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| Original image from By Social Security Administration - Social Security Administration, Public Domain, https://commons.wikimedia.org/w/index.php?curid=43304462 Modified by the author |
Of course, that effort ended up going nowhere – Bush spent some political capital in his failed push, and then burned through a bunch of what was left with his botched response to Katrina later that year.
Now we’re back at it and the threat is arguably sharper. We’re dealing with a Republican party that is less independent from its president than 20 years ago, a president less inclined to listen to reason, and an off-brand Tony Stark who’s been given the keys to the kingdom and may well have the capability to make the Social Security system so dysfunctional that it falls apart without Republicans in Congress needing to leave their fingerprints on the murder weapon.
Social Security’s demise is hardly a foregone conclusion, but it’s enough of a possibility that I thought it was worth looking at what our options might be after it happens.
The part of this post above the fold is the TL;DR of the whole thing, a series of declarative statements.
Below the post is the “too long” explanation of that first declarative statement.
I hope I’ll lay out explanations of the rest over the next few weeks, but there’s usually a large gap between my intentions and my accomplishments.
Laying out the spine of the argument is easier, so here it is.
There are lots of different ways of organizing a retirement system: government pay-as-you-go (PAYGO) like Social Security; private PAYGO like an old-fashioned company pension; pre-funded company pensions, and private retirement accounts. But the differences among those systems are differences in accounting. Underneath, every single retirement system has to do the same thing. It has to move claims on current output from people who earned those claims by working to produce current output, to people who are no longer working and therefore not playing a role in the production of current output.
A retirement system might want to give a helping hand to people who, for whatever reason, had relatively low lifetime earnings. It also doesn’t want to incentivize people not to take care of themselves during their working lives. Those two goals are potentially in conflict, but Social Security strikes an intelligent balance between them.
People describe the Social Security trust fund as a fiction or a Ponzi scheme, the government borrowing money from itself to pay itself. That’s sort of true, but it’s more false. The 1983 reforms that led to the large (but shrinking) trust fund we have today represented an implicit bargain about who on the income scale would pay when. People of average or lower income would pay up front in the 1980s, 1990s, and 2000s, in order to build up the trust fund, so that Social Security was there for them when they retired. People of higher incomes would pay in the 2010s and after in order to fulfill that promise. Destroying the system now is letting higher-income folks out of their end of the deal, just when it becomes time to pay. And the part about it being a Ponzi scheme—“There’s no money in there for you when you retire! The money you pay now just goes right at the door to pay today’s retirees!”—that part is simply based on a failure to understand what a retirement system does, which is that it moves claims on current output from people who are working, to people who are no longer working.
Replacing Social Security with individual accounts has three problems. First, individual accounts have administrative costs that are an order of magnitude higher than Social Security. Second, the intelligent balance between cushion and incentives described above is impossible with individual accounts. And third, the promise of higher returns by putting money into the private market instead of Social Security is logically impossible to achieve on a system-wide basis, because of the unavoidable nature of every retirement system (moving claims on current output from people working to people who are no longer working).
A large part of why Social Security has financial problems is that more and more of the claims on current output are going to people in forms that don’t get taxed to cover Social Security. That’s a fixable problem.
Social Security faces three fundamental problems. First, an increasing share of the population is of retirement age. Second, the growth of GDP per capita is slowing down. Third, the system as currently funded will run out of money. That third one, as mentioned above, is fixable. The first two don’t have such obvious solutions, but they are just as serious for any alternative to Social Security, because the underlying nature of any retirement system is that it moves claims on current output from people who are working, to people who are no longer working.
Lastly—and to justify the title of “After Social Security”—if Musk et al. succeed in destroying Social Security, it will be disastrous, but it doesn’t have to mean the end of sensible retirement arrangements forever. The bad part is, they will have stolen a lot of money and impoverished millions and probably led to a significant amount of premature death as people face challenges they could have overcome had they had access to the Social Security benefits that were their due. But any retirement system is ultimately a social arrangement, one that (say it with me now) moves claims on current output from people who are working, to people who are no longer working. The true wealth of a country is not measured in collections of financial assets, but in the ability to accomplish useful things. To the extent that we still have that ability after Musk is done experimenting on us, it will be in our hands to decide whether to re-establish a decent retirement system.
