NationStates Jolt Archive


Social Security explained

Impedance
09-05-2007, 07:51
I'm getting pretty sick of people on here who completely misunderstand how the Social Security system works. So what follows is an explanation of the facts: The first generation of retirees to benefit from social security got a fabulous deal - they had not paid into the system during their working lives, they could not have because the system didn't exist until then. But they got the benefits anyway.

Subsequent generations misunderstood the system, thinking of their social security payments as "investments". In reality, they are nothing of the sort. They are (and have always been) a tax - quite literally in fact, social security is funded through the payroll tax. It's not your money that you get back - just like the first generation of beneficiaries - they didn't pay anything in, so it couldn't be their money they got back.

So where did the money come from to pay the benefits to the first generation? Yep, that's right, from the payroll tax. Social security is "pay-as-you-go": taxes collected this year are used this year to pay benefits. This is how it has always worked. To view your payments as "investments" is just plain wrong - they are not.

This is why the Bush Administration plan for privatising social security (allowing current workers to divert their payments into private retirement accounts) would never have worked. In fact, had it been implemented, it would have rapidly bankrupted the entire system. Why? Because diverting current revenue into private accounts means it cannot be used to pay benefits to current retirees - that money therefore has to be found elsewhere - a problem that Bush has "solved" with magic asterisks - IE. He doesn't know how.

Of course the system wouldn't die overnight, because social security does have a trust fund. Now why is this? Why should a "pay-as-you-go" system need a trust fund? The answer is to be found in the looming demographic crisis. Known as the "pig in the python", the demographic crisis is a result of the baby boomer generation, creating a huge bulge in an otherwise skinny age distribution. Simply put, the ratio of retirees to workers is going to narrow sharply - right now, there are roughly 3.4 workers for every retiree. Come 2030, there will be only 2 workers for every retiree. So if the system remained purely "pay-as-you-go", then either taxes would have to rise considerably, or benefits would have to be drastically cut. Projections indicate that as of 2016, benefit payments will start to exceed payroll tax receipts.

The trust fund goes a long way towards solving this problem. It's not like the problem wasn't forseen either. Back in 1983, Congress raised the payroll tax by 2%, generating a social security surplus. This surplus, since then, has been invested in a massive trust fund - in an attempt to buffer the system, to ensure that benefits won't need to be cut much (if at all) and that the payroll tax won't have to increase again (hopefully). Thanks to the trust fund, the system can run untroubled until at least 2037. Affordable injections of money could extend the day of reckoning until 2050 - or further still.

So what was the trust fund invested in then? Well, some of it was invested in stocks and corporate bonds, but the vast majority ($1.2 trillion) was invested in US Government bonds. Why? Because government bonds were (and still are) considered the most secure form of investment. In principle, anyone can buy a government bond. Lots of private banks invest in them. Lots of international banks and investment funds also invest in them. So investing the social security surplus in them seemed like a good idea.

It was a good idea, but what we didn't bank on (and couldn't realistically have predicted) was the Commission on social security reform (appointed by the Bush Administration back in 2001) claiming that US government bonds are "not a real investment" when accumulated by a government agency. No, I'm afraid I'm not making this up. The same commission happily admits that government bonds are perfectly good assets when accumulated by private pension funds, but are apparently "worthless" when accumulated by a government agency such as social security. No, this doesn't make any sense to me either. It makes even less sense when you learn that the chairman of said commission, Senator Daniel Patrick Moynihan, was one of the people who pushed for the payroll tax increase in 1983 that generated the trust fund in the first place. Here's an idea: Let's launder the trust fund by putting it in private banks, who will then buy US government bonds. Will that make the assets "real"?

But Ok then, this is a mad world, so let's entertain the madness for a while and see what happens. If the trust fund isn't "real", then the surplus becomes a deficit. How big is this deficit going to be? The Comission says 37% of payroll tax receipts. This is about 2% of GDP. Interestingly (and I'm sure this is purely a coincidence), the Bush tax cut, when fully phased in, will reduce government revenues by about 1.7% of GDP. Do you begin to see what's going on here? Were supposed to believe that the social security "defecit" (which isn't a deficit at all if the government is honest about it) is an "insupportable burden on the budget" if it's an obligation to retirees. But the Bush tax cut, which will cost almost as much, is a "modest sum". So which is it?

Some people also seem to think that the "pay-as-you-go" nature of the social security system constitutes a Ponzi (or pyramid) scheme. I agree that there are similarities, but only if you consider your social security payments to be "investments", which as I've already said, they aren't. A Ponzi scheme is a deliberate stock market fraud, engineered by bogus "entrepreneurs" to con people out of their investments - eventually the scheme implodes and the money is all gone. It relies on conning enough new investors to pay off the old ones. Social Security might look like the same thing on paper - but it isn't. Firstly, it doesn't try and make a "profit" for past "investors". Secondly, the supply of new "investors" isn't going to run out. But most importantly the payments to retirees are legally guaranteed by the government, backed up by a dedicated tax and a huge surplus trust fund.

So the social security system isn't really in "crisis" for any good reason. Either the Commission on social security reform can start being honest and admit that the trust fund does exist and it's assets are real, or failing that, the Bush Administration can renege on it's tax-cutting agenda in order to make up for the "deficit".

References:

Paul Krugman (columnist), New York Times, July 22nd, 2001
Paul Krugman (columnist), New York Times, November 5th, 2000
Paul Krugman (columnits), New York Times, July 25th, 2001
Greater Valia
09-05-2007, 07:54
Horrible formatting.
Impedance
09-05-2007, 07:59
Fixed. Sorry, don't know how that happened in the first place.