Friday, April 2, 2010

End It, Don't Mend It.

On Sunday, March 28, 2010, Florida State Governor Charlie Crist debated Speaker of the House Marco Rubio on Fox News Sunday. Both are running in a GOP primary for the U.S. Senate. One of the more interesting moments in the debate occurred when Chris Wallace explored differences in opinion between the 53-year-old Crist and the 39-year-old Rubio on Social Security. Governor Crist gave the standard answer of, “we have to preserve Social Security,” meaning no changes can be made in the program even though it is about to implode. However, with rare candor, Speaker Rubio endorsed the position that Social Security, as it exists, is not sustainable and that reform is necessary. In his discussion, Speaker Rubio included the possibility that retirement ages may need to be raised and/or cost of living adjustments decreased to make Social Security solvent. He endorsed Congressman Paul Ryan’s (R-WI), “road map” for Social Security reform, which also includes allowing younger workers to opt out of Social Security and in to personal retirement accounts. Congressman Ryan appeared the previous Thursday (March 26, 2010) on Fox Business Channel’s Stossel as part of a discussion about the growing threat of federal entitlements. Currently, spending on Medicare and Social Security account for 50% of the federal budget and that percentage will continue to rise if reforms (and cuts) are not made. Without serious alterations to the programs, the spending obligations will become unsustainable (and squeeze out federal spending for anything else). For too long, most Americans have viewed the federal debt as, “just a number,” but the debt crisis in Greece should remind us all that there is a breaking point. Arguing for the status quo and stating that these programs (Social Security and Medicare) have to be preserved for future generations, was a representative of the AARP (American Association of Retired Persons). Of course, maintaining the status quo essentially guarantees that these programs will not be there for future generations.

Like Speaker Rubio, Congressman Ryan (age 40) is also a member of Generation X. The generational divide on this issue is stunning, with the AARP and the grey-haired Governor Crist arguing for, “preservation,” of Social Security as it is and the younger generation that sees the proverbial writing on the wall and knowing that, without significant changes, the program is unsustainable. Speaker Rubio and Congressman Ryan argue for serious reforms to make Social Security solvent for future generations and these reforms would fundamentally change how we think about Social Security. Although Medicare faces larger looming short falls and represents a greater burden on future federal spending, it is harder to argue that some measure to provide health insurance for elderly persons who may be too high an insurance risk to obtain it privately. On the other hand, for most Americans, government help in retirement planning is both unnecessary and provides a lower return on the money, “invested,” than one could achieve investing the same sum on his or her own. Furthermore, the payment structure of Social Security is unsound economically and the funding source for Social Security is immoral. Speaker Rubio and Congressman Ryan have it wrong. Social Security should not be mended, it should be ended.


When the Social Security Act was passed in 1935, the program was designed not to be a welfare program for those who could not afford to plan their own retirement, but rather as an entitlement for all Americans, regardless of means, to assist with their retirement. Ostensibly money is taken from your paycheck, which your employer matches (just like with your 401K), it is placed into some sort of trust fund, retirement account, or, as Vice President Gore might say, “lock box,” for you until you retire and receive benefits upon retirement. That sounds nice. It is a program for working Americans, not welfare. They benefits paid out to you in retirement are from the money you paid in while working. It is not a government give-away, but rather something the individual has earned.

Unfortunately, Social Security does not actually work that way. The revenue from Social Security taxes (both the employee payroll tax and the employer matching) go into a general fund. That fund is not invested or put into a savings account somewhere, but rather it is used to pay current retirees Social Security benefits. In other words, the money that is taken from you as a worker in the payroll tax is given to someone who is currently retired, not put away and saved for you. When there has been surplus in the Social Security revenues (more is taken in by the payroll tax than is needed to pay retiree benefits), that money has not been saved or invested to bolster the solvency of the program. Rather, it has been applied to the general revenue as a way of lowering the federal budget deficit (or to be spent on other things). In fact, of the years in the mid 1990’s when the federal budget was balanced or ran a surplus, there would have been a deficit in all of them except one had the Social Security surplus money not been applied to the general budget revenue.

Such a system can be sustained for as long as there are more workers than retirees. However, the number of retirees is increasing. The largest generation in the history of the United States, the baby boomers, is now hitting retirement age. Taxpayers are eligible for full retirement benefits at the age of 65 (now 67 for those born after 1960), but can collect reduced benefits as early as age 62. The average life expectancy in 1935, when the Social Security Act was passed, was 62. The average life expectancy is now 78. Not only are the ranks of the retirees about to swell with new retirees, but the current retirees are living longer. In 1935, many people did not live to collect Social Security and those that did only collected it for only a few years. Now most retirees collect Social Security for at least ten or fifteen years and some for as long as twenty. During the period of Social Security surpluses in the mid 1990’s, there were five workers for every retiree (and of course all of the baby boomers were in the work force then). That number is now three and shrinking. It is apparent why such a payment structure is economically unsustainable: since revenue from current workers is required to pay current benefits, the ability to pay promised benefits disappears as the number of workers per retiree dwindles (and this year, for the first time, Social Security is taking in less money than it is obligated to pay out). There is a term for taking money from one group and using it to pay profits or benefits to another group rather than investing it for the benefit of the person the money came from. It is called a Ponzi scheme. Bernie Madoff went to jail for doing exactly what the federal government is doing with your Social Security contributions.


