Misunderstanding Social Security

Bush (following thinking expressed by the libertarian Cato Institute) made many wrong and deceptive statements about our existing Social Security Program. For more details, read Michael A. Hiltzik, The Plot Against Social Security, How the Bush Plan is endangering Our Financial Future and Max J. Skidmore, Social Security and its Enemies, The Case for America’s Most Efficient Insurance Program.

The following are six erroneous myths:

#1. Social Security is an investment, with lower returns than would occur with private investment in the Stock market.

Social Security is not an investment. Social Security is the way that we repay our obligation to our older members. To the extent of its means and will, every society cares for its young, old and disabled members. Before Social Security, our seniors used to be cared for by their family members, with those who had no families being cared for in typically poor quality public homes. With Social Security, our working members pay money (through our FICA tax) which is immediately distributed to older members.

It is our way for working adults to repay the parents, teachers, police officers and many other older people who cared for and raised them when they were children. Only libertarians (often white males) who view themselves as self-made believe that they owe nothing to their elders, such that they have no obligation to support social security. Paying our FICA tax is an obligation, much like paying our income tax to support public services we receive and making mortgage payments to pay for our house.

Revenues from FICA taxes are immediately paid to older recipients. There is no money for investment, with one exception. In 1983, anticipating that when the Baby Boom members reached retirement age, large increases in FICA taxes would be necessary, FICA taxes were raised a lesser amount to create what might aptly be called a Baby Boom Reserve. The surplus over what was immediately paid to seniors is used to purchase government bonds. This surplus is less than 15% of FICA revenue and will decline as baby boomers retire to receive Social Security.

Unfortunately the raising of FICA taxes to create a Baby Boom Reserve has been an enormous con game. It was instituted such that the reserve funds would substitute for raising taxes when baby boomers retire. Unfortunately, our congress has simply spent the money it received from the Baby Boom Reserve’s purchase of bonds. Thus the government will have to raise taxes to repay the Baby Boom Reserve funds when they are need. The result has not been to preclude raising taxes then. It has been to substitute the regressive FICA taxes for income taxes that would have been necessary to pay for the services supported by selling bonds to the Baby Boom Reserve funds. Our poorer members who pay FICA taxes on their first dollar of earnings subsidize our wealthier members who pay no FICA taxes on income above $90,000. The largest challenge for maintaining Social Security is the enormous federal debt which makes it more difficult to repay these funds.

#2. Social Security is like the purchase of a retirement insurance policy.

As noted above, FICA funds (except for the Baby Boomer Reserve) go directly to Social Security recipients. When present workers age enough to receive social security, what they will receive is indexed progressively to what they are paying in during their working years. But what they receive is not the same money they paid in. It will come from those who are working at that time.

Social Security is simply the pooling of money paid by working people and then distributing it to seniors. Social Security does not just provide an inflation adjusted annuity type payment to seniors. It also provides a disability benefit in case the worker is disabled, and a life insurance benefit in case the worker dies, leaving children. In the case of death, inflation adjusted payments are made to the children and their surviving parent until they become adults.

So to substitute private protection for social security, a person would have to buy a life insurance policy, a disability policy and a retirement income policy. For all but perhaps a few, these would cost much more than they are paying to support their seniors, with the expectation that their juniors will later support them

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#3. There are going to be too few workers to support Social Security for Baby Boomers.

Since shortly after Social Security was initiated, 4 workers have paid FICA taxes for every aged recipient. During the height of the Baby Boomer retirement cycle, this ratio will drop to 2 workers for every aged recipient, it will then increase again as the retired Baby Boomers are replaced by the following smaller generation. But the percentage of workers now in the labor force is now the largest it has been in history (due to increased participation by women) and is expected to stay large. As the percentage of retired seniors increases, the percentage of children is decreasing such that the percentage of total dependents remains the roughly the same. Working adults will be supporting more seniors, but fewer children. Paying for more retirement homes, but fewer schools.

In addition, there are many working age adults in North America to the South of us, who are and will continue migrating here. They may begin with lower wage jobs, but their wages will increase and as their children are educated and become workers, they will pay taxes to support Social Security during the Baby Boom years.

#4. Social Security is going broke. It won’t receive enough to pay its obligations.

Social Security payments (obligations) have continually changed since it was initiated. Social Security payments are currently indexed to increase as worker’s income increase. Thus as productivity enables workers to obtain a higher standard of living, retirees will also see their Social Security payments increase proportionately.

If changes were made to index Social Security payments to increasing inflation alone, then future retirees would receive Social Security proportional to maintain our present standard of living, but not the increased standard of living of workers then.

Using extremely pessimistic projections of our productivity (much less than our average during the last half century), the Baby Boomer Reserve is expected to be depleted in 30 years or so, at which point the revenues would only be 70% of what is needed to pay seniors proportionately to what workers are then earning. But this 70% would still be proportionate to what is needed to maintain our present standard of living. That is, Seniors could live as they now live, but not with a 50% higher standard of living that workers are projected to have then.

However if the productivity and the economy increase as they typically have for the last 50 years, there will be enough revenue to allow seniors to live as workers will. In all of this discussion, it must be remembered that social security is not meant to provide all of retirement income. So the standard of living of a specific retired family will depend as it does now on its other retirement resources.

#5. Funds invested in the stock market would yield much more than what seniors are projected to receive.

Except for the temporary build up of the Baby Boom Reserve, there is no money for investment. If productively and the economy increase as pessimistically as the assumptions cited above in projecting Social Security revenues, then the stock market will also do miserably, providing very low returns to investors. On the other hand, if the stock market what it has typically done over the last half century, it will be because productivity and the economy have increased enough that their will be plenty for Social Security, even enough to increase benefits or lower FICA taxes. This usage of two contradictory assumptions concerning productivity and economic increases, one for projecting future FICA revenues and the other for projecting stock market returns, is perhaps the most blatant deception of those who would destroy Social Security.

Also remember that to replace Social Security Benefits, one would have to not only invest money for retirement and convert it to an annuity upon retirement; it would also be necessary to buy a life insurance policy and a disability insurance policy, with benefits indexed to workers’ wage increases.

One factor that is never mentioned by advocates of privatizing social security is administrative costs. Social Security administrative costs are 1%. The administrative costs associated with investments are many times 1%, the costs associated with purchasing an annuity are high and the costs of purchasing insurance policies is an even higher percent. In addition the administrative costs to the government for tracking individual investments and distinguishing various types of investors and social security recipients would be very high.

The simplest way to increase the return on the money in the Baby Boomer Reserve is simply to raise the rates that the government pays on the bonds bought by the Baby Boomer Reserve.

#6. Social Security won’t exist when younger workers retire.

As has been shown above, Social Security doesn’t face challenges which would force it out of existence. At worst, benefits may be cut below keeping up with worker’s wage increases. More likely, it can continue to operate under present assumption. Ultimately social security depends upon political support from both workers and retirees. There will be more support for high benefits when a larger proportion of adults are retirees. When the proportion of adults who are retirees drops again (perhaps in the 2040’s), the costs to workers will decline and thus their motivation to cut benefits.