Last week I tried to educate myself about Social Security in the US. For as long as I can remember I've heard that the program was heading for trouble. I always thought it would be nice if I could opt out of it and plan for retirement entirely on my own.
As I read more, it became pretty obvious that there is some ridiculous stuff going on with Social Security. It is beyond a joke. Yet, shockingly, I've concluded that given a choice, opting out of the current Social Security program would be incredibly foolish. 5 years ago I would've been the first in line to opt out, but now I know better. Because its currently structured in such a way that it will inevitably become an unbearable burden for the government, and that burden is going to be forced onto all taxpayers and anybody else with assets in US dollars whether or not they are participating in the Social Security program. This thing badly needs to be reformed or else obliterated.
I thought I'd share what I've learned with the rest of you. Maybe none of this is news to you, but I found it pretty shocking myself. I've drawn pictures because it's easier to follow the money visually. I'm totally bored at work lately, this seems like a good way to spend my time. If any of you are already familiar with this stuff and I've made any mistakes, please correct me!
<img src="http://www.bringbackthesun.com/socialsecurity/01.png">
The basic concept is simple enough. People with jobs pay FICA or SECA taxes, which go to the Social Security Program. The Program pays benefits to whoever qualifies (they take a bit of the money to cover administration costs). This system seems pretty good. You work hard and get a steady income. Later on when you become unable to work, or reach a certain age, you still get a steady income.
That seems obvious, but what about times when more money is being taken in the tax than is being paid in benefits, and vice versa?
<img src="http://www.bringbackthesun.com/socialsecurity/02.png">
We have an answer for that -- the Social Security Trust Fund. It has Fund right in the name. And you can trust it -- that's right in the name as well. So, we have to assume, we must be all set. But how does it work? Like magic.
If the Social Security Program has any excess income (tax), this money goes into the Social Security Trust Fund. If there is a deficit because benefits paid > tax received, money is taken from the Social Security Trust Fund to cover the deficit.Social Security has been around since the 1930's, so even if we have to dip into the Trust Fund from time to time, we can probably sort things out before it is depleted. There must be an awful lot of money in there by now! What a brilliant solution. The government has so kindly put aside a little nest egg for our futures. Right? That's just how I would have saved for retirement myself anyway, except it is administered by the government. Very reassuring. But, I'm a little bit curious -- what do they do with all that cash? Do they just stockpile it? Invest it in some low-risk manner so that it will grow? I wonder if I could do the same with some of my own savings.
<img src="http://www.bringbackthesun.com/socialsecurity/03.png">
Non-marketable securities. Essentially this is an I.O.U. note, a promise to pay back the cash at face value, and a promise to make interest coupon payments (recurring payments of some small percentage of the face value as an incentive to hang onto the I.O.U.) So, um... then who are they loaning the cash to? The US Treasury. And the cash goes?? Into the general fund. And from there??? They spend it. Well, okay. That certainly clears things up. The money in the Social Security Trust Fund moves directly into the government's general fund, and from there it is spent. Is that really what happens?
Yes. All cash in the Social Security Trust Fund is traded for an I.O.U. This is done on a daily basis. There is a law requiring it. Now I'm feeling a little concerned. But surely the government wouldn't borrow all that money (from itself) unless they had a great plan for paying it back.
<img src="http://www.bringbackthesun.com/socialsecurity/04.png">
And there's the answer. This money is spent and gone; therefore, to repay the I.O.U. they must come up with the money through other taxes, or else just create new money. That is how the government makes money after all. That is how they will make the money that repays their loan from the Social Security Trust Fund.
<img src="http://www.bringbackthesun.com/socialsecurity/05.png">
I'm glad that's been cleared up. There's not real money in the Trust Fund, there are I.O.U.s -- and although the total cash value of these I.O.U.s is huge enough to support the Social Security Program through years and years of deficit, the only real method of cashing in is to pull it out of other taxes or print more money. There problems are very immediate, as soon as you dip into the Social Security Trust Fund.
The I.O.U.s have no real value, despite having the appearance of an investment. To illustrate this, let's compare the real scenario with a hypothetical situation.
Let's say for a moment that the Social Security Trust Fund is simply a huge stockpile of cash. Let's say Social Security is running in deficit and needs to use some of the cash from the Trust Fund to pay current benefits. And finally, let's say in a brilliant scheme a criminal mastermind broke into the Social Security Trust Fund vault and made off with every last cent from the Trust Fund.
The government still has an obligation to pay out Social Security benefits, despite the money being stolen. They must either (a) redirect money brought in through other taxes, (b) print more money for the payments, (c) cancel the program outright, (d) increase FICA and SECA rates, or (e) decrease benefits.
Let's change the hypothetical situation just slightly. Our criminal mastermind is also a comedian and after emptying the vault they left a note -- "I.O.U. approx. $2,500,000,000,000." Ha ha, you're killing me.
One more small tweak. Instead of a criminal mastermind, let's say politicians took the money and left the I.O.U. And that's the truth. These inconsequential I.O.U.s really make the picture quite complicated, don't they? Look at all those squares and lines. I wonder if the system could be streamlined? Let's give it a try by heading directly to the problem.
