Why Social Security Is Broken

by JoeTheEconomist August 23, 2011 11:33 AM

The subject of Social Security guarantees a heated debate. Today, in Washington there is a debate. One side of experts says that there may be a problem with Social Security in 21 years. The other side of experts says that there will be a problem in 21 years.  Both sides agree that the Social Security Trust Fund will be exhausted in 2033, so the argument is centered on whether a problem in 21 years is really a problem at all.

The experts in Washington believe that the problem facing the Social Security system is that it is running out of money.  They are wrong.  The fact that Social Security is running out of money is an outcome rather than a problem – much like a fever is an outcome of the flu.  The fever is the visible outcome, but it is not the disease.   The fact that Social Security is running out of money is the visible outcome.  The disease is the fact that Social Security is a terrible investment.

It should surprise no one that a terrible investment runs out of money.  People avoid bad investments whether it is on Wall Street or in Washington.  It is a matter of economic gravity that poor returns drive people out of any financial system.

Washington will tell you that payroll taxes are mandatory – which is true. The problem is that wages are not mandatory.  People can stop working.  People can shift wages into benefits which are not captured by payroll taxes.  Businesses can shift wages into stock options which are not part of the payroll tax equation.  This is not evasion.  It is the sound of people fleeing a failing system.

The question of solvency is in reality the unavoidable outcome of poor economic returns of Social Security.  Economic returns are what you get for what you contribute, and they are terrible particularly for younger workers. According to the Social Security Administration, some younger workers can expect to get back as little as 40 cents on the dollar. That means that Social Security isn’t terribly different than spending quarters to buy dimes for younger workers.

Experts argue that raising taxes and lowering benefits for future generations are the only two solutions because the experts are focused on the solvency of the Trust Fund.  This approach is treating the symptom.  It is like trying to cure chicken pox with zit crème. 

Unfortunately in this case, their cure will make the disease worse.  Raising taxes and lowering benefits on future generations will make the economic returns of the system worse. As returns drop, so does participation. As participation drops, the system will see greater and greater cash shortfalls.

The experts do not believe in economic gravity.   In their world, no one retires earlier because of lower compensation.  No one acts in their own self interest to avoid the tax.  And no one loses a job because of the higher cost of employment.  In the mind of Washington experts, the economy is a frictionless system where rising costs have no consequence.

The problem is that Social Security is spending quarters to buy dimes.  The experts would tell you that the solution to this problem is to get people to spend quarters to buy nickels.  This is lunacy.  These solutions make the system less appealing to the working generation – without whom the system fails in spectacular fashion. 

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