That’s the spine of the argument, and it only took me about 750 words.
The rest of this post will be making good on the first claim, the thing that is most important of all to understand before trying to solve Social Security’s problems: Every retirement system moves claims on current output from people who are working, to people who are no longer working.
Heading for the showers
Types of showers
The takeaway
People describe the Social Security trust fund as a fiction or a Ponzi scheme, the government borrowing money from itself to pay itself. That’s sort of true, but it’s more false. The 1983 reforms that led to the large (but shrinking) trust fund we have today represented an implicit bargain about who on the income scale would pay when. People of average or lower income would pay up front in the 1980s, 1990s, and 2000s, in order to build up the trust fund, so that Social Security was there for them when they retired. People of higher incomes would pay in the 2010s and after in order to fulfill that promise. Destroying the system now is letting higher-income folks out of their end of the deal, just when it becomes time to pay. And the part about it being a Ponzi scheme—“There’s no money in there for you when you retire! The money you pay now just goes right at the door to pay today’s retirees!”—that part is simply based on a failure to understand what a retirement system does, which is that it moves claims on current output from people who are working, to people who are no longer working.
Replacing Social Security with individual accounts has three problems. First, individual accounts have administrative costs that are an order of magnitude higher than Social Security. Second, the intelligent balance between cushion and incentives described above is impossible with individual accounts. And third, the promise of higher returns by putting money into the private market instead of Social Security is logically impossible to achieve on a system-wide basis, because of the unavoidable nature of every retirement system (moving claims on current output from people working to people who are no longer working).
A large part of why Social Security has financial problems is that more and more of the claims on current output are going to people in forms that don’t get taxed to cover Social Security. That’s a fixable problem.
Social Security faces three fundamental problems. First, an increasing share of the population is of retirement age. Second, the growth of GDP per capita is slowing down. Third, the system as currently funded will run out of money. That third one, as mentioned above, is fixable. The first two don’t have such obvious solutions, but they are just as serious for any alternative to Social Security, because the underlying nature of any retirement system is that it moves claims on current output from people who are working, to people who are no longer working.
Lastly—and to justify the title of “After Social Security”—if Musk et al. succeed in destroying Social Security, it will be disastrous, but it doesn’t have to mean the end of sensible retirement arrangements forever. The bad part is, they will have stolen a lot of money and impoverished millions and probably led to a significant amount of premature death as people face challenges they could have overcome had they had access to the Social Security benefits that were their due. But any retirement system is ultimately a social arrangement, one that (say it with me now) moves claims on current output from people who are working, to people who are no longer working. The true wealth of a country is not measured in collections of financial assets, but in the ability to accomplish useful things. To the extent that we still have that ability after Musk is done experimenting on us, it will be in our hands to decide whether to re-establish a decent retirement system.
That’s the spine of the argument, and it only took me about 750 words.
The rest of this post will be making good on the first claim, the thing that is most important of all to understand before trying to solve Social Security’s problems: Every retirement system moves claims on current output from people who are working, to people who are no longer working.
Heading for the showers
There are lots of different ways of funding retirement.
You can save money in a retirement account, on your own or through work.
Companies used to have pensions: work for us for 20 years or more, and when you retire, we’ll send you money until you die.
You can have systems like Social Security, which is largely “pay as you go,” (usually referred to with the somehow unsatisfying acronym “PAYGO”): current workers pay a portion of their current earnings into the system, and that money is sent back out the door as the benefit checks for retirees.
You can have a system that is “pre-funded”: the money collected from current workers doesn’t go out the door to pay current retirees, but is instead saved in some form, and then paid out when those current workers retire.
But the most important thing to understand about all those different systems is that underneath, they all do the same thing: They move purchasing power from people who are currently working to people who are currently retired.
“Sure, that’s how Social Security works, but not my Individual Retirement Account. I saved up money when I was working, and now I’m withdrawing that money and spending it. I did the responsible thing and provided for my own retirement, rather than expecting others to pay me when I was done working.”
