Saturday, August 21, 2010

Happy 75th Birthday!

Last Saturday – August 14 – was the 75th birthday of Social Security, the first of Franklin Delano Roosevelt’s New Deal programs, not to mention the most enduring and controversial.

Before packing for another grueling vacation, this time at Martha’s Vineyard, Obama celebrated the occasion by using his Saturday address to remind the great unwashed that his party remained the guardian of this government-engineered house of cards, whereas, he warned, the Republicans had the tumbrel waiting to carry the program to its privatized doom on Wall Street.

No sane person, however, would deny that Social Security is headed for doom under its own steam, but the day of reckoning – probably 2037 and beyond – is so far in the future that, what the heck, there’s no rush to worry about it now. That “let tomorrow take care of tomorrow” mentality has been the bane of this program throughout its history, preventing its flawed design from being corrected. Feckless politicians since its inception have only patched the Social Security program to give it a few more years of life in the short term but no real chance to survive on its own in the long term. Why haven’t taxpayers and future Social Security beneficiaries howled for major reform? Because the design of the Social Security program contributes to its support and its intractability. Here’s how.

Social security was a child of 1930s social mores and norms. Notwithstanding the difficult straits the Depression imposed on people, the nature of their time caused them to refuse welfare handouts. Unlike today, people then accepted only what they felt they earned, and that feature of society was behind not only the design of the Social Security Act, but also the three New Deal work programs, namely, the Civilian Conservation Corps (CCC), the Civilian Works Administration (CWA), the Works Progress Administration (WPA), the and its predecessor, the Federal Emergency Relief Administration (FERA) begun under the Hoover administration.

FDR wanted Social Security to be “a matter of earned right” and therefore morally acceptable by making it “contributory social insurance” rather than a welfare program funded out of general tax revenues. Its earned “rightness” came from a sense of personal responsibility to save for the future and from the private rather than public nature of the program – i.e. people worked, paid into an interest-bearing trust fund, and received back distributions from their “investment” in Social Security. It was not a handout.

Despite criticism about its regressive nature (initially everyone paid into the system 1% of income up to $3,000) FDR was a big picture politician. Responding to a critic who questioned the economic soundness of the program, he said, “I guess you’re right on the economics, but those taxes were never a problem of economics. They are politics all the way through. We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions … With those taxes in there, no damn politician can ever scrap my social security program.”

One insightful politician of the time, however, saw potential problems with granting the federal government the monopoly FDR sought. Senator Bennett Clark (D-MO) wondered if private retirement pensions might not outperform a government-run plan, so he introduced an amendment allowing private employers to opt out of Social Security if the employer matched the government program in premiums and benefits and had the employee’s consent. The Clark Amendment was debated in the Senate and passed 51-35. FDR was furious and threatened to veto the Social Security bill if it came to him with the amendment. When the House passed its version of the Social Security bill without the Clark Amendment, FDR and his cronies used a parliamentary trick in the conference committee to work out a compromise without the amendment, promising to appoint a joint committee to study it and report back to Congress in 1936, the following year. That never happened. Clark was prescient, however. Over the past 70 years, private pension plans have returned 8% while Social Security benefits have averaged less than 2%.

When deciding how to start a program that was to be funded entirely by contributions – FDR’s mandate – the government had to solve the dilemma that the first beneficiaries would not be receiving the return of their own contributions unless the program pay-outs did not begin for one or two decades. That defeated the purpose of helping the elderly in 1935 and beyond. In a curious twist of political logic and manipulation, therefore, the designers of Social Security decided that it wasn’t important who made the contributions that were paid out in current benefits as long as all beneficiaries had contributed some amount to the system. And since in the early years of the program, the number of contributors would exceed the number of beneficiaries, the excess contributions could be paid out in benefits rather than into the reserve or trust fund as initially planned. However, lacking a paid-in beginning reserve, the Social Security program would have to be subsidized from the beginning by general revenues, and even if it got into the black in future years, the committee foresaw deficits reappearing in 1965.

Even as the design of the program shifted from a “savings” program, in which John Jones got John Jones’ contributions with interest, to a pay-as-you-go system in which current contributors paid current benefits, the initially planned payroll tax had to be increased and it had to be incremented sharply in following years to keep the program solvent and to build a reserve. Taxes would begin in 1937 and reach their highest in 14 years and benefits would begin in 1940. This design had political logic – pleasure (benefits) came before pain (higher taxes later) and taxes would support contemporaneous benefits for at least a generation, perhaps until 1980, after which the issue of solvency would be left to another generation of voters and politicians.

Playing the present against the future figured importantly in the design of Social Security. Politicians looking for reelection votes had a built-in way to get them with this program. Benefits were delivered before an election; taxes were raised after elections. Increased benefits today were paid by today’s workers – not today’s beneficiaries – which is one reason the program is so endearing to the retired and those approaching retirement.

Over time, the program was manipulated in a way that brought in additional taxpayers faster than benefits were increased so that the added cost of benefits was spread over a larger taxpayer base. Moreover, when future benefits are rising relative to low current and past taxes, the tax base perceives (and receives) superior returns on what it paid in, whereas later entrants into the tax base, even if the future benefit to current tax relationship is less favorable, have no consciousness of the bias toward early entrants (because they weren’t one.)

Those who were the earliest entrants into the Social Security system got something for nothing. Ida Fuller, a Vermont legal secretary, paid into the system a total of $24.75 from 1937 to 1940. When she retired in 1940 at 65, she began receiving a monthly Social Security check of $22.54, and when she died in 1975, she had received $22,888.92 – a payout of about $1,000 for every dollar she had paid in. Even those who paid taxes for their entire career paid only enough to support retirees during those early years. They paid less than the benefits they would receive – i.e. they also got something for nothing. Not to worry that Social Security was actuarially unsound because costs didn’t equal benefits and no residual benefit was paid to a decedent’s estate; to a politician, this was an advantage, not a problem. Giving away something for nothing was a way to get reelected. And after all, current politicians represented the current generation of voters, not a future generation.

