Social Security
by David H Dennis

For years and years, all we've heard is that the American Social Security system is in crisis. But, unless you read between the lines pretty closely, it's easy to misunderstand this often confusing and technical subject.

So how serious is the situation, really? After all, you've probably gotten the news from someone with a pretty hefty axe to grind. Conservative lobbying groups like the Cato Institute get much of their money from banks, mutual funds and other institutions that would greatly benefit from Social Security privatization. On the other side of the political spectrum, Mother Jones never met a government program it wouldn't defend to the death. Even mainstream publications like Time and Newsweek get much of their information from third parties with a stake in the system or its destruction.

I work for no securities firm, I gain no commission from trades, I will not get rich if any form of Social Security reform is passed. I work for no government; I labour in no dank and dangerous government office; I will not get poor if Social Security reform is passed. And, other than my fate as an involuntary participant in the program, I have no axe to grind. In other words, in writing this essay, I'm in search of the truth, and have no greater motivation than to give it to you.

But it won't be easy.

How does Social Security Work?

Social Security advocates start with a truly grim disadvantage: The program has been tremendously oversold to the American public. Many people, in fact, think the only retirement program they need is Social Security.

They couldn't be more wrong. Even Social Security's strongest advocates think of it as a "Social Program" that's designed to supplement your retirement income and make sure you have a certain minimum income you can count on come retirement. Unfortunately, this minimum income is pretty minimal, and the cost of providing it is crippling. In a nutshell, that's the main argument against Social Security: It's a rotten deal that you would never voluntarily agree to if you knew all the facts.

For many decades, Social Security's literature had a simple explanation of itself, as quoted in Milton Friedman's Free to Choose. It went like this: The money you pay into Social Security is collected into a trust fund, and benefits are paid to you out of those savings when you become disabled or retire.

If this was actually the way Social Security worked, there would be no Social Security crisis. The problem is that the program would have been politically untenable if people didn't start getting benefits almost immediately after the program started. As of the late 70s and early 80s, what happened was straightforward and particularly dangerous: The money that got paid into Social Security went straight to current retirees. The Trust Funds had a negligible amount of money in them, as I recall only enough to run the system for a few months.

Now, oddly enough, this kind of finagling can create good returns for participants - but only when the population is steadily growing. Throughout the 50s and 60s, the working population grew steadily, enabling Social Security to keep taxes down to a reasonable level, while increasing benefits for present retirees.

Unfortunately, the generation of the Baby Boom decided they weren't totally thrilled by the prospect of having lots of kids. To make matters worse, starting in the 50s and 60s, dramatic medical advances began that enabled us to live longer and longer, thus putting a massive hole in Social Security's calculations. In a few years, when the baby boomers (those born in the 50s and early 60s) retire, their successor generation will not have enough people to support the system at the present level of taxes and benefits.

If you're familiar with chain letters and multi-level marketing schemes, you may notice a certain commonality. Everything works just fine and dandy until you run out of participants. Then, the whole thing collapses, bringing down a lot of people who put in a lot of money in good faith. That's why chain letters such as Make Money Fast are illegal. If the identical package to Social Security was proposed by a private entity, it would be too. Using future participants to pay off current debt is a scam that's as old as the hills - and that's precisely what Social Security does.

People in the government, including former Senator Bob Dole, started to realize that something was going wrong. Social Security Commissions were created, and the end result was a classic prop-up. Instead of trying to solve the problem now, they did some minor tinkering with the system to postpone disaster.

What they did was to put together a real trust fund, invested in government bonds, in which they would put surplus money siphoned off from the Social Security taxes. As a result, there is now some truth in the statement that Social Security is saving some of your money for you. But still not nearly enough to avert catastrophe. And Social Security taxes, which fall disproportionately on the poor, are higher than ever.

So what's the end result of this? Instead of running out of money in 2012 - and bear in mind that's just 16 years from now, an eyeblink by demographic standards - the system will start losing money and drawing on the current trust funds. The trust funds will run out about 16 years later, in 2029. (Of course last year, the identical report said they would run out in 2030. So the trend looks pretty lousy). The odds are pretty good that, if you're reading this, you're likely to retire around then. Or at least want to.

The Mother Jones article points out that "minor changes" can be made in the program to ensure its solvency for the next 75 years. Did you notice that interesting trick? The Mother Jones "cure" cannot ensure its solvency for all time, it can just push the future back a few more years. True, the author of this article will most likely be dead by then - but I still wouldn't call that a solution. I'd call it another cynical prop-up. And what do we have to do for this miracle cure? Increase Social Security taxes by 17%, and all will be well. That is, tack on 1.1% to the employer's 6.2%, and 1.1% to the employee's 6.2%, and the system will be saved for a while longer. That's one massive tax increase, by anyone's standard. [1]

What sort of alternatives are there?

Because the ultimate fate of Social Security looks so dire, increasing attention has been given to ways to make the system work. Most of them focus on either privatization or making the system more investment oriented.

