Tuesday, October 2, 2012

Social Security - Tax, Investment, Safety Net, Annuity, or Wealth Transfer Scheme?

Is Social Security a Tax, an Investment, Safety Net, Annuity, or a Wealth-Transfer Scheme?  It is a little of each.

A reader recently took me to task for my analysis on Social Security.  I cranked the numbers, based on my income over the years, and came to the conclusion that what I will get out will be about what I paid in, plus 4% interest.

The reader pointed out, correctly, that Social Security is non-linear.  For middle-class people making a median income (about $51,000 a year) they might get back what they pay in, plus a modest interest rate of return.  For those who paid in the minimum, however, the amount paid out might far exceed that ever paid in.  And for those making at or above the maximum taxable amount (about $108,000 as of this writing), they might get out less than they paid in.

And the reader, who fell into the latter category, felt this was a total rip-off.  And not surprisingly, many folks in his situation think that they would be better off "investing" that money and thus favor things like "privatizing" Social Security.

But that point of view is assuming that Social Security is an investment, which it is not.  In a way, Social Security is like the story of the three blind men and the elephant.  One feels the tail and proclaims it to be a snake.  One feels the flank, and assumes it is a stone wall.  The other feels the trunk and, well, I don't remember what he thought it was.  The point is, what you think you see in Social Security has a lot to do with your perspective.

Social Security is, in a way, like a Life Annuity.   You pay into it over time, and when you retire, you get a fixed amount (with adjustments for inflation) until you die.   And like any Annuity, if you live only for a year into retirement, you get very little for what you paid in.   Annuities are "unfair" this way, of course, but the flip side is that if you live until 110, you still get paid.  And that is the point of an Annuity - and Social Security - that the amount you get out is going to depend on how long you live.  Like an insurance policy, we pool the risk of living too long, among a large number of people.  We all pay in, and spread the risk.

Social Security is also a Safety Net, in that no matter how much money you end up with when you retire, the Social Security is there for you, if you should lose it all.  My intrepid reader assumes that when he retires, he will be wealthy - and would be wealthier, if not for all that Social Security tax money he had to pay.   But he fails to realize that between now and retirement, he could literally "lose it all" - to poor investment decisions, personal problems (divorce, drug use, etc.), lawsuits, or any one of a number of scenarios.   And I've seen this happen to people here on retirement island, more often than not.  Once they were high-flying $150,000-a-year "consultants" and now they are destitute and living on Social Security.  That "safety net" is all that have left, and they are lucky to have it.

Social Security is also a Tax.  Yes, anytime the government takes money from you, it is a tax.  The idea that there is a Scrooge McDuck Money Vault with "your" Social Security money in it, is a fantasy.   There is no money "set aside" for you by the Social Security Administration.  The money comes in, is replaced by an I.O.U. from the Treasury, and then goes right back out again into the general revenue fund of the U.S. Government.  Current benefits to Social Security recipients are paid out from the general fund, basically.    Thus, the idea that Social Security will "run out of money" are idiotic, as there is no fund of money to "run out of".

When Social Security faces a shortfall, which it does every decade or so, they raise the upper limit cutoff for taxation.  A decade ago, it was about $88,000.  Today, it is about $108,000.  Why this is not automatically indexed for inflation is beyond me.  However, by leaving it at fixed numbers, the GOP can allow Social Security to periodically "starve" and then claim it is "in crises".  The Democrats then raise the cutoff, which is what should have been done, anyway, and the GOP can accuse them of creating the "biggest tax increase ever!"  It is a stupid game, but that is what Washington, D.C. is all about.  And the biggest punchline is that the folks making $50,000 a year, who are largely unaffected by all of this, are lead to believe that their taxes have been raised.

Social Security is not really an Investment, however.  Unfortunately, the Social Security Administration now sends out these little portfolios every year, showing how much money you will get when you retire.   This is an implied promise of a benefit, and even with disclaimers, it is hard not to use Social Security numbers in your retirement planning.   The portfolio they send out makes Social Security look like an investment - that you paid in, over the years, and you will get paid back, when you retire.   But it is not that.

And many on the right have argued that it should be an investment.  George Bush argued that Social Security should be "Privatized" and people allowed to invest "their money".  The problem with privatization is that some folks will invest poorly, or the market will tank when they want to retire (timing issues) and some will do well, while others suffer, through no fault of their own (or due to their own poor handling of money).

At that point, those folks would starve - and we cannot allow that to happen in this country (literally, we cannot and would not).  So a safety net for the safety net would be needed - and more people would end up on SSI - Supplement Income, which is like welfare for the elderly.

Social Security is a bit of a Wealth-Transfer Scheme, however.  As my reader pointed out, many people on the bottom end of the scale get back a lot more than they paid in.  However, we are talking the bottom of the scale - the amount paid out by Social Security is so paltry that they would be living far below the poverty line.  And without Social Security, they would starve, as they saved little or nothing in their lives, either through choice or circumstance.

Those at the top of the pile pay in, but get back less, in proportion to their income (this is assuming that both rich and poor live equal-length lives, but this, of course, is not true.  The poor die off far sooner than the wealthier).

