The Truth About Social Security
Originally published October 1, 2008
It’s an election year so you’re bound to hear more lies about Social Security and how to save it. My goal is to arm you with information you’ll need to recognize these lies.
Social Security is actually what the government calls OASDI (Old Age, Survivors and Disability Insurance) and is withheld from payroll checks as FICA (Federal Insurance Contribution Act). For most workers, the Social Security (OASDI) portion of the FICA withholding will equal 6.2% on the first $102,000 of income. However, since the employer also has to pay an equal 6.2% on the first $102,000 of income paid, it is actually a tax of 12.4% that can total as much as $12,648 this year.
Originally, Social Security was a pay as you go program that collected only enough money to pay Social Security claims. However, about 30 years ago congress realized that such a Ponzi scheme can’t go on forever and decided to raise Social Security taxes and reduce benefits so that the system could collect a surplus to pay for the baby boomer retirement that would have otherwise bankrupt it. During the 30 years that followed, there were numerous other adjustments, all raising taxes, reducing benefits or both.
In a way, the plan worked; if you read the most recent Monthly Treasury Statement (MTS), you’ll see in black and white a journal entry indicating OASDI has a $2.4 Trillion dollar balance in its account (see Schedule D on page 25 of the following link).
OASDI is the largest of a potpourri of government trust funds that in total show assets of $3.8 trillion dollars (that’s 3,800 billion dollars). The problem is the money is NOT THERE!
When we look at the bottom of page 25 (Schedule D) we see a small note that says “investments are in treasury securities unless otherwise noted” and when we look a little closer we see that out of the $3.8 trillion, only $6 million isn’t in Treasury Securities and that is in Agency Securities (this is what is issued when the various trust funds borrow money from each other). Well, many people might say, Treasury Securities are safe and pay an OK interest (last year a bit over 5%). I won’t argue with that at all, Treasury Securities are backed by the full faith of the U.S. Government. The problem is that’s where most people stop thinking.
Show me the Money:
A Treasury Security is a debt on the U.S. Government all right, but in this case that is precisely the problem; the only place the U.S. Government gets money is through tax collections. That means U.S. Government debts are debts that must be paid by taxpayers. Confused? I don’t blame you, but let’s try to make sense of this by following a Social Security dollar and see if that clears up some of the muck we’re being served by Washington.
Every year the U.S. government collects hundreds of billions in Social Security taxes. These taxes flow into the U.S. Treasury and are faithfully credited to the Social Security account just as the checks that the Treasury sends out to pay benefits are debited to the account. However, due to the fact there is no legal provision for Social Security to save, invest or even hold money, the excess (surplus) funds (that couple hundred billion) is never deposited in the Social Security Trust Fund. Instead, the Treasury gives the Social Security Trust Fund what are called Special Treasury Bonds that bear interest, but are totally non-negotiable (cannot be traded on the open market). The money is then turned over to congress.
Just like all the Treasury Bills and Bonds that are sold on the open market, these Special Treasury Bonds are debts of the U.S. Government, which, as was noted above, is a fancy way of saying they are debts due from U.S. taxpayers. This means the money we send to Social Security from each paycheck, above that used to pay current benefits, that we think is being saved to fund our retirement is taken by congress, spent just as though it were from income tax receipts and all that is left in the Social Security Trust fund is a Special Treasury Bond that is actually a debt we’ll have to repay later. This debt, which should really be money we’re saving, is growing at a rate of about $200 billion per year irregardless of whether the federal government balances its budget or not.
Let’s recap this to insure I’m being clear. The U.S. Government collects money from us that it says it is saving to use for our retirement. However, instead of actually saving it as it leads us to believe, it writes an IOU from us (an IOU from the U.S. Government is an IOU from its taxpayers) to us. In other words, it takes our retirement money, spends it on a lot of stuff we don’t even want and forces us to take out a loan to pay it back to ourselves.
