Social Security Primer

Every now and then we like to do things nice and easy; somehow, we never, ever seem to do nothing, completely, nice…and easy…. And we like to do it nice and rough.

Tina Turner singing Proud Mary

I wish I could find a way to do this nice and easy; I don’t know how; the facts are rough.  Many of you won’t accept this at first, if ever.

The social security system we have in the United States is part of a historical phenomenon that swept through Europe, North America and prosperous nations everywhere.  Examining the system’s origins and traits in a neutral light can lead to a less emotionally-charged debate and consideration of changes that might be made.  Herewith is an unbiased description of the program without any indication of the author’s opinion that the social security system should be repealed and replaced.

“Social Security” as we know it in the United States is a government-run pension for the elderly paid for by taxes on workers and employers.  It didn’t begin here; rather, it began with Kaiser Wilhelm and Chancellor Otto von Bismarck in 1889 Germany.  Some say they were motivated to buy peace with a block of German voters by granting them a pension plan in exchange for their acquiescence to an authoritarian government.  Whatever the motivation, the program began as assistance to the elderly provided by the government and financed through taxes on workers, businesses and general tax revenue of the government.

There were several other nations that enacted old age pension plans prior to the United States.  One was Chile, which adopted its program in 1925, ten years before the United States.  Old age pension systems spread to prosperous nations all over the globe, as well as some not so prosperous nations such as Chile and Russia.  How much the system pays in benefits is related to how rich the nation is because a nation cannot long pay benefits in excess of its own wealth; there is just no way to keep the revenue coming in to pay for generous benefits when the nation is poor.

Russia is a dramatic illustration of a poor nation that attempted to provide benefits that are more generous than its small economy could afford.  There probably isn’t enough wealth in the entire land to pay the promised benefits.  The government has “cut” benefits through indirect rather than direct means, such as delaying checks for long periods and then paying the beneficiaries with an inflation-ravaged currency.

The old age pension systems go under various names and they all began with payments to the elderly financed by taxes on everyone else.  We might not initially recognize an “old age” pension system as the same as our “Social Security” system and the Japanese might not recognize their system as conceptually the same as ours, but all these systems have common origins. In the U.S. we have superimposed numerous features on the program, such as provisions for disability and death benefits.  There is a means-tested component to the U.S. system that was added relatively recently, called “SSI” for Supplemental Security Income.  SSI pays benefits to low-income persons only.

Two recent, and humongous additions are Medicare and Medicaid.  Medicare provides healthcare benefits to the elderly and Medicaid provides such benefits to low-income people.  They aren’t strictly part of the social security retirement program but are so closely intertwined with it that they are at least siblings.

President Roosevelt, with a little help from Congress, enacted Social Security in 1935.  Some Republicans argued the program was actuarially unsound and voted against it.  The benefits in those days were small by today’s standards.  Dollars paid in the 1930’s were worth a lot more than today’s dollars, but even after taking away inflation the benefits were less than today.  Yet, the program provided immense benefits to the early recipients in one respect; they got a lot more out of it than they paid into it.

Ida Mae Fuller was the first recipient of Social Security.  She and her employer paid $24.75 to the system during the three years before her retirement in 1940 and she collected $22,889 during the next 35 years (Citation: Michael Cannon, “Common Sense, Common Dreams,” Cato Institute; Wikipedia).  Was this just an example of “good luck” similar to what can happen with a life insurance policy?  For example, someone who buys life insurance one day and dies the next can be said to have had good luck with respect to the insurance company.  The Social Security system is not good luck in this sense.  Ida Mae Fuller received an immense subsidy from taxpayers.  No insurance company would have sold such an annuity to a person three years from retirement for $24.75.  Her subsidy was larger than some because she lived to 100.

Ms. Fuller was not an exception; most recipients in those days received a HUGE subsidy paid for not by proceeds or earnings from their “contributions” but by working persons. I place “contributions” in quotes because the government calls your Social Security taxes “contributions” instead of what they really are; taxes.  For two generations retirees received, on average, huge subsidies compared to what they paid in to the system.

There are exceptions to this generalization because some groups did NOT receive subsidies, but paid in more than they received; Blacks are a prominent example.  Why?  Because the longevity of Blacks was so much less than Whites.  Blacks did not collect, on average, what they paid into the system.  That was true then and is true today.

Why did I say above that the subsidies lasted for two generations?  Because approximately 50 years after the program commenced people began receiving much less than what they would have received had they been able to invest the money in conservative investments.  Different economists calculate this in different ways so there is no exact date when Social Security turned from generally being a subsidy to being a net loss for most people.

How can that be, when benefits were often increased by subsequent Congresses and when benefits were eventually indexed to increase with inflation?  The reason isn’t that the benefits declined over the years; in fact, they increased even in real dollar terms.  What has increased at a much faster rate are taxes.  So today people do not, on average, receive a good deal from Social Security because the increase in taxes over the years vastly exceeds the increase in benefits.