The problem is right there in the phrase, “I saved up money.” You could replace that with stocks, bonds, any financial assets you like, or even art or jewels if they were key parts of your retirement portfolio.
Think about what you’re going to need and want in retirement: food, shelter, medical care, entertainment, travel.
Are those the things you’re storing up for retirement?
Do you have a room in your house where you squirrel away the food you’re going to eat between the ages of 67 and 82? Have you placed in there a doctor, a nurse, and the medical technology that will be useful when you’re 70? If you own your house, that is one piece of your real savings you can take care of now, but are you storing the electricity and gas you’ll use in the future? Have you stored up the paint job the house will need when you’re 70, or the roof replacement when you’re 75?
You saved money, or things that can be sold for money.
As a thought experiment, imagine an economy where the only output is some basic foodstuffs.
Alex grows wheat. Bill raises chickens. Chris raises vegetables. And Dana has a fruit orchard that he tends.
Ernie is retired. And so, by definition, Ernie is not producing any food.
Alex, Bill, Chris, and Dana are all engaged in producing the economy’s output. In this simple economy, each person’s income is the piece of the economy’s output that they produce: Alex’s income is the wheat she grows, Bill’s is his chickens and eggs, Chris’s income is a bunch of garden produce, and Dana’s is in tree fruits. Each of them owns the things they’ve produced.
Ernie has no income – he produced nothing. He might own money, but you can’t eat money, and when everybody’s done producing whatever they produce, Ernie still doesn’t own any food.
A, B, C, and D can trade amongst themselves, exchanging one type of food for another.
If Ernie has money, the others could presumably sell Ernie some of their food in exchange for money, but remember the rules of the thought experiment: the whole economy is these basic foodstuffs. When Alex swaps with Bill, she gives up something useful (wheat) in exchange for something useful (chicken meat and eggs). If she swaps with Ernie, she gives up her useful wheat in exchange for money, with which she can…do what?
10 years later, Ernie will be dead, Bill will be retired, and his daughter Betty will be doing the work of raising chickens, and the situation remains the same. Mostly, people produce things that people want and need, and swap them for other things that they want and need. But if Bill is to be able to survive in retirement, like Ernie before him, there has to be a system by which some of what is produced is moved from the people who are producing it right now, and redirected to others who are producing nothing right now.
An actual economy is obviously far more complicated than this, but it shares an underlying reality with our simple thought-experiment economy.
Those of us who are currently working are each playing our own small role in producing some small piece of all the stuff the economy produces. Our income is our share of what we (with others) produced, just as Alex’s income is the wheat she grows and Dana’s income is the fruit he harvests. We have claims on stuff because we’re currently helping to produce stuff.
Retirees, by definition, aren’t currently helping to produce stuff, so their claims on stuff come from – well, they come from some system of moving claims on stuff to themselves from people currently generating claims on stuff by producing stuff.
Now let’s see how each type of retirement system accomplishes this.
You can save money in a retirement account, on your own or through work.
Companies used to have pensions: work for us for 20 years or more, and when you retire, we’ll send you money until you die.
You can have systems like Social Security, which is largely “pay as you go,” (usually referred to with the somehow unsatisfying acronym “PAYGO”): current workers pay a portion of their current earnings into the system, and that money is sent back out the door as the benefit checks for retirees.
You can have a system that is “pre-funded”: the money collected from current workers doesn’t go out the door to pay current retirees, but is instead saved in some form, and then paid out when those current workers retire.
But the most important thing to understand about all those different systems is that underneath, they all do the same thing: They move purchasing power from people who are currently working to people who are currently retired.
“Sure, that’s how Social Security works, but not my Individual Retirement Account. I saved up money when I was working, and now I’m withdrawing that money and spending it. I did the responsible thing and provided for my own retirement, rather than expecting others to pay me when I was done working.”
The problem is right there in the phrase, “I saved up money.” You could replace that with stocks, bonds, any financial assets you like, or even art or jewels if they were key parts of your retirement portfolio.
Think about what you’re going to need and want in retirement: food, shelter, medical care, entertainment, travel.