In the early years of Social Security, its intergenerational design was a source of frequent criticism. Why should the current generation be allowed to compel future generations to bear a tax burden it did not, and likely would not, impose on itself? Why should future generations be made to pay – not for their own future benefits – but for those of the current retired generation? The designers of Social Security essentially shrugged off such questions and said they weren’t interested in people who weren’t yet born; let them take care of themselves.

The intergenerational financing of Social Security had other advantages. It made the system seem as if it was self-supporting and fiscally responsible. Retired voters assumed the benefits they were receiving resulted from taxes they had paid in the past. But throughout its 75-year history, the system has never balanced current taxes against the present value of current benefit costs. The current generation of retirees has never concerned itself with the cost of their benefits on future generations because they never thought of Social Security (and Medicare more recently) as converting part of their children’s wealth, if not their grandchildren’s, into their benefits.

It becomes apparent why FDR and the designers of Social Security weren’t interested in a mandated self-directed private saving system, like a 401(k) program. As FDR astutely observed, politics outweighs economics, and a 401(k)-type program has no political leverage. The current generation wouldn’t be able to get something for nothing – i.e. it wouldn’t be able to receive benefits it hadn’t yet saved. FDR needed a system in which participants appeared to be paying into a corpus for their future retirement when in fact that retirement income would come from a future generation of workers. Every retired generation, therefore, will always fight to protect the return on the taxes they paid, and politicians will not be inclined to resist a common interest group that is as politically active as retirees. That is what makes Social Security reform so intractable.

Martha Derthick, a student of public policymaking, exposes the seduction of Social Security:

The program had a powerful appeal to self-interest – the self-interest of the taxpayer-voter, who got back far more in benefits than he paid in taxes, and the self-interests of the politician, who could all at once, provide the current taxpayer-voter with these excess benefits, defer high tax rates to a future generation, and proclaim with a straight face the “fiscal soundness” of the program.

Indeed, this is the flaw in all government spending that isn’t paid by the generation on which the spending is spent. It (i) mortgages a future generation, and (ii) it disconnects the current generation from the obscenities of reckless spending – like that of the Obama administration.

In the end, the Social Security program is a program for redistributing wealth, created during a generation that abhorred the redistribution of wealth and in fact hewed closely to the Jeffersonian ideals of self-sufficiency. The aim of the designers of the Social Security program was the opposite: to fight self-sufficiency and create dependency. Just as Medicare displaced private health insurance, Social Security sought to displace private retirement programs. Early on a displacement of 50% was believed possible, but in the 1960s zealots like Commissioner of Social Security, Robert M. Ball, an early player in the creation of Social Security, wanted it to displace all private retirement programs. If not politically, then practically, Ball was a socialist who believed dependency on government benefits produced grateful voters, and if not grateful, at least voters who would play one politician against another causing programs to expand and herald in a welfare state that could not be dismantled by future generations of voters and politicians.

Is Social Security a Ponzi scheme? A Ponzi scheme transfers money from one group of contributors (late entrants) to another group of contributors (early entrants). No wealth is created. However, the early entrants expect a return on the money they contributed, so they get much more than they gave. The organizer takes a significant part of the receipts and uses them for other purposes than to pay the contributors. As long as new entrants contribute more than the exiting early entrants are paid, the scheme works. When exiting entrants are due more than new entrants are paying in, the scheme collapses.

Social Security works much the same way. New money is paid to old money. To pay for expanded benefit costs, more money is needed than old money paid. Some portion of the receipts is swept out of the trust fund, used for other purposes, and replaced with government bonds – essentially an IOU (which is why raising taxes to increase reserves is silly.) The ongoing viability is jeopardized when new entrants are insufficient to cover exiting entrants. (As a society gets richer, its birthrate falls, so when the program started, there were 16 workers for every beneficiary; today there are 3.3 workers per beneficiary, and in 2030 there will be 2 workers per beneficiary.) If it walks like a duck and quacks like a duck, is it a duck? Sure is. Social Security is a Ponzi scheme.

This year, for the first time since 1983, the government will pay out $41 billion more in benefits than it receives in Social Security tax revenue. This is due to the high unemployment caused by the recession and is likely to continue into next year. It is a warning sign of things to come. In 2014 and years following, current benefits will exceed current taxes, triggering withdrawals from the trust fund, and assuming the government stands good on it IOUs, by 2037 the trust fund account will be empty and Social Security receipts will only cover 75% of benefits. In addition to paying its IOUs, the government will have to make up the 25% shortfall out of general revenues – the same source for paying those IOUs. In other words the Treasury currently owes Social Security $2.5 trillion in IOUs, which was originally taxed out of the incomes of working Americans, and to repay it, it will have to tax working Americans again to get the $2.5 trillion to pay the IOUs. Taxpayers get taxed twice to pay the same benefit! Why? Because their government purloined their savings account. What a country!

Is Social Security solvent? Only if those IOUs can be paid. And a recent Gallup poll showed that 60% of currently working Americans bet they can’t – i.e. they don’t expect to receive any benefits from Social Security when they retire.

People have been forced by law for 75 years to go along with this pay-as-you-go Ponzi scheme, promised that after years of taking their money and giving it to retirees, the government will take other people’s money and give it to them when they retire. If or when there is little money to pay the last people retiring after years of paying into the system, they will get hosed.

Bernie Madoff would be proud.

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