I have read that the average person retiring today will receive Social Security in the amount of 2% more than inflation.  That is, if the person had been able to invest his or her own money, as in a 401(k), the Social Security payout would be equal to an average yearly 2% real dollar return on the person’s investments in the 401(k).  If the individual had been able to control his own money and invest it, a very conservative yield would have been twice that.  In other words, if I had been able to invest my Social Security taxes myself, I would receive at least twice what Social Security provides me.

For today’s young people, the projections are that AT BEST the average person will receive no additional real dollar return on his or her Social Security taxes.  That is, the taxes, had they been invested for the individual, will be as if they simply stayed even with inflation but no more than that.

Think of that; young people today will receive no real dollar increase on their taxes when Social Security pays them, meaning their ‘contributions’ will have gained nothing in real dollar terms even after 40+ years of work.

Social Security is a “pay as you go” system, meaning that money paid into it by working taxpayers and their employers is paid out to beneficiaries shortly after the government receives the money.  Ida Mae Fuller didn’t receive her windfall because her taxes were invested in productive assets.  She received the money because many working taxpayers were paying into the system after she retired.

There is a type of investment that has probably existed almost as long as prostitution and politicians; it is called a “pyramid scheme.”  The promoter takes in a few investors for a payment, of e.g. $10 each and then pays a handsome return to these investors of, e.g. $20.  He does this by obtaining new investors and using their money to pay the initial investors.  The investment thus looks like a very good deal to people on the outside.  The investors in the second wave make out well too if the promoter brings in enough new investors to pay $20 to each person in the second wave.  This can go on for some time as long as the promoter brings in more and more investors.  It can’t go on forever because at some point the promoter would have to bring in more people than there are on the planet to pay the most recent wave of investors.  The game is to collect lots of money based on the tremendous reception garnered from paying so much money to early investors and then ceasing all payments while absconding with the money collected but not paid out.

In the United States most people have heard of a “Ponzi scheme.”  Ponzi was a real person who started his investment scheme in Boston in 1919.  It was just another variation on a pyramid scheme where he paid off the initial investors well and then ran of gas when he couldn’t keep it going by getting enough new investors.  He was imprisoned for several years and then deported to his native Italy.  He died impoverished in Brazil in 1949.

Social Security is not “like that;” it IS that, i.e., a pyramid scheme.  Social Security makes no investments, paid early entrants a windfall and is now in the position where it is impossible for it to pay future retires what they will pay into it.  Unlike Ida Mae Fuller, we have been paying into the system all our working lives.  And we can’t get ever increasing numbers of “investors,” i.e. taxpayers, to pay us off.  In fact, the system is going the wrong way; when Ida retired there were 16 workers for every recipient.  Now there are 3.

The U.S. Social Security system is literally, unequivocally, without hyperbole, indubitably a Ponzi scheme.  So are the old age pension systems in many other countries. 

One writer ingeniously pointed out that the U.S. Social Security system is illegal in all 50 states.  What the author meant is that an identical system run by a private individual or business is illegal in all states because it meets the criteria of a pyramid scheme, that is, it constitutes criminal fraud.  It isn’t illegal for the government to do it because the government allows itself to do things you and I can’t do.

Another writer described how a Ponzi scheme works in the cryptocurrency world; “a multilevel marketing fraud that pays early investors with funds from new marks.”  Andrea O’Sullivan in Scamcoin, an article in the August/September 2022 Reason Magazine.

Many people say that Social Security’s main problem is demographics, i.e., the ratio of workers to retirees has gone down a lot.  The ratio was much higher in 1935 when the program began than now, largely because people live so much longer and have fewer children.

Let’s do a “thought experiment” as Einstein suggested in physics.  What if Social Security had been from the beginning a program where people put their money into their own retirement accounts and owned the accounts, similar to 401 (k)s and IRA’s?  Even if it were a compulsory government program whereby people put a percentage of each paycheck into the program.  As in Chile and some other countries.

Then there would be no demographic problem; people would have their own money available to them at retirement and it would not matter what the worker-retiree ratio was.  It could be 1 worker for every 10 retirees for that matter; it wouldn’t matter because the retirees would not be relying on taxes collected from workers.

That is why I contend that demographic changes are not the cause of Social Security’s problem.  It is true that the aging of the population has exacerbated Social Security’s problems, but the system would run out of money even without this; it would just take longer.  And, as noted above, a properly designed retirement system would not be dependent on workers’ taxes.

If you do view longevity as the problem with Social Security, consider these facts; life expectancy in 1935, the year Social Security became law, was 62.  Today life expectancy is 82.  When Social Security began, the retirement age for full benefits was 65.  It is gradually being raised to 67.  If Social Security began this year in an equivalent manner the full benefit age would be over 80. 

