Last week Alex Tabarrok wrote a message on the marginal revolution entitled ”Is social security a Ponzi schedule?“
His answer is yes.
That reminded me of what I wrote about social security in my book from 2001, The Joy of Freedom: an economist Odyssey.
Here is the beginning of the chapter.
I say we are scraping the power [Social Security] System and replace it with a system where you add your name at the bottom of a list, and then send some money to the person at the top of the list, and then you. . . Oh, wait, that’s our current system.
—Dave Barry, “Election can come down to whom the most opening kisses”, ” Miami HeraldSeptember 24, 2000
In 1991, one of my students, Stephen Banus, wrote to the Social Security Administration to request information about the social security tax he had paid and the benefits he could expect to receive. In the letter that he returned, Gwendolyn King, the Commissioner of Social Security, wrote:
I want to assure you that social security is built on a solid financial basis. Social security benefits will be there when you need them.
A cautious man and a good planner, Banus sent a similar request in 1995. This time the message in the form letter was different. The Social Security Commissioner, Shirley Chater, wrote:
The latest report of the Social Security Board of Trustees says that the social security system can pay benefits for around 35 years. This means that there is time for the congress to make the changes needed to protect the financial future of the program.
In just four years, the Commissioner had reduced the general insurance that the benefits would be “if you need them” up to “about 35 years more”. What happened between 1991 and 1995?
In fact, not much happened in those four years, except that the Social Security Commissioner in 1995 was perhaps less unfair than her counterpart in 1991. The fact is that social security was never a ‘healthy financial basis’. Unlike the official propaganda of the Social Security Administration, there is no real trust fund. About 80 percent of the wage taxes collected from current employees today are sent to current pensioners, with only a short stay in Washington. The government spends the rest of the money on other items. The so -called Trustfonds contains bonds created by the government. These bonds are simply Iou’s from one government branch to another. Chris Jehn, an associated director of the Congressional Budget Office, compares these bonds with notes that you write every year and in a box for your child’s university training. The memorandum says: “I owe $ 5,000 to my daughter’s lecture fund.” After 18 years of such a saving, when your child turns 18, open the box and comes out, not $ 90,000, but 18 worthless pieces of paper.
Those who retired in the early 1940s received enormous benefits in exchange for paying low payroll taxes for just a few years. But since the system is “adult”, so that the current pensioners have paid for almost their entire effective life tax, these pensioners have received a much lower return.
A private individual who has set up such a financial chain letter would go to prison. In fact, he did that. His name was Charles Ponzi, and he was arrested in 1920 for promising investors that they could double their money in 90 days and used the proceeds from later participants to keep his obligations to earlier. This is how the term ‘Ponzi schedule’ was born.
There are two important differences between the original scam of Ponzi and the social security system. The first difference is that the social security is run by the government and, regardless of its constitution and her questionable ethics, is legal. The second difference follows from the first: While Ponzi had to rely on losers, the government can use violence. It is true that the government refers to the wage taxes of social security – a substantial 10.6 percent (an extra 1.8 percent for disability insurance and another 2.9 percent, levied on all income from work, is for Medicare) of the income of each employee up to $ 80,400 in 2001 – as “contributions”. But just don’t try “contribute”. That is what Valentine Byler, an Amish farmer in New Wilmington, Pennsylvania, did in 1961. His religion learned that her members had to take care of each other and tried to act towards his religious beliefs by not paying social security tax. The Internal Revenue Service responded by seizing and selling three of his horses to collect $ 308.96 from unpaid taxes.
The new line of the Social Security Administration is that the fund is a solvent until 2037. What the government officials say that it really means is that the last of the special federal government bonds are purchased and stored in the ‘Trust’ fund of social security by 2037 to the American treasury. This “sale” of bonds is just a transfer between the left and right hands of the government. To free up the money to pay for these bonds, the treasury must drive new bonds, increase taxes or lower other expenses.
The more relevant date is therefore when the government’s benefit payments begin to exceed his income from payroll taxes and interest on these bonds – because that is when the bonds are sold for the first time and the government must come up with extra money. That date, the Social Security Administration, will now be 2024, about two -thirds of the road through the Baby Boomers’ retirement.
In the late nineties, the government’s own actuaries estimate that, in order to maintain promised benefits, the tax rate would have to rise in the coming decades from the current level of 12.4 percent to more than 18 percent. With a rate of 18 percent, the tax on social security would be around 7.5 percent of the total GDP. But the total federal income from all sources, not only from the wage tax of social security, have remained within a limited reach of 18 to 20 percent of GDP since the early 1950s. If this historical constant held, the social security program would only last around 40 percent of the total tax revenues collected by the federal government, so that the remaining 60 percent for Medicare, interest on the debt, defense and everything else that the federal government does. That seems unlikely, which means that the chance of considerably increasing the social security tax rate is fairly small. At a certain point in the future, the benefits will therefore have to be less than promised.