Privatization is a simple concept: Instead of having the government take and manage your money, you manage your own retirement account, like an IRA. Instead of taking your SS tax money and handing it to them, you hand it to an investment company which you select. You can then decide what mix of stocks, bonds, mutual funds and other investments you can use to save for your retirement. Your retirement funds become your own, not the government's. A little later, we discuss exactly what this might mean for you financially, but the bottom line is that you could save substantially less than you have to pay in Social Security taxes now, and still be far better off.

The main argument against privatization is that many people aren't sophisticated enough to handle their own money. That sounds like a horribly condescending statement, doesn't it? Unfortunately, there has been a long and tragic procession of financial hitmen who have preyed on the hapless and the dumb. As long as Social Security exists, we're all gypped equally. If all our investment decisions became private, some of us will be gypped even worse. Others will make millions.

Fortunately, there are some excellent indications that financial sophistication is on the rise. You really can't go wrong with most of the available mutual funds, for example. And there are amazing resources that rank and evaluate mutual funds, many of which are available free on the web. I believe very strongly that people should take charge of their own financial futures, but they should select fairly conventional pooled investment options, such as mutual funds, unless their own research convinces them. Never let a salesman talk you into doing something without carefully researching it yourself!

So if we privatize Social Security, what can we do about those who are collecting benefits now? We can't leave them to starve on the street, can we?

The most common response to this is not to privatize all of Social Security, but just the amounts we're presently collecting beyond those that finance current retirees. For instance, we might set a cutoff date for the system, say at age 40. Those over 40 should pay SS taxes and get SS retirement. Those under 40, who would be far better off without SS, should be given the option to opt out of the program.

However, there is one radical proposal that is by far the best I've ever seen. Harry Browne, Libertarian Presidential Candidate, proposes in his book that we should sell off some of the billions of dollars in public lands and other assets we presently hold, and use the proceeds to finance the remaining Social Security beneficiaries. Much of this is sparse grazing land that the Bureau of Land Management leases out at incredibly low rates to ranchers to graze cattle. Other public lands include massive forests which we lease out to loggers - again, at killer rates. Selling off these lands would not only let us collect substantial amounts of money, it would be good for the environment, too.

If we didn't privatize, though, what are the alternatives? All of them boil down to a simple thing: Acknowledging that, although Social Security is a terrible deal, our government simply can't afford it anymore. In other words, we have to make the deal worse so that it can survive at all. Here are a few examples of things being proposed to "fix" the program:

As you can see, however innocuous and reasonable these changes might look, all they really do is reduce your return on investment to an even more pathetic level. For example, raising the retirement age from 65 to 70 is like pulling $ 84,000 ($ 1,400 x 12 months x 5 years) out of your pocket.

How should Social Security be judged?

One strange thing about the arguments surrounding Social Security privatization is that the two sides really don't seem to be speaking to each other. Indeed, it feels like they are talking about two completely different things!

If Social Security is judged as the Left wants it to, it can be thought of as a phenomenal success. To them, Social Security is a social programme, a way of protecting people from destitution in retirement. Retirees who would be out on the street starving are now able to live their last years with dignity. Furthermore, privatizing Social Security would be less efficient (those dingy Social Security offices present an overhead of only about 1% of benefits paid) and would throw people to the wolves of "investment advisors" who advertised the latest investment vehicle with the 45% commission.

Oddly enough, in the 1930s, Social Security was not an expensive program. Why? Almost nobody lived long enough to take advantage of it! In fact, a recent article in the Wall Street Journal accuses the program of being racist. Why? Blacks in the 1930s rarely made it to 65, and so they would pay into the system without much hope of ever getting anything back. Whites had a life expectancy of a hair over 67, so they would make a little. If we wanted to continue Social Security as a social program with low expenses, continuing the spirit of the 1930s program, the present retirement age should have been raised to about 80. Few people live beyond that age, and so few checks would be written out. Due to the high political power of senior citizens, few would dispute the unliklihood of such a move.

My friend Heather Ann[2] pointed out another interesting fact: Social Security is biased heavily against the poor, despite the advertisement that it's a redistributory program. The poor tend to start working at an early age, instead of going to school, and yet they still have to wait until the same age as anyone else to retire. So the rich work from about 25 to 65, while the poor work from 18 to 65. That's a lot more working years, and a lot more payments into Social Security. And, worse yet, the poor live shorter lives, and so they are less likely to collect at all.

So, as we can see, an analysis of Social Security from the perspective of the left is likely to find it wanting in many respects. However, publications of the left have a curious reverence for the program, probably because it's one of the few things government does that the people generally respect. They fear that, if Social Security is shown out for what it is, cynicism of government will become even stronger than it is now, and that will harm pretty much everything government does. It certainly coloured my own political judgement; I really had no politics until I found out about the Social Security crisis. Once I understood it, I thought of it as not just a bad program, but a betrayal. And that, understandably, made me a "Government can do no right" Libertarian. I have a feeling that many people will follow similar paths in the near future.

And that brings us to the rightist analysis, which is even more damning than the analysis from the left.

If Social Security is judged as the Right wants to, it is nothing short of catastrophic, at least for people who are presently working. The Right judges Social Security as an investment scheme, and if we judge it under the harsh lens of financial returns, the results are not just poor - they are horrifying, disgraceful.

