Guest Post: Social Security: The New Deal’s Fiscal Ponzi

Tyler Durden's picture

Submitted by David Stockman via the Ludwig von Mises Institute,

The Social Security Act of 1935 had virtually nothing to do with ending the depression, and if anything it had a contractionary impact. Payroll taxes began in 1937 while regular benefit payments did not commence until 1940.

Yet its fiscal legacy threatens disaster in the present era because its core principle of “social insurance” inexorably gives rise to a fiscal doomsday machine. When in the context of modern political democracy the state offers universal transfer payments to its citizens without proof of need, it offers thereby to bankrupt itself—eventually.

By contrast, a minor portion of the 1935 legislation embodied the opposite principle—namely, the means-tested safety net offered through categorical aid for the low-income elderly, blind, disabled and dependent families. These programs were inherently self-contained because beneficiaries of means-tested transfers simply do not have the wherewithal—that is, PACs and organized lobbying machinery—to “capture” policy-making and thereby imperil the public purse.

To the extent that means-tested social welfare is strictly cash-based, as was cogently advocated by Milton Friedman in his negative income tax plan, it is even more fiscally stable. Such purely cash based transfers do not enlist and mobilize the lobbying power of providers and vendors of in-kind assistance, such as housing and medical services.

Social insurance, on the other hand, suffers the twin disability of being regressive as a distributional matter and explosively expansionary as a fiscal matter. The source of both ills is the principle of “income replacement” provided through mandatory socialization of huge population pools.

On the financing side, the heavy taxation needed to fund the scheme has been made politically feasible by the mythology that participants are paying a “premium” for an “earned” annuity, not a tax. Consequently, payroll tax financing is deeply regressive because all participants pay a uniform rate regardless of income.

At the same time, benefits are also regressive because those with the highest life-time wages get the greatest replacement. This regressive outcome is only partially ameliorated by the so-called “bend points” which provide higher replacement on the first dollar of covered wages than on the last.

The New Deal social insurance philosophers thus struck a Faustian bargain. To get government funded pensions and unemployment benefits for the most needy, they eschewed a means test and, instead, agreed to generous wage replacement on a universal basis. To fund the massive cost of these universal benefits they agreed to a regressive payroll tax by disguising it as an insurance premium. Yet the long run results could not have been more perverse.

The payroll tax has become an anti-jobs monster, but under the banner of a universal entitlement organized labor tenaciously defends what should be its nemesis. At the same time, the prosperous classes have gotten a big slice of these transfer payments, and now claim they have earned them—when affluent citizens should have no proper claim on the public purse at all.

Accordingly, social insurance co-opts all potential sources of political opposition, making it inherently a fiscal doomsday machine. It was only a matter of time, for example, before its giant recipient populations would capture control of benefit policy in both parties, and most especially co-opt the conservative fiscal opposition.

Within a few decades, in fact, Republican fiscal scruples had vanished entirely. This was more than evident when Richard Nixon did not veto but, instead, signed a 20 percent Social Security benefit increase on the eve of the 1972 election. Worse still, the bill also contained the infamous “double-indexing” provision which since then has generated massive hidden benefit increases by over-indexing every worker’s payroll history. The fiscal cost of relentless universal benefit expansion has driven an epic increase in the payroll tax. The initial 1937 payroll tax rate was about 2 percent of wages, but after numerous legislated benefit increases, the addition of Medicare in 1965, the Nixon benefit explosion and the Carter and Reagan era payroll tax increases, the combined employer/employee rate is now pushing 16 percent (including the unemployment tax).

Accordingly, Federal and state payroll taxes for social insurance generate $1.2 trillion per year in revenue—four times more than the corporate income tax. So with the highest labor costs in the world, the U.S now imposes punishing levies on payrolls. It thus remains hostage to a political happen-stance—that is, the destructive bargain struck eight decades ago when high tariff walls, not containerships loaded with cheap goods made from cheap foreign labor, surrounded it harbors.

Yet there is more and it is worse. The current punishing payroll tax is actually way too low—that is, it drastically underfunds future benefits owing to positively fictional rates of economic growth assumed in the 75-year actuarial projections. As a result, the benefit structure grinds forward on automatic pilot facing no political opposition whatsoever. In the meanwhile, the fast approaching day or reckoning is thinly disguised by trust fund accounting fictions.

In truth the trust funds are both meaningless and broke. Annual benefit payouts already exceed tax receipts by upward of $50 billion annually