Let’s say you hired an investment advisor to plan your retirement and every year you handed him thousands of dollars feeling secure it would be there when you needed it. However, rather than investing your money he uses it to finance his wild lifestyle and stuffs your retirement account with IOU’s he forges your name on that are actually debts from you to you. Would you be mad? Would he go to jail (if you didn’t catch him first)? Well, that is exactly what the U.S. Government does with your Social Security money; in the private sector we call this theft, but for our government it’s business as usual.
Does Social Security treat all Americans equally?
Let's say two people who have earned the right to identical Social Security benefits of $2,000 per month retire on the same day at exactly 65 years of age. The first person lives until age 95 and the second person dies on his 66th birthday. To make this easy, we'll ignore any cost of living adjustments and just assume the payments are always $2,000 per month and that neither person is married or has a dependent who would receive his Social Security benefits after his death. The first person will collect $2,000 per month for 30 years (12 x 30 x $2,000) or a total of $720,000. However, the second person will collect only one year's worth of benefits totaling $24,000.
Since the accounts are held by the government and Social Security is just an annuity with no material death benefit, there is nothing left over from a lifetime of contributing for his decedents to inherit - it's just game over. Some might suggest this is just the luck of the draw and part and parcel of the system - too bad, so sad.
According to the U.S. Center for Disease Control (CDC), the life expectancy for an African American male born in 1990 (a person who turned 18 this year) will live until he is 64.5 years old. In other words, statistics suggest this man will die six months before he is able to collect his first full Social Security check. However, the same table says a white male born the same year will live until he is 72.7 years old. This means the white male will collect over seven and a half years worth of Social Security before dying. The implication here is that, intentionally or not, Social Security statistically provides better benefits for white Americans than it does Americans of African descent.
In other actuarial tables I’ve read that Latin Americans also live shorter lives than most Europeans and that Scandinavians and Japanese people tend to live the longest of all. Another interesting note is that poor people, whose heirs could clearly put even a modest inheritance to good use, live significantly shorter lives than wealthy people.
Will more money fix the system?
Obama wants to significantly increase Social Security taxes and says that will make the system solvent. The problem with this concept is that it implies the government will somehow magically come up with a way to save money. Unfortunately, it can’t; there is no legal provision for the government to save money and, thank heavens, no provision outside of a bailout, for it to invest. Therefore, the Obama plan would simply increase the amount of debt held in the Social Security Trust Fund that our children and their children would be obligated to pay and give congress more money to spend; any wonder now why most of our illustrious congressmen and women always want to increase Social Security Taxes? They convince us they are saving money so we don’t get angry about the higher taxes – said another way; they flat out lie to us.
What about an Al Gore “Lock Box”?
One of the great things about being a politician is you get to name things without having any concern with “truth in advertising.” In financial circles, the term “lock box” has a very specific and clear definition; it is safe place to store cash until it’s needed. During his acceptance speech at the 2000 Democratic convention, former vice president Al Gore, described it as follows:
“I will not go along with any proposal to strip one out of every six dollars from the Social Security trust fund and privatize the Social Security that you’re counting on. That’s Social Security minus. Our plan is Social Security plus. We will balance the budget every year, and dedicate the budget surplus first to saving Social Security. Putting both Social Security and Medicare in an iron-clad lock box where the politicians can’t touch them -- to me, that kind of common sense is a family value.”
Was Mr. Gore describing a place where the Social Security surplus, which is currently running at a rate of $200 billion per year (not to mention over $100 billion in annual interest owed from the Special Treasury Bonds the Trust Fund currently holds), would be stashed in cold hard cash? No, he was not. He was describing a system that would work much as the system has always worked and still employs today, but with one exception.
If (when) the federal budget is balanced without the inclusion of the Social Security money it borrows, the excess funds will be used to pay down publicly held government debt. This has many implications that Mr. Gore clearly didn’t think through, but one very important caveat that I’ll be he knew existed.