I understand the view that longevity is one of the problems; my point is that the problem could have been avoided with a properly designed program where people actually owned their retirement funds, as in an IRA.

Below is part of an article by Chris Pope that supports contentions above that Social Security was a boon to early recipients and a loss to later generations.  Private Accounts are no Silver Bullet, September 15, 2022.  Article appeared in City Journal of September 17, 2022.

“The Social Security Act of 1935’s Old Age and Survivor’s Insurance (OASI) program was originally a fully funded system: it imposed payroll taxes on workers and set the revenues aside for benefits in retirement. But congressional Democrats wanted the system to pay out benefits immediately, while Republicans wished to prevent the accumulation of enormous investment reserves for the federal government to manage. As a result, bipartisan legislation in 1939 transformed the program into a pay-as-you-go system, under which retirees’ benefits are usually out of proportion to their prior contributions as workers.

This arrangement was very appealing to the initial cohort of retirees. Those reaching the age of 65 in the 1960s, for instance, received benefits averaging 8.8 times their prior contributions—after accounting for interest. But subsequent generations have had to pay for their forebears, as well as their own benefits, and so Americans retiring since the year 2000 have received less than they paid in. As a result of increased longevity and falling birthrates, the ratio of workers to retirees is also falling—from five-to-one in 1960 to two-to-one in 2040—and the system will lack the funds to pay benefits as promised starting in 2034.”

The Social Security Trust Fund

Ah, the Trust Fund.  The fund is said to have had approximately $3 trillion dollars at its peak.  This fund will at least keep benefits at their current level for a number of years and then benefits might be slashed because taxes won’t pay for all the retirees.

The Trust Fund comes from years when the Social Security system had more taxes coming in than it paid to retirees.  For example, the system might have had $80 billion more in tax receipts in one year than it paid out. 

That money was turned over to the United States Treasury and the United States spent it on other things because the overall budget was (and is) in deficit.  If this is true, how can we say there is a Trust Fund?  Here is what happens mechanically; The surplus tax receipts in a year when Social Security taxes brought in more than was paid out were turned over to the Treasury for other spending programs and the Social Security system got a bond, referred to as a “special issue Treasury Bond.”

Where did the bond physically originate?  It was printed on a Social Security Administration printer and then filed in a cabinet in a Social Security office!  The cabinet is locked sometimes!  The bond is not marketable and has no specific assets behind it.  You can’t make this stuff up!  What I mean is government does specious accounting that you rarely see in the private sector.

When the Social Security Administration needs to cash in one of these bonds (when Social Security tax receipts are less than money paid to retirees) the Social Security Administration takes one of these bonds and turns it over to the Treasury and says “I need X dollars to meet this year’s retiree obligations.”  The Treasury then goes out and borrows the money.  I say “borrow” because our government has deficits almost every year.

What happens is no different than if the “Trust Fund” never existed; the Social Security Administration simply goes to the Treasury for supplemental funds whenever it needs them.

In reality, Social Security and other taxes go to the Treasury and the Treasury pays for government expenditures.  The United States Treasury simply makes a book-keeping entry of surplus or deficit for the Social Security Administration; Social Security tax receipts and payments to beneficiaries are nothing more than accounting entries on the Treasury’s books.

I realize the above paragraph is repetitive but I believe it is of monumental importance for our country’ financial health.

One time I explained this to an acquaintance.  When I got to the end I asked if he still believed there is a trust fund.  He said yes.  That is an illustration of how difficult it is for many people to accept that Social Security has all the problems it has.

Later I thought of something I wish I had said to my acquaintance; “IT JUST DOESN’T MATTER; IT JUST DOESN’T MATTER.”  I use that expression because I liked it so much when Bill Murray said it in a different context in one of his movies.

It doesn’t matter because even if we assume the “Trust Fund” is real and had $3 trillion in it, Social Security has unfunded liabilities of approximately $30 trillion.  What that means is that if it were properly funded, as most private sector retirement plans are, it would have $30 trillion dollars in assets, not $3 trillion.  We are in deep trouble even if we assume the “Trust Fund” is real.

Medicare and Medicaid

So why am I not complaining about the treatment of today’s elderly when we are receiving such a lousy return from Social Security?  Because a much bigger pyramid scheme came along later that is providing us with such a windfall that it knocks out any deficit we experience from Social Security and still gives us a whopping subsidy.  MEDICARE.  Medicare is 30 years younger than Social Security and is still in the stage of providing a windfall for the first two generations of recipients.  That won’t last much longer but people my age currently receive a huge subsidy under Medicare.  Jeff Flake stated that the average senior citizen has paid $150,000 into the program and receives $390,000 in benefits. That figure is higher today because of inflation. It can’t last much longer; no Ponzi scheme does.