<img src="http://www.bringbackthesun.com/socialsecurity/06.png">
Here's the first option when the Social Security Trust Fund needs to cash in some I.O.U.s. The money comes from other taxes. Simple and brilliant -- yet, if the end solution is to take this money from taxes what purpose did the Trust Fund serve? It's certainly not depleted when this starts to happen -- there is $2.5 trillion worth of I.O.U.s, but to cash them in the real money is coming straight from taxpayers. Hmm. I see no real purpose, so let's reduce the extra components and make a simpler and more efficient process.
<img src="http://www.bringbackthesun.com/socialsecurity/07.png">
What a lovely circle we've drawn. If Social Security doesn't bring in enough in FICA/SECA contributions to pay for benefits, just tax it out of us in other ways. Brilliant...
<img src="http://www.bringbackthesun.com/socialsecurity/08.png">
Here is where I start to realize that if the government had given me a choice to opt out of Social Security, I would be giving up my benefits but I would still be stuck with the bill for other people's benefits once the program begins to fail. Sure I didn't have to pay the contributions if I've opted out, but they would be funded through other taxes which I still had to pay. And I thought opting out would be a way to just avoid that mess... but no.
<img src="http://www.bringbackthesun.com/socialsecurity/09.png">
That leaves option #2: print more money. Once again, the I.O.U. is being handed back to the Treasury and tossed straight into the trash while the real money comes off the press, runs straight through the Trust Fund and gets paid out as program benefits. Since it didn't serve a purpose in the end, let's just cut it out of the picture.
<img src="http://www.bringbackthesun.com/socialsecurity/10.png">
And there it is. If Social Security needs more money, just print it. No problem. If only money grew on trees we could all solve our problems this way. Of course, this devalues the dollar, causes inflation, makes social security benefits harder to survive on, etc.
<img src="http://www.bringbackthesun.com/socialsecurity/11.png">
All problems should be solved like this. There is a shortage of corn? Grow more. The polar caps are melting? Well, just open your windows and turn on the AC. Any problem can be solved by solving it. So there is no problem at all.
There is another option, the Treasury can sell more securities to gather cash to repay Social Security. This doesn't fix the problem, it just puts the I.O.U. in someone else's hands. And it depends on investors being willing to put their money in Treasury securities. Which they won't be if they believe the dollar they get paid back will be much weaker than today's dollar. They will put their money into something else that doesn't have inflation risk. But anyway, doing this just buys more time to solve the problem. Pay Social Security by getting cash from an investor, and then pay back the investor how? One of the same methods described above.
This really started off with a very simple idea though, didn't it?
<img src="http://www.bringbackthesun.com/socialsecurity/12.png">
Yeah. That doesn't look so bad. It makes sense, and seems obvious (just like the first time we saw it), but we have the same question as before: what about times when more money is being taken in the tax than is being paid in benefits, and vice versa?
<img src="http://www.bringbackthesun.com/socialsecurity/13.png">
Well, here's one idea for what to do. I came up with it in 15 minutes and it would fix everything.
First, let's have the Social Security Administration set the FICA/SECA contribution rates in such a way that projected upcoming contributions will be enough to pay projected upcoming benefits. Don't leave it to an act of congress to change the rate, don't allow them to cut the rate as part of a stimulus package. Just create an algorithm and let the program run with it. Very basic -- contributions collected need to match or exceed benefits paid. The difficult part is trying to accurately predict them, sure. After predicting, the real numbers leave you with some excess or deficit.
What to do about that excess/deficit? And what about that $2.5 trillion trust fund that is already sitting there.
First off, quickly reinvest the entire trust fund into new special issue US Treasury Securities that pay a 0% interest rate and no maturity date. Just an I.O.U. from the Treasury that's good for cash whenever Social Security needs it (which, ideally, would be never).
Second, if there's excess, DO NOT put it into some trust fund. We know where it will go from there. It should be refunded to the taxpayers who contributed to it, to their great joy. Let the government balance the rest of their budget instead of emptying a Social Security Trust Fund. There's no need for a trust fund, anyway. It's an inevitable fact that, in the long run, Social Security contributions NEED to match benefits. So let's just confront that truth today.
Then, if there's a deficit, borrow money from the treasury. By "borrow money," I mean cash in on some of those zero interest securities with a promise to purchase an equal amount of the same securities next year. The algorithm for determining next year's contributions would have to take this into consideration. Next year's contributions would be raised enough so that there is excess which can be used to repurchase the Treasury securities before the remainder is refunded to the taxpayers. People don't like taxes increasing, and people DO like tax refunds, so the government would have a very good motive for keeping Social Security paying for itself in this model.
Finally, what about that $2.5 trillion Social Security Trust Fund? It can sit there forever tied up in 0% interest Treasury Securities. Then the government never needs to worry about paying itself off. It would become a constant monumental reminder of many years during which the government used 2.5 trillion dollars of Social Security contributions to fund other things. The government can continue to tout the Trust Fund as a good thing and the uninformed and misinformed will go on believing that this huge number makes Social Security invulnerable. Meanwhile those who see through the Trust Fund to the problems on the other side can also rest assured. And the government doesn't have to figure out how to eventually come up with that money. Everybody wins.