting its grubby hands on 401(k) accounts. First, there probably isn’t a constitutional way of simply taking them over so it becomes a matter of convincing 401(k) owners that the federal government can do a better job of managing their assets. That’s a tall order, given the long-term rate of return on payments made to the Social Security system. Second, all those 401(k) assets aren’t cash; most holdings are stocks, bonds and money market accounts. Liquidating all those holdings would make current financial market disruptions look like a tiny bit of bother.

No. It appears to me that the real motivation is that Congress would be able to take in a large chunk of cash without having to raise taxes or force the US Treasury into borrowing more. All of this would be done under the promise of making retirement funds more secure. Yeah, right. Remember Ronald Reagan’s most feared words: “I’m from the government and I’m here to help.”

UPDATE: In a letter to the editor of the Wall Street Journal on 18 November 2008, Rep. George Miller denies he has plans to end 401(k)s and replace them with some government-run pension system. Instead, he writes, he is interested in more complete disclosure of the details and costs of 401(k) accounts and removing the unfair tax burden on seniors who may be forced into begin taking withdrawals from their retirement accounts because they have attained a statutory age.