Judd W. Patton, Ph.D. (Biography) Bellevue University Online
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Six Misconceptions About Social Security

by
Dr. Judd W. Patton

     Social Security is headed for bankruptcy! No one disputes this fact, too many retirees to workers in the future. The dispute is over what to do - you know - reform proposals. Proposals range from raising the retirement age, to raising the payroll taxes, to cutting benefits, to eliminating the limit on earnings subject to the payroll tax, to having government trustees invest a portion of the Trust Fund in private assets, to letting individuals invest a portion of their payroll  taxes into their own retirement accounts or into stocks, bonds, and mutual funds. The debate is on!

    In the spirit of intellectual inquiry and academic interest in a genuine reform of Social Security, the following six misconceptions are offered to clarify the discussion.

Social Security Taxes are Contributions

     Not! From its inception in 1935, Social Security - officially known as Old Age and Survivors Insurance (OASI) - has been compulsory. Try telling your employer you plan to end your "contribution" and see how voluntary it is! The Federal Insurance Contribution Act (FICA), is a misnomer of the first magnitude. Social Security payroll taxes are taxes.

     More importantly, Americans do not have a legal right to these taxes. In 1960 in Flemming vs. Nestor, Mr. Nestor sued the Federal government claiming he had a right    to collect Social Security benefits since he had paid his Social Security "contributions." The U.S. Supreme Court ruled that he, and all workers, have no such property right. "I paid in, I contributed, and therefore I deserve my benefits," is, therefore, a common  mis-belief among Americans. Congress can change, as the current debate reveals, any and all criteria as to benefit amounts, tax rates, retirement age, etc. They can cut or eliminate benefits regardless of workers' so-called "contributions."

Social Security is Constitutional

     This misconception is easy to identify and confirm. Blow the dust off your United States  Constitution booklet, and go to Article I, Section 8. Our Founders enumerated 20   powers or areas for the Federal Government. All other areas "are reserved to the States respectively, or to the people" (Amendment 10). Can you find a power giving the Federal government the responsibility to care for the retirement welfare of American citizens? I will give you five minutes to find the answer! For the record, there is no such power and no such amendment has ever been passed giving such authority. Social Security is unconstitutional.

Workers pay Only One-Half of Social Security Payroll Taxes

     Well, it is true that workers today pay 6.2% of their earnings (up to an earnings limit of $72,600) and the employer pays the 6.2% as well. Yes, that adds up to 12.4% in payroll taxes. (Self employed pay 15%.) But as economists often say, "There ain't no such thing as a free lunch." That 6.2% "mandated benefit" is not free; it forces employers to reduce workers' market- determined salaries or fringe benefits. Otherwise, the mandated cost  would inflict losses on employers, causing unemployment. In other words, mandated benefits simply replace market- determined benefits and/or monetary compensation. Economically this means that workers, in fact, pay the full 12.4%. The bottom line is don't be fooled: It's your money the employer is sending to Washington, D.C.

Social Security is a Government Insurance Program

     Superficially, Social Security appears to be just a government pension plan for the   elderly. Rather, it is a pyramid or Ponsi scheme. It is not based on sound principles of insurance. Private insurance companies invest the premiums of their customers in stocks and bonds and other income-producing assets. Real wealth is created. Later, the earnings from that wealth is used to pay annuities or pensions. But Social Security is not a savings-and-investment program. Social Security taxes (premiums?) create no wealth. The payroll taxes are not invested, but are used to pay current retirees and survivors under the program. It's called a pay-as-you-go system. Some call it an intergenerational income-transfer program. It is indeed!

     Now understand this, please. A pyramid or Ponsi scheme (illegal in all 50 states) works under the unsound and unethical principle that early investors are paid handsome returns with cash taken from later investors. As long as more and more investors (suckers) are attracted, the scheme works and appears to be successful. Eventually, however, the system  collapses with the inevitable decrease in the number of new investors. In like manner, Social Security seemed to work well in the early years when there where few eligible retirees and lots of workers. A person retiring in 1940 could get an inflation-adjusted return of 135%!! But as the ratio of workers to retirees has declined over the decades, so has the average expected return, now 4% in 1999. A minus return is a distinct possibility in the near future. One wonders what Mr. Ponsi would have thought about Social Security "stealing" his idea.

Social Security can be saved by Federal Budget Surpluses

     In fiscal 1998, our government ran a $70 billion surplus, the first since 1969. Some politicians propose saving Social Security with these and future surplus funds. It's ironic, but the budget surplus was generated by "raiding" the Social Security trust fund and   other trust funds in the first place! Here's what happened and happens generally.

     In 1998 the Social Security trust fund had its own surplus of $99 billion dollars. It wasn't invested to create real wealth and an income stream. That is not permitted. These funds are, by law, borrowed or "invested" into a special class of non-marketable U.S. Treasury securities ( government IOUs). The SS surplus then ends up in the Treasury's general fund and is subsequently spent on other government programs. Some Trust Fund! Since1970 these SS surpluses have financed, in part, government deficit spending. However, in 1998, with a booming economy, "borrowing" from the SS trust fund actually helped generate a Federal budget surplus.  But understand this. If the trust funds had not been "raided," the general budget would have had a significant deficit, just like the preceding 28 years.

     And in all likelihood all the talk about what to do with these "supposed" budget surpluses would not have emerged!

     The key point to understand is that the Social Security trust fund is nothing more than a pile of IOUs. These non-marketable IOUs are not assets but unfunded liabilities, government investing in its own debt. They represent payroll taxes that have been diverted to general spending. When Social Security outlays eventually exceed payroll taxes, expected in about 2012, the government will need to raise taxes, cut its spending, or borrow more money to pay off the debt (IOUs) to the Social Security trust fund when the SS managers redeem the IOUs.

     So, to answer the question, can Social Security be saved or "fixed" by not "raiding," or by "raiding" less of its own excess revenue (Present Clinton's proposal)?  Of course not, it is still a Pyramid scheme relying on more and more workers to retirees, just the opposite demographic as to what is actually occurring - more retirees to workers in the next century.

     Social Security can be saved by Privatization Investing retirement money into the creation of real wealth is an essential element to any economically sound reform of Social Security. Thus privatization, the act of converting a government- run program into a private activity, appears appropriate at first glance. However, a private pyramid scheme is just as unsound as a government one. Current proposals to have government trustees invest a portion of the SS trust fund into the stock market, or to establish "private accounts" where individuals make their own investment decisions (within certain government guidelines of course), is privatization-lite at best. Truly these proposals are not boni-fide privatization reforms in any meaningful sense of the word. The latter idea would be better classified as a mandatory savings program - a truly socialist proposition with its own grievous flaws.  Americans would not be free to use "their" money as they see fit. For example, they could not withdraw it or decide how much to "contribute." Taxation and government oversight can never be a feature of real privatization.

Conclusion

     The Social Security system, passed in 1935, is not a legitimate, savings-investment, insurance program. Taxes are not invested into real, income-earning assets. There is no trust fund but in name only. Americans have no property right in their supposed "contributions." The Social Security system today is a compulsory, redistributive, unconstitutional, pyramid scheme that contains the seeds of its own destuction given the demographics of the next 30 years. Reforming  or "tweeking" a corrupt system is not a meaningful option. There is only one true privatization reform of Social Security. There is only one  Constitutional solution. There is only one economically and morally sound system. Our nation must begin the difficult but manageable process of dismantling the Social Security system - yes, in total. The sooner the debate begins on how best to do it, on how to transition to free-market retirement options with their vast array of investment and retirement program choices, the sooner all Americans will remove the
social insecurity in their futures.

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