The caveat to all this is that throughout the years when the mainstream media trumpeted our federal government was operating at a surplus it was not counting the value of the Special Treasury Bonds being issued to the myriad of trust funds, of which Social Security is just one. This was like borrowing money from your credit card to pay your home mortgage and not counting the credit card debt. If the Special Treasury Bonds issued to these trust funds were included in the calculation, the only year we really had a surplus was in 2000 and it was closer to $50 billion than the nearly quarter trillion we read in headlines.
However, we’ll set that caveat aside and muse what it might be like if we could assume a balanced federal budget; one that is balanced without the benefit of money being borrowed from government trust funds.
On the surface, it sounds appealing; use surplus Social Security receipt to pay down publicly held government debt. Of course, this would do nothing to the growing debt owed to the Social Security Trust Fund, which increases now at a rate of $200 billion per year plus over half that much again in interest, but we’ll set that aside for now to explore the “unintended consequences” I believe Mr. Gore has not fully considered.
In evaluating how this might work out, we first have to assume a balanced federal budget. If the federal budget is balanced, there will no longer be a need to issue Treasury Bonds or Bills to finance deficits – there is no deficit. Therefore, the only financing the government will need is what a public company might call a “line of credit” that is used to smooth out cash flow. In other words, borrowing under balanced budget conditions would be less than a rounding error when compared to what the government does today.
If we turn again to the Monthly Treasury Statement (MTS) and look to Table 6 on page 20 we can see there is slightly less than $5.5 trillion dollars of U.S. Government debt held by the public. There is an additional $4.2 trillion held at government agencies like the Social Security Trust Fund, but these debts cannot be repaid until such a time as when the trust funds are experiencing negative cash flow. This means that under the Lock Box doctrine we must use the surpluses from all the trust funds (most of which comes from Social Security) to pay down publicly held government debt.
Initially, this would work fine (we’re still ignoring that every penny used to pay down government debt is offset one for one with Special Treasury Bond debt that would go into the trust funds); there is no doubt there is more U.S. Government debt floating around in the public system than it needs to work efficiently. However, according to the intermediate annual audit report completed by the Social Security trustees for 2007 (see link below for table), Social Security will take in an additional $2 trillion in surpluses during the next ten years and, if we add interest on the Special Treasury Bonds, this would come to about $3.5 trillion. The implication here is with the Lock Box program we would pay down our publicly held debt to about $2 trillion by 2017, but at the same time, balloon our debt to the Social Security Trust fund to a total of nearly $6 trillion.
I’m not smart enough to suggest how the world’s capital markets might react to such a significant and quick reduction in publicly traded U.S. Treasury Bonds and Bills, but my inclination is to believe it wouldn’t be very well received. Remember, not only do investors depend on U.S. Government debt, which is thought of worldwide as the “risk-free” benchmark, but foreign governments depend on the availability of this debt as well. Due to this, reducing it too much could lead to what I think we can accurately describe as some dangerous unintended consequences.
However, even if we were to set aside the clear implication that at some point this program would reduce publicly traded U.S. government debt to zero, we still have to come to grips with the fact the Lock Box holds ONLY Special Issue U.S. Treasury Bonds that still must be paid for with fresh tax collections. In other words, the Lock Box concept does absolutely nothing to address the core of the issue – the Social Security Trust Fund contains no money nor can it under unless there is a legal provision passed to allow it to invest in the private sector. This leads us back to the conundrum that if we are to have money to fund our retirement in the future, we must save and invest money today; the Lock Box theory is that adding debt to the U.S. taxpayer’s balance sheet and placing the ownership of that debt in the Social Security Trust Fund is that same thing as saving and investing money.
How the System can be Fixed:
We all know that if we are to have money later in life we must save money now. We know this well and even teach our children the value of thrift with tales of ants and grasshoppers. We also know that there is no current provision for the U.S. Government to save money. Therefore, if we are to save for our future we have two choices, we either need to redirect the money into private accounts we can control and watch grow or we need to pass laws so the U.S. Government can invest freely in the private sector.