But there are other scenarios where Social Security transfers money from one person to another, not based on money paid in.  For example, if you are disabled, you can collect Social Security disability, which, while based somewhat on what you paid in, usually will pay out far more.    And yes, there is fraud and abuse in this area.  I know a number of people who claim disability under Social Security for various ailments that seem somewhat specious.   They are not missing limbs or eyes or anything, and seem to enjoy vigorous activities in their lives.  For some reason, however, these activities don't include work.
And then there are just weird scenarios where people get money for no apparent reason.  A wealthy friend of mine got $200 a month checks because his Father was retired while he was still a minor.   Another friend got a check because he was a minor when his Mother died.  Neither "needed" the money - it was an entitlement handed to them.  And maybe this - and disability - are where we can tighten the belt somewhat.   But as with our tax laws, for every incremental dollar you spend policing the system, you recover less and less in terms of money saved.  So there reaches a point where you accept a certain level of cheating as inevitable - and that makes a lot of people understandably mad.

Does Social Security need "fixing"?  Is it in "Crises"?  These are political hot-button topics, and buzzwords used to get people upset, using baiting techniques.   Perhaps I am a bit jaded, but since the day I was born, over a half-century ago, people have been saying that Social Security is in "crises" and needs an "overhaul".  And yet, every time around, the system seems to get fixed, mostly by raising the cutoff rate on the Social Security tax, or by cutting benefits slightly (such as by making them taxable, which was done, as I recall, in the 1980's).

Some on the Right have suggested, oddly enough, putting a "needs test" or "means test" on Social Security, so that if you are super-rich, you don't collect benefits.   This is very odd, as if a "needs test" was put on Social Security, this would make it more of a wealth-transfer scheme and less of an investment.   And yet many Republicans are arguing that this will "fix" Social Security.

But, like with anything else, I have long given up trying to make sense of Republicans.  The party of smaller government ends up expanding government.  The party of fiscal responsibility ends up the party of big spending and huge deficits.  The party of rugged individualism and personal freedom ends up as the party wanting to snoop into your bedroom.  And with "means testing" the GOP now proposes turning Social Security into a full-blown welfare program.    Predictably Irrational, they are!

My reader argues that the system is "unfair" to him, as he has to pay this money in, and has no hope of getting it all back.   I am not sure that is a valid argument, as no one has a guarantee of getting anything back, particularly if you die at age 61 and never collect.   Moreover, the idea that you "get back" everything in taxes that you paid in, is somewhat specious.   Does he complain that he isn't getting his fair share of highways out of his gasoline tax?  That his income tax doesn't pay him back in terms of direct or indirect benefits to him?

Taxation, which is what Social Security is, takes money from all of us, hopefully in an equitable manner, and uses it to spend on the public good.   The disputes, of course, are whether the tax is collected in an equitable manner and whether they are spent on the public good.    With many folks who are mega-rich paying little in taxes (in terms of percentage of income) and many on the other end of the scale paying nothing, it seems like an unfair collection system.

And some might argue that spending $361 Million each, on an already out-of-date jet fighter, is not a smart use of that tax money.  Others might argue that it acts as a deterrent.  Still others might argue that the money spent is mere welfare for certain defense contractors (disclaimer:  I am a defense contractor).

And yes, some will argue that things like welfare, social security, SSI, disability, Medicare, and the like, are "unfair" in that the amount paid in by some, goes to pay others.   But the alternative is to allow people to live destitute lives, at the bottom-end of our society - starving in the streets like in some third-world country.   Not only is that not desirable, it is not sustainable.   Starving people tend to storm the gates of the very rich - eventually.

Some folks, such as Mitt Romney and his 47% comments, that the people who get paid out of the system, don't pay in their "fair share".   But if you think about this, it makes no sense.  If they could afford to "pay in" to the system, and get back exactly what they paid in, why bother with taxes at all?   But of course, that is their point - abolish all taxes, except those that fund huge defense programs, of course!   The idea that we can ask someone making $20,000 a year to pay in all they take out is somewhat specious.

And one might argue that these "safety nets" or other programs allow people to work for minimum wage in our economy.   And in fact, such government intervention in their lives might be preferable to letting them manage their own money - as the poor, by their very nature, do a piss-poor job of that.  Left to their own devices, the poor will spend money on a Jet-Ski, before they buy health insurance or fund their own retirement.  And yes, I see this first-hand, all over America.  And we end up paying for them, anyway, in terms of emergency room care and SSI payments.

And yea, some folks call that the "Nanny-State", and maybe they are right about that.  But from where I sit, I see a lot of very stupid folks out there (having just driven through the Carolinas and rural Virginia, as well as Augusta, Georgia) who could use a good Nanny, if not indeed, a good spanking now and then.

But I am not sure that abolishing or "fixing" Social Security is the spanking they need.   What we need to do - and what will inevitably happen, thanks to AARP - is that the tax limit for Social Security will be raised, from $108,000 to $125,000 or some other number, and more money will pour in.  The "crises" will be solved, and eventually, all those Baby Boomers will die off, and the system will balance out.

It's either that, or Soylent Green.