Are those the things you’re storing up for retirement?
Do you have a room in your house where you squirrel away the food you’re going to eat between the ages of 67 and 82? Have you placed in there a doctor, a nurse, and the medical technology that will be useful when you’re 70? If you own your house, that is one piece of your real savings you can take care of now, but are you storing the electricity and gas you’ll use in the future? Have you stored up the paint job the house will need when you’re 70, or the roof replacement when you’re 75?
You saved money, or things that can be sold for money.
As a thought experiment, imagine an economy where the only output is some basic foodstuffs.
Alex grows wheat. Bill raises chickens. Chris raises vegetables. And Dana has a fruit orchard that he tends.
Ernie is retired. And so, by definition, Ernie is not producing any food.
Alex, Bill, Chris, and Dana are all engaged in producing the economy’s output. In this simple economy, each person’s income is the piece of the economy’s output that they produce: Alex’s income is the wheat she grows, Bill’s is his chickens and eggs, Chris’s income is a bunch of garden produce, and Dana’s is in tree fruits. Each of them owns the things they’ve produced.
Ernie has no income – he produced nothing. He might own money, but you can’t eat money, and when everybody’s done producing whatever they produce, Ernie still doesn’t own any food.
A, B, C, and D can trade amongst themselves, exchanging one type of food for another.
If Ernie has money, the others could presumably sell Ernie some of their food in exchange for money, but remember the rules of the thought experiment: the whole economy is these basic foodstuffs. When Alex swaps with Bill, she gives up something useful (wheat) in exchange for something useful (chicken meat and eggs). If she swaps with Ernie, she gives up her useful wheat in exchange for money, with which she can…do what?
10 years later, Ernie will be dead, Bill will be retired, and his daughter Betty will be doing the work of raising chickens, and the situation remains the same. Mostly, people produce things that people want and need, and swap them for other things that they want and need. But if Bill is to be able to survive in retirement, like Ernie before him, there has to be a system by which some of what is produced is moved from the people who are producing it right now, and redirected to others who are producing nothing right now.
An actual economy is obviously far more complicated than this, but it shares an underlying reality with our simple thought-experiment economy.
Those of us who are currently working are each playing our own small role in producing some small piece of all the stuff the economy produces. Our income is our share of what we (with others) produced, just as Alex’s income is the wheat she grows and Dana’s income is the fruit he harvests. We have claims on stuff because we’re currently helping to produce stuff.
Retirees, by definition, aren’t currently helping to produce stuff, so their claims on stuff come from – well, they come from some system of moving claims on stuff to themselves from people currently generating claims on stuff by producing stuff.
Now let’s see how each type of retirement system accomplishes this.
Types of showers
Social Security
The type of system where the flow is most obvious is a PAYGO system.
(Yes, Social Security also has a trust fund. For a couple of decades the money sent in as taxes was more than the money sent out as benefits, with the extra being sent to the trust fund, and for some years now the money being sent in is less than the benefits that are owed, so the difference is being made up by withdrawing from the trust fund. So it hasn’t been a pure PAYGO system. But even when the trust fund was accumulating, most of the money sent in as taxes did go out the door as benefits, and even now when we’re drawing on the trust fund, most of the money going out the door as benefits is coming from the taxes being sent in. So the core of the system is PAYGO.)
160 million people are working, earning claims on stuff by helping to produce stuff. 54 million retirees are receiving Social Security benefits. Social Security taxes take some of the claims on stuff from the people who are working, and send them to the people who are retired.
Abstracting from other taxes, if you get paid $100, you only get to decide what to do with $93.80 of that, because the other $6.20 is being collected from you and sent to a retiree. (Yes, there’s an additional $6.20 that your employer sends in, so it’s not wrong to think of it as: You’re earning $106.20, and $12.40 of that is being collected from you and sent to a retiree.)
Individual retirement account
(Yes, Social Security also has a trust fund. For a couple of decades the money sent in as taxes was more than the money sent out as benefits, with the extra being sent to the trust fund, and for some years now the money being sent in is less than the benefits that are owed, so the difference is being made up by withdrawing from the trust fund. So it hasn’t been a pure PAYGO system. But even when the trust fund was accumulating, most of the money sent in as taxes did go out the door as benefits, and even now when we’re drawing on the trust fund, most of the money going out the door as benefits is coming from the taxes being sent in. So the core of the system is PAYGO.)