Aside from the inherent immorality of a Ponzi scheme, Social Security is financed with an immoral revenue system. Social Security is a paid for by a payroll tax (yes, your employer matches what you pay, but who really believes this does not come out of what you could be making?). The payroll tax is a flat tax of 7%. It is interesting that the political left was adamantly opposed to a payroll tax holiday as an economic stimulus and yet equally adamantly opposes a similar tax for the federal income tax. You cannot have a flat income tax rate, they argue. It is unfair and regressive. It is a greater burden to those that have less and those that make more should share a larger percentage of their income with the public (pay a higher tax rate) because that still leaves them with plenty. Yet, this is exactly how we pay for Social Security. The billionaire pays the payroll tax on his own earnings at the same flat rate as the person making $20,000 per year. However, the Social Security tax is even less fair than a flat income tax. One could argue a flat income tax is fair because everyone pays the same proportion of his or her income. But the payroll tax is only levied on wages and salary. Income from investments (interest earnings, stock dividends, etc.) is completely exempt from the payroll tax. It is not a true flat tax, but rather it is the Steve Forbes flat tax (Forbes ran for President in 1996 on the flat tax and was accused of serving his own interest as a wealthy person because his flat tax also exempted income from investments and applied only to wages and salary). So, the hypothetical wage earner making $20,000 pays 7% of his entire income in Social Security tax, whereas someone who makes $50,000 in salary and another $50,000 from investment income pays only 3.5% of his or her earnings in Social Security tax. This further shifts the burden of the tax to poorer individuals. Furthermore, the payroll tax is only levied on the first $109,000 of salary. This means someone who has a salary of $1 million per year pays only about 0.7% of his or her income in Social Security tax (and considerably less if that person has other investment income). Social Security is paid for by an unfair, regressive tax, which is far more burdensome to those of low and middle incomes than it is to the wealthy.

Ostensibly, Social Security exists to help those who have limited means have more security in their retirement. However, when the program was created there was concern that the public might not support another program of welfare for the impoverished and therefore it was created as an entitlement for everyone, to insure everyone’s retirement security. For this reason, it was sold as a retirement account that you pay into and reap benefits from latter as if your money was being invested for you or kept for you. As noted above, this is not the case. However, to maintain this charade, Social Security benefit payments are proportional to the amount one pays in while working. Therefore, the benefit payments are higher for people who made more money while working and lower for those who had lower incomes. Anyone making $109,000 per year (provided that all of the initial $109,000 is wage earning) or more receives maximum benefit payments in retirement, but the person making $20,000 per year will get a much smaller Social Security cheque. Furthermore, the wealthy can and will, on average, retire at an earlier age and therefore collect Social Security for longer. A lower income person may not be able to afford to retire at the age of 65, may have to work for longer, and therefore will not start collecting his or her Social Security until later.

Putting the tax and benefits structures together, what we have is a tax that is born mostly by those of lower incomes to pay benefits that go in greater proportion to those of higher incomes. The Social Security entitlement represents an immoral transfer of wealth from the working poor to the more affluent.


Social Security has often been called the, “third rail,” of American politics and the suggestion that is should be reformed, changed, or abolished is often the death knell for a political candidate’s campaign (i.e. Barry Goldwater, Paul Tsongas). However, on close inspection, the program is unjustifiable. It is a Ponzi scheme that is about to become insolvent and represents a transfer of wealth from the poor to the affluent. Furthermore, it does not even represent a good investment. One could do as well with a savings account or purchasing a life insurance policy. One could do better, easily, with a modest investment portfolio. Despite recent volatility in the stock market, it represents a sound strategy for long term (decade or multi-decade) investments that can be converted to safer investments closer to retirement age. If workers could invest the 7% of their income taken in the payroll tax, they could have a much higher return on their investment (particularly if they also got paid the 7% of their income their employer matches in the payroll tax). Finally, there is simply no justification for the federal government to aid in providing retirement benefits for people who have the means to plan for their own retirement.

There are a number of proposals, opposed by demagogues committed to maintaining the unsustainable status quo in a cynical (and usually successful) ploy to garner votes in the short-term, to restore the solvency of Social Security and make it sustainable. These include ideas like raising the retirement age (to match the increase in life expectancy), means testing benefits (which would minimize the transfer of money to the wealthy), raising the amount of income that is taxed by the payroll tax, and reducing benefits (such as reducing the amount of inflation-triggered cost of living adjustments). Any or all of these might improve some of the problems identified above, but none of them change the fundamentally immoral nature of the program, or guarantee it will remain solvent in the long-term, as it will remain a Ponzi scheme.

Social Security should not be tweaked or mended. It should be eliminated. A welfare program to assist with the retirement needs of the working poor and a separate program of federal disability insurance can rise from its ashes, but these should be paid for from the general tax revenue and remain on budget, not paid for by some sort of trust fund chimera. Social Security commitments to current retirees and individuals nearing retirement (say 55 and older) should be kept, but younger workers with the means to save should be made to plan for their own retirement. The program should be replaced with personal retirement accounts that each individual owns. His or her own investments, grown over time, will then provide for his or her retirement. If there are concerns that such a strategy is “too risky,” or, “people won’t do it,” then contributions to such accounts could be mandatory and the federal government could regulate the accounts, setting standards for safer investment strategies (although, personally, I would favour allowing more individual freedom). There are better ways to assist Americans with retirement planning than this unworkable relic of the New Deal.