The social security pyramid

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The following is from Thomas Sowell. Barbarians inside the Gates. pp. 51 - 53

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The social security pyramid

A RECENT LETTER FROM AN ELDERLY LADY living on Social Security reacts to a growing impression that people like her are "a drag on society" and closed: "We don't ask to live this long."

Perhaps the time is long overdue for those of us who have been criticizing the Social Security system to say, loud and clear: The elderly are not the villains. The politicians who set up this system have been guilty of a hoax from day one—and they have added more hoaxes as the years went by. That is why Social Security is either going to run out of money or else have to raise huge taxes from the younger workers, if the system is not changed in some fundamental way.

The first hoax, from which so many others flowed, was that Social Security was "insurance." Social Security has never been insurance. Any insurance company that set up a system like Social Security would be declared bankrupt and its officials would be jailed for fraud.

Insurance is based on taking the money of many people and investing it in something that will produce wealth that can later be used to pay off the claims of those people. With insurance, it does not matter how many old people and how many young people are involved, because the company is supposed to have enough assets to cover its liabilities—that is, what it has promised to pay out.

Social Security has never had enough assets to cover its liabilities. It is not insurance but a pyramid scheme, in which those who come in first get money from those who come in later. Like other pyramid schemes, there is always the great danger that those who come in later will be left holding the bag when the pyramid collapses. That is why such schemes are illegal—except when the government does it.

The puzzle is not why Social Security is in trouble now, but how it managed to escape collapse for so long. The big factor was that there was a small generation born in the 1930s, when Social Security began and larger generations born in the 1940s and 1950s. It was an expanding pyramid, which can pay off big for those who got in first.

Eventually, as the birthrate declined, there was no longer a very large younger generation supporting a much smaller older generation. Now, as the huge "baby boomer" generation begins to move toward retirement age, the big question is what will be left in the till for Social Security to pay to them.

The quick answer is not enough to cover what they have been promised, unless the Social Security taxes on the next generation soar to new heights, taking a third or more of their total income.

None of this is the fault of the elderly. Many older people point out that, if they had been allowed to take the same money that they put into Social Security and invest it in the stock market, for example, they would be getting more income than they receive from the government—and it wouldn't be costing the younger generation a thing.

How is this possible? Because real investments create more real wealth—more factories, homes, computers, etc.—which means that everyone can be better off at the same time. But money paid into Social Security is just more money for politicians to play around with. It is used to pay for everything from Congressional junkets and other federal boondoggles to making the national debt look smaller than it is on paper.

In other words, when you spend the money as fast as it comes into Washington, you don't build up any wealth for the future. Of course the Social Security system gets government bonds in exchange for the money that is spent, but this is just a paper transaction that represents no actual increase of real wealth. Government bonds represent nothing more than claims against future taxes.

When those claims start coming due big time, in the decades ahead, there is going to be hell to pay if the system continues as it is. Somebody is going to have to be defrauded, whether the old or the young—probably both, to one degree or another, through one trick or another.

The government can welsh on its promise to the elderly by delaying the age at which it begins to pay off, give them what they are entitled to with one hand and tax part of it back with the other or no doubt do other tricks that will surely occur to the clever folks in Washington. At the same time, they can think up new ways to drain money out of the paychecks of the young.

The only way out is to actually create more wealth, by allowing working people to invest their retirement money in something besides politicians' promises.

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9 June 2024