160 million people are working, earning claims on stuff by helping to produce stuff. 54 million retirees are receiving Social Security benefits. Social Security taxes take some of the claims on stuff from the people who are working, and send them to the people who are retired.
Abstracting from other taxes, if you get paid $100, you only get to decide what to do with $93.80 of that, because the other $6.20 is being collected from you and sent to a retiree. (Yes, there’s an additional $6.20 that your employer sends in, so it’s not wrong to think of it as: You’re earning $106.20, and $12.40 of that is being collected from you and sent to a retiree.)
Individual retirement account
For this one, it doesn’t matter whether we’re talking about a formal IRA recognized in the tax code, or just some stocks and bonds you accumulated while you were working.
Think about what you have to do in order to use that account to support yourself in retirement. Every year, you take a portion of the assets there and sell them. Then you use the money to pay your expenses for the year.
Who bought the assets you sold? Around the edges, some of it could have been other retirees changing the allocations in their portfolios, but those other retirees are also, on balance, selling assets for money, not to acquire other assets. And so, on balance, the people buying assets from retirees are people who are working.
Those working people are getting claims on current output from the work they do helping to produce current output. There’s a portion of those claims they decide not to spend on stuff now, but instead to buy assets that they’ll hold onto for when they’re retired.
To stick with the numbers from the Social Security example above, if you’re earning $106.20, you might decide to spend only $93.80, and use the other $12.40 to buy assets from a retired person. There’s no tax structure involved, but $12.40 worth of claims on stuff is being moved from you – a person currently working – to a retiree.
Company pension, PAYGO
Think about what you have to do in order to use that account to support yourself in retirement. Every year, you take a portion of the assets there and sell them. Then you use the money to pay your expenses for the year.
Who bought the assets you sold? Around the edges, some of it could have been other retirees changing the allocations in their portfolios, but those other retirees are also, on balance, selling assets for money, not to acquire other assets. And so, on balance, the people buying assets from retirees are people who are working.
Those working people are getting claims on current output from the work they do helping to produce current output. There’s a portion of those claims they decide not to spend on stuff now, but instead to buy assets that they’ll hold onto for when they’re retired.
To stick with the numbers from the Social Security example above, if you’re earning $106.20, you might decide to spend only $93.80, and use the other $12.40 to buy assets from a retired person. There’s no tax structure involved, but $12.40 worth of claims on stuff is being moved from you – a person currently working – to a retiree.
Company pension, PAYGO
In the days of employer-operated pensions and health-insurance systems, there was some pre-funding (the company, like an individual building up their IRA, would buy some assets and set them aside to cover costs of retirees in the future). But there were also PAYGO elements, where benefits for retired workers was an item in the company’s overall costs.
Let’s say the company has $200 in revenue and $70 in costs of inputs (energy, materials, etc.). That leaves $130 to be divided between profits and compensation of employees. And let’s say the bargaining process between the company and its workers has resulted in the workers earning $106.20, and the owners getting $23.80 in profits.
Now we figure in a PAYGO pension plan. We’ve got to find $12.40 to support our retirees.
Maybe we raise our prices a little, so revenue goes up to $202. There’s a piece of it. Who paid that extra $2? Everyone buying our product, and most of those people are currently working, so we’re collecting claims on stuff from people who are currently working. Maybe profits go down, perhaps to $20.00, so there’s another $3.80. That’s not coming from people currently working, but it is coming from people who get income from owning the capital involved in currently making stuff.
We’ve got $5.80 covered, and the remaining $6.60 comes from a reduction in our employees’ salaries – another clear transfer away from people currently generating claims on stuff. The whole $12.40 is handed over to our retirees.
Company pension, pre-funded
Let’s say the company has $200 in revenue and $70 in costs of inputs (energy, materials, etc.). That leaves $130 to be divided between profits and compensation of employees. And let’s say the bargaining process between the company and its workers has resulted in the workers earning $106.20, and the owners getting $23.80 in profits.