I don’t know about you, but there are few things that scare me as much as contemplating the hundreds of unintended events and added corruption there would be if the U.S. Government were investing trillions of dollars with the goal of making a profit. One, of course, would be that we’re another step closer to socialism, but that’s just the tip of the iceberg. This means, the only viable solution is to partially privatize Social Security so that we can save and, if we choose, invest our own money, but what might that do to those who are currently retired or nearing retirement?
A Gradual Move Towards Privatization:
Under the current tax structure, there are about $200 billion surplus dollars collected each and every year by Social Security (not to mention about half that again in accrued interest owed on the $2.4 trillion in Special Treasury Bonds. My proposal is to take the majority of that $200 billion and distribute it to Americans that are a decade or more away from retirement. Those who have been paying into the system lose absolutely nothing and those already retired will be well covered by the over $600 billion the Social Security system would still keep (total annual collections will be just shy of $800 billion in 2008). As we move forward, the amount distributed would vary depending on how much of a surplus there is each year. And, as we balance the federal budget, any surpluses will go towards paying down the Special Treasury Bonds in the Trust funds and that would go to a surplus as well.
With this proposal, we would work with a hybridized system of part traditional Social Security and part privatized retirement accounts for several decades and even once the last person is paid who contributed to Social Security, we would still maintain accounts to cover survivor and disability insurance. Both of these are things insurance (pooled risk) should cover.
But, Wall Street is a Rigged Lottery:
The first thing those who don’t want to lose the control of our money do is pull up a Wall Street poster children of greed, risk and abuse and use them to scare voters. Ironically, if voters knew what congress did with our money they would sooner bet it on horseracing; at least when you gamble there is a chance of winning. However, voters aren’t told the congress side of the story, so many are convinced by the Wall Street lies.
My proposal is to limit investment options for these privatized Social Security retirement accounts to three options and in all cases, any funds or banks applying to offer an approved Social Security retirement account must meet very strict criteria, which would include a maximum total fee structure and not be allowed to make “soft money” expenditures (that’s Wall Street lingo for passing money under the table and charging it to the clients). The three and only three accounts would be as follows:
- Total Stock Market Index Fund – Yep, this is the good old Wall Street lottery or, at least, that’s what some people in congress would like you to believe. However, what they don’t tell you is that no matter when you start, if you go back through the history of the U.S. stock markets and use gradual dollar cost averaging (regular deposits made weekly, biweekly or monthly) over a working lifetime, the average annual return is ALWAYS in the low double digits.
- Total U.S. Treasury Bond Index Fund – This fund distributes money across all of the maturity dates for U.S. Treasury Bonds and Bills. Generally speaking, the fund yields noticeably less than the Stock Market when viewed over the long-term, but tends to perform well when stocks are down and exhibit less volatility.
- Federally Insured Certificates of Deposit – These would be special CD’s in that they could be cashed with zero penalties under certain conditions dictated by Social Security Laws.
Once a person got to within seven years of retirement, there would be a federally mandated asset allocation table used to limit the exposure of the Social Security retirement account to the stock markets. This would gradually move from a maximum 100% stock market exposure to 20% exposure at retirement. At three years out from retirement, there would be a federally mandated move made in the bond exposure that would move exposure from the broad index to shorter term indexes. This would be the only time people would move from the total bond index.
By the time an American worker reaches middle age he or she will have several hundred thousand dollars in retirement savings that can be moved from one approved institution to another. Since institutions will be anxious to find new customers, banks and brokerages will trip all over themselves treating customers well and offering free / low-cost services they reserve today only for the well-to-do. As a result, American workers will benefit.
America will also benefit since these workers now own a stake in life. These workers will have hope and with hope comes all sorts of good behavior.
Bottom Line: Over two trillion dollars of our hard earned money that we “deposited” with faith into Social Security has been taken and spent by congress – it’s not there. Congress has replaced that money with IOU’s that say we (the taxpayers) will pay the money back to ourselves. This is the same thing as a robber with a gun taking your retirement money, forcing you to write yourself an IOU and calling it all even. Absolutely the only feasible way for us to protect our retirement is for us to put our money outside the reach of congress and the only way to do that is through demanding the partial privatization of Social Security.