How bad? Plug your own figures into this simple calculator[3] and find out. Just in case you want to stick around here for a while (this link is also at the end of the document), if I was born in April 1962 (as I was), and I earned an average of $ 30k a year (which is about the national average income), my Social Security benefit would be $ 1,417 a month. If I took the money "invested" in Social Security taxes and placed it at 8% (the approximate average annual rate of return for stocks), I would have investments worth $ 7,473 a month. As you might imagine, things get even worse at high income levels.

As you can see, it would take a lot of inefficiency on the part of private investment companies to swallow up the difference in return between $ 1,417 a month and $ 7,473. Oops, I forgot something. When you died, the money that earned that $ 7,473 a month would still be there - over a million dollars for your heirs. Under Social Security, I believe you get a $ 255 death benefit. How generous of them.

To make matters worse, as we have already discussed, the $ 1,417 the government is promising us today is unlikely to be the amount we'll actually receive, because the system is likely to go through several more earthquakes, with substantially reduced benefits every time.

Advocates of Social Security will strike back and say that the 8% average after inflation average return might decline. Or you might see negative returns for some years. Or you might invest in something really stupid that lost most of its value, and be worse off.

That's a fine argument, and one that should make you properly cautious as you make your investment plans for the future. Any good financial advisor will explain how you should diversify your investments, to minimize your risks of loss in any one stock, bond or other investment. And you should listen to that advisor, or do your homework in other ways.

So Social Security advocates come back and say: "Look, there are limits to growth, the economy might shrink to next to nothing, and with Social Security, you still have your benefits."

Do you? Social Security, through its basic "live for today" system of taking money from present workers to pay current retirees, is highly dependent on the US economy continuing to do reasonably well. If the US economy crashes sufficiently to make returns on a good diversified investment portfolio go down the tubes, the Government's income from Social Security taxes will crash, too. And by now I'm sure you realize what that means: The government will be unable to keep its promises, just as it's breaking them now.

The Bottom Line

There is no security in this world, and what looks like security is an illusion, pure and simple. The only good thing about Social Security is that you know you'll get something for your retirement. It could only be a dollar a month, but it would be something. The odds of an unprivatized Social Security giving you adequate value for your Social Security taxes are precisely zero.

Many of you know the story of Charles Keating, head of Lincoln Savings. His S&L took money from innocent depositors, put it into dicey projects, and lost virtually every dime. Now, you wouldn't think that people would keep investing with him, even after he lost most of their money, right?

When it comes to Social Security, all I want is a chance to behave just as I would if I'd invested in Mr Keating: Cut my losses and invest in something that might actually give me a positive return on my money. As it is, Social Security is financial rape: The equivalent of being forced to invest with Mr Keating, even after knowing you're not likely to see a single dime back from him when the time comes.

To me, that's a tragic situation that's being forced on us by our own government, acting as traitor. I say we shouldn't have to take it anymore. What do you say?

Notes & Links

[1] Reference: The End of Social Security as we know it?, Mother Jones.

Perceptive individuals who take the time to read that article will note a common Mother Jones characteristic - they're attacking the people, not the concept. They don't waste any time trying to rebut the basic premise that Social Security is a lousy deal for retirees. They probably realize that battle is hopeless. Rather, they take for granted that you will feel Social Security reform is bad simply because the people driving it politically are businessmen who could make big profits from its privatization. Therefore, their opinions are suspect. Unfortunately, the truth of this doesn't make Social Security good, or the businessmens' solution bad. It just means that you, in trying to make up your mind about the issue, should check out this and other essays written by people who don't have any institutional stake in the outcome.

Relevent excerpt:

These analyses ignore the basic fact that, with minor fixes, Social Security can remain solid far into the next century. "There's no crisis," says Robert Ball, a former commissioner of Social Security and spokesman of the liberal wing of the Social Security Advisory Council, a 13-member panel appointed by Clinton in 1994. If no adjustments are made, Social Security could continue to finance benefits at only 75 percent of the current level after the trust funds are depleted in 2030. But with a few adjustments -- such as changing cost-of-living calculations, raising the retirement age, increasing taxes on individuals when their benefits exceed what they paid in, and/or bringing new workers into the system (e.g., state and local employees who have separate pensions) -- the Social Security system can continue to pay full benefits for the next 75 years. Or by imposing a relatively small tax increase now -- boosting the share that employers and employees pay from 6.2 to 7.3 percent -- the government could solve the problem all at once, say analysts.

[2] Heather Ann contributed to the ideas in this essay. She has a fun and frivolous home page; visit it once you're sick of reading cold, uncomfortable Social Security facts.

[3] Americans for Tax Reform Social Security Calculator

A more carefully designed (but time-consuming to load) calculator is available at the Cato Institute's Social Security web site. It was designed and coded by KPMG, a major accounting firm.

The creator of the Chilean Social Security Privatization explains how they managed the process.

David H Dennis
Last modified: Fri May 30 16:21:40 PDT 1997