Now we figure in a PAYGO pension plan. We’ve got to find $12.40 to support our retirees.
Maybe we raise our prices a little, so revenue goes up to $202. There’s a piece of it. Who paid that extra $2? Everyone buying our product, and most of those people are currently working, so we’re collecting claims on stuff from people who are currently working. Maybe profits go down, perhaps to $20.00, so there’s another $3.80. That’s not coming from people currently working, but it is coming from people who get income from owning the capital involved in currently making stuff.
We’ve got $5.80 covered, and the remaining $6.60 comes from a reduction in our employees’ salaries – another clear transfer away from people currently generating claims on stuff. The whole $12.40 is handed over to our retirees.
Company pension, pre-funded
The essence of this is no different than an individual retirement account. To draw on the retirement fund, the company has to sell assets in it. On balance, the people buying the assets are people who are generating new claims on stuff by working – that is, by producing stuff.
The takeaway
Every way of arranging retirement is a method of taking claims on stuff from people who are earning them by being involved in making stuff currently, and putting those claims into the hands of people who are no longer involved in making stuff.
That fundamental truth of retirement finance has a crucial implication for the sustainability of Social Security.
If someone says, “Social Security is unsustainable,” there are two ways of interpreting what they mean.
The first is that, as currently structured in terms of how we collect revenue for the system and how we calculate benefits to be paid out, the system cannot continue. This is a reasonable statement – a true statement, even. Tax revenue for the system is less than benefit payments, so we’re drawing on the trust fund. There are no plausible demographic or economic projections under which that changes any time soon, so the fund will be exhausted, and then revenues will only be enough to fund a smaller and smaller portion of what the system’s benefit formulas have promised people.
But “unsustainable under current rules” implies that it can be fixed by changing those rules, something I’ll discuss in a later post.
The second sense of “unsustainable” is that a system like Social Security is inherently flawed and can never work in the long run. In the extreme, people call it a “Ponzi scheme.”
But Social Security, like every other retirement system, is simply a way of moving claims on stuff from people currently working to people no longer working.
If Social Security is inherently unsustainable, then retirement itself is inherently unsustainable.
Don’t trust someone who tells you we should get rid of Social Security because it’s inherently unsustainable, but wants you to believe that something else will work.
Next time: Social Security’s sense of fairness and the elegant balance of goals
That fundamental truth of retirement finance has a crucial implication for the sustainability of Social Security.
If someone says, “Social Security is unsustainable,” there are two ways of interpreting what they mean.
The first is that, as currently structured in terms of how we collect revenue for the system and how we calculate benefits to be paid out, the system cannot continue. This is a reasonable statement – a true statement, even. Tax revenue for the system is less than benefit payments, so we’re drawing on the trust fund. There are no plausible demographic or economic projections under which that changes any time soon, so the fund will be exhausted, and then revenues will only be enough to fund a smaller and smaller portion of what the system’s benefit formulas have promised people.
But “unsustainable under current rules” implies that it can be fixed by changing those rules, something I’ll discuss in a later post.
The second sense of “unsustainable” is that a system like Social Security is inherently flawed and can never work in the long run. In the extreme, people call it a “Ponzi scheme.”
But Social Security, like every other retirement system, is simply a way of moving claims on stuff from people currently working to people no longer working.
If Social Security is inherently unsustainable, then retirement itself is inherently unsustainable.
Don’t trust someone who tells you we should get rid of Social Security because it’s inherently unsustainable, but wants you to believe that something else will work.
Next time: Social Security’s sense of fairness and the elegant balance of goals
Enjoyed reading that. But next time, shouldn't it be the "elegant balance of ghouls"?
ReplyDeleteSure
DeleteHi Karl. I'm glad you are writing again and enjoyed this lesson! Best to you and your family!
ReplyDeleteGreat to hear from you, Rob!
DeleteWe're doing well. Well, you know, "well," given the broader context.
I just published the next part:
https://thedanceofthehippo.blogspot.com/2025/04/after-social-security-elegant-balance.html
Say hi to Joanne.