One More Time: Social Security

Now that the election is in full swing, the subject of Social Security will surely come up.  Those who want to be elected will swear that they will “protect” the Social Security system, although they are usually vague about how this will be done and no major changes have been made to the system since 1983.  The motive is to persuade seniors that voting for them will somehow guarantee a continued flow of checks.

Another sure way to pull ahead in the polls will be to accuse their opponents of characterizing Social Security as a “Ponzi Scheme” or (truthfully) telling Americans that it stands on shaky ground.  Seniors don’t want to hear this and would prefer to keep their head in the sand by voting for the candidate who helps them deny reality.

The reality most Americans don’t want to face is that the system is based on taxes, not on contributions.  Two arguments dominate.  The first is that it’s “my money” that has been held in some mysterious trust fund.  The second is that it’s a right and not an entitlement.  The first is wrong.  The second is mostly wrong.

Social Security was built on a faulty assumption that there would always be enough workers to support all retirees.  Since then America had a post-war baby boom and a major increase in life expectancy.  More people are retiring and they are living longer and collecting longer.

Previously, everyone paid into the system by the FICA tax.  Some of this money was immediately paid out to retirees.  The rest went into a trust fund for the future.  But in 2016 all of the money coming in is immediately being paid out, and that is not enough.  Money must be taken from the trust fund to make up the difference.  A retiree is not collecting his contributions from some personal account; the money is coming from today’s workers.

Is it really a Ponzi scheme?  No.  A Ponzi scheme is defined as “a fraudulent investment operation where the organization pays returns to its investors from new capital paid to the operators by new investors, rather than from profit earned through legitimate sources.”  Social Security is not a Ponzi scheme only because it is not fraudulent.  The government is upfront about the fact that older folks are paid by a direct transfer from the younger workers.  Otherwise it fits the definition.  Not enough profit/interest is earned to cover current obligations.  It is clearly not anyone’s invested money coming back to him or her.

Some then characterize it as an entitlement.  Is it an entitlement?  No, again.  As I explained in February 2013, an entitlement requires a legal obligation to pay a certain benefit at a given time, but the government states in one of their actuarial notes that it is not technically a liability because there is no such legal obligation.   Since no contractual or legal obligation exists for paying full scheduled benefits on time once the trust fund reserves are depleted, it doesn’t fit the definition of an entitlement.  (But I don’t think that’s the explanation most people hoped to hear.)

But what of the trust fund?  The results of my research in February of this year showed that the government also has its own definition of a Trust Fund with more flexibility than anyone would ordinarily expect. They can change the rules whenever they want to and have done so many times in the past (usually to retirees’ advantage, but that doesn’t mean it couldn’t go the other way).

Finally, this recent article tells how most retirees regret their decision about when to collect benefits.  The swing between early collection and waiting until age 70 is from 75% to 132%.  About a quarter wish they had waited longer.   How will they feel when the trust fund is depleted (estimated about 15 years from now) and the payout must be reduced to only the amount covered by current “contributions”? 

Not to worry – the politicians who have not had the courage to address the looming problem for the last 30 years will undoubtedly come up with a solution that keeps voters happy and drives the country further into debt.  That’s the way they “solve” problems in Washington, until they run out of money.