Is Social Security a pyramid scheme.
Monday, July 4, 2011

SocSec & Pyramids

Pyramid schemes typically benefit the earliest participants the most. When Social Security was instituted back in the 1930s some people were able to start drawing almost immediately, and they continued drawing for the rest of their lives. Other poor slobs were at the start of their working lives, and paid in for forty or more years to retire in their 60s or slightly older.

Social Security was predicated on the idea that there would be a small number of people drawing out, and a larger number paying in. The people drawing out would soon die, and the number of people paying in would remain high. So there would be a constant transfer of money from the poor working slobs to the retirees, who were doomed to die in a short time.

Things didn’t work out that way. Medicine enabled people to survive longer. So the number of people drawing out increased. Despite a baby boom that started in 1946 and went on through the late 1950s and early 1960s, people entered the work force later, and the baby boomers themselves had fewer children than their parents. So you have an aging population at the top, and that population is not leaving soon enough. Combine that with another population that’s entering the work force later, and that’s not having enough children, and add in policies that permit drastic forms of population control, and you have a disaster coming.

I’m not sure of the accuracy of the numbers involved, but I’ve seen it claimed that at the beginning Social Security had 42 workers supporting 1 retiree. At present the ratio is 3 workers for 1 retiree. You can picture this as shown in the figure below. The first triangle represents the original situation, and the second is the current arrangement. How can you change the ratio of workers and retirees so that it is closer to the first? Several answers come to mind. Not all of them are moral, and not all of them are politically possible.

  1. Stop paying for medicine and treatment after a certain age. Let them die.
  2. The monkey house solution. In Kurt Vonnegut’s Welcome to the Monkey House old people are actively encouraged to commit suicide.
  3. Raise the retirement age to closer to the average age of death.
  4. Discourage people from prolonged schooling.
  5. Do away with child labor laws, and get them into the work force earlier.
  6. Increase the number of foreign workers coming into the country, and paying Social Security taxes.
  7. Increase taxes.

1 and 2 are off the table for pretty obvious reasons. 3 might be possible, but people already near retirement age won’t like it, and it’s politically risky. 4 is also politically risky because of generations of propaganda linking a good education with wealth and better job prospects. 5 is never going to happen. 6 is possible under the guise of illegal immigration amnesty. 7 is every liberal pol’s favorite option, but will meet with opposition from tea party and small government types.

You could also hold the payments for retirees steady with no adjustments for inflation. The amount paid out in real dollars, i.e., inflation adjusted dollars, will decline, and eventually the income from taxes will equal the outgo to retirees. This, however, means that the beneficiaries, as time goes by, will live in increasingly impoverished circumstances.

The best thing, however, is to do Social Security right. The original system, as I’ve said, is based on transfer payments. That is not income from investments. That’s income from people coming into the work force, and staying for an extended time, and consenting to the transfer of their money to someone else. This requires a steady population influx and a high ratio of workers to retirees/beneficiaries. Investment, in a company such as Apple, or Verizon, requires that the company make a profit, or, if it issues bonds and preferred stock, that it make payments on time. If Social Security was put on an investment footing, rather than transfer payments, people would make investments in companies, and would, depending on their vigilance and competence, receive rewards that outmatch the performance of the securities (U. S. Treasuries) that make up the Social Security trust fund.

The conversion to private funding, along the lines of current 401(K) plans, will have to happen gradually in order not to impoverish current beneficiaries, but it has to happen.