Money Management and the Economy

Monday, March 24, 2008

Your Social Security is more Secure than your Securities

You aren't smarter than the market. It really is that simple.

Allen Sloan over at Fortune Magazine is making the case that Social Security will run out of money in 10 years. His are the crocodile tears of the very people who have looted social security, using the excess social security taxes to provide themselves and their rich cronies with tax breaks. He makes clear his new-found concern for social security is really an excuse to further raid the treasury with his suggestion for a solution: "We can still buy time by investing current cash surpluses in non-Treasury assets." I.e. we should use social security taxes to buy some of his rich buddies' fancy financial products.

To understand how this really works you need to start with social security taxes. The original idea was that the taxes paid by current workers would pay the current benefits for people who were retired. In turn, the next generation of workers would pay the retirement of the next generation of retirees.

The critics like to describe this as a "ponzi " or pyramid scheme, but it isn't. It ought to be clear to anyone that once they retire they will be supported by the people still in the work force. The question is how those people will get paid. Whether its personal savings or social security that money will have to be taken out of the economy - which is another way of saying that those still producing will have to pay the bill. Far from a scheme, that is simply the way life works. People are born, join the work force, retire and die.

In the early 1990's there was a recognition that there was an element of a pyramid being created by the country's demographics. More people were entering the workforce than leaving it for retirement and the resources available to pay social security benefits was greater than would be sustainable when the baby boomers retired and those numbers reversed. The result was the "Social Security Trust Fund" where current workers paid more social security taxes than was necessary to pay current retiree benefits.

The extra money from Social Security taxes was put into treasury bills. The same treasury bills the government uses to borrow money from anyone else. Like the T-bills Mr. Sloan and his friends buy to avoid taxes and that, presumably, the government will have to pay him and his friends a higher return on to borrow the money they are currently borrowing from the Social Security trust fund.

The problem is not how the trust fund is invested. Its that many of the conservative critics don't want to have to pay off the loans the government took out to provide tax breaks to their rich friends. Social security taxes are incredibly regressive. They tax low income wage earners at a higher rate than those making over $100,000. Every year we pay more social security taxes than are needed to pay current retirees and the government borrows that money instead of raising the more progressive income tax. As that surplus is disappearing the government has two options, raise taxes or borrow more money from elsewhere.

Where Mr. Sloan is fundamentally wrong is suggesting the problem is ten years off. It is happening now. Each year the surplus available from social security taxes is declining and the government is having to borrow more from other sources, reduce spending or raise taxes. That process will continue into the foreseeable future. Putting social security trust funds into non-government securities will just speed it up. Of course, Mr. Sloan and his financial services friends will make a hefty profit from fast tracking the social security deficit.

But the larger problem is that the social security issue is an example of a much more fundamental shift. Over the next 50 years, fewer workers are going to have to produce the goods and services used by a large number of people who aren't in the work force. Social security is only one institution which is going to be effected by that reality, so is every business. Global markets may be able to absorb some of the production, but for the United States that will require continuing to transfer huge amounts of wealth overseas in the form of loans and/or capital.

And if you want to find a ponzi scheme look no further than the dot-com "bubble" or the real estate "bubble" or dozens of other unsustainable investments. The money "lost" in these bubbles was found by the people who got rich off them, just like any other pyramid scheme. But don't let anyone convince you to base your retirement on those investments whether its your 401-K or the social security trust fund.

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