Another estimate, by Jagadeesh Gokhale**, shows estimated net taxes paid by males and females into Medicare and is further divided by age group.  For a 30-year-old male the estimated net taxes paid (i.e. after taking into account Medicare benefits that will be received) is $246,000; this means a LOSS for the 30-year-old.  The net benefit for a 70-year-old male is $285,000, i.e. benefit over and above what taxes the 70-year-old paid.  The reason I picked these age groups from the author’s table is that I have a daughter and son-in-law in their early 30’s and I was 70 at one time.

What these means is that I am, as an average person my age, receiving a net subsidy of $285,000 under Medicare and my son-in-law, assuming he is average for his age, is paying for most of my subsidy ($246,000).  The additional $39,000 of my subsidy comes from other age groups. 

These figures are from 2013 and are 70% higher as of 2024 because of inflation, i.e. $485,000 subsidy for me and a $418,000 loss for my son-in-law.

Medicare and Medicaid are vast programs, much more expensive even than Social Security.  Economists peg Medicare’s unfunded liability at more than $80 trillion!  Trillion, not billion.  When you take into account the unfunded liability of Social Security and Medicare you reach an unfunded liability well over $100 Trillion.  That measure of our nation’s indebtedness should be added to the official 2023 deficit of $33+ Trillion.

Social Security, Medicare and Medicaid are often referred to as “Entitlement Programs.”  That is because people think they are programs that will continue automatically.  That is not true.  Our government can modify or terminate any and all of these programs by simple legislation.

There is one difference between Social Security and the two medical programs of Medicare and Medicaid; the medical programs are funded to a large extent from general tax revenue.  Social Security is partly funded that way now in a way because it too has to go to the Treasure to get money.  But as stated above the whole thing is really accounting entries on the Treasury’s books.

Another author put it this way:

In any case, the crowd loved it. Many them were in their 60s and 70s, O’Reilly’s core demographic these days, and clearly Factor fans, possibly secret Tea Partiers who seemed to bear little resemblance to the socially progressive Manhattanites who usually fill these seats. Perhaps that’s why O’Reilly happily shared his distaste for “people on the dole,” i.e. welfare and food stamps, but specifically excluded from his criticisms anybody enjoying the far more expensive entitlements Medicare and Social Security.

This appeared online on June 19, 2014.  It is about Bill O’Reilly’s (former Fox television commentator) appearance at the 92^nd Street Y, as interviewed by Geraldo Rivera (a reporter who has worked for various networks.)  I thought it interesting how the article noted O’Reilly excluded from criticism the more expensive programs Medicare and Social Security.  O’Reilly is typical of many conservatives or populists.

I am critical of welfare (it provides damaging incentives for some of the recipients, especially if they stay on for long periods of time) and food stamps because the program has been expanded so much that it is close to being another middle class entitlement program.*  However, I know that they are not the budget-busters that Social Security and Medicare are and that those programs are a far greater “dole” i.e. windfall, to past and current generations than welfare or food stamps.

*Occasionally the program experiences cuts as well as expansions.  The trend is expansion.

Another thing about “poverty programs” is that we use the poor as an excuse to expand government.  The poor should be outraged at how they are used as justification for expansive government yet receive little benefit.  Two statistics I have read point this out; 70% of money spent on poverty programs goes to providers, not the poor.  Some of us refer to this as the “poverty industry.” 

The other statistic is that the poor actually pay more in taxes than they receive in direct benefits.  We could end all poverty programs and at the same time terminate all taxes on the poor and the poor would be better off.

Fungible commodities

I’d like to upset the apple cart more by pointing out some of what I said above is incorrect and that is because money is a “fungible” commodity.  That means one unit of money can be substituted for another unit of money and there is no difference.  For example, I can give you a dollar bill from my billfold or one from my safe deposit box and it makes no difference; one can be substituted for the other.

When retirees receive their Social Security check or deposit, there is no way to determine where that money originated.  Dollars coming into the government from Social Security taxes and from other taxes and fees are all part of one barrel called “revenue.”  Then the money is paid out and you cannot tell in any way shape or form where the money originated.  The government also borrows money and all this money gets put into one barrel and then it comes out as spending.  All we know is that the government takes in X amount of dollars and spends Y, and if Y is larger than X (i.e. a deficit) then the government borrows money.

What is the implication of all this? the Social Security system, as with all specific government programs, is an accounting convention and nothing more.  It bears repeating; a government check sent to a retiree cannot be traced to any specific tax or funding mechanism; it is just some portion of the money that came into the government and nothing more nor less.

This characteristic of fungible commodities has other applications; for example, if politicians justify a state lottery based on the contention the proceeds kept by the state will go for education you can now understand this isn’t true because there is no way to trace money budgeted for education as coming from a specific source.  All we know is the state takes in X dollars and spends Y dollars and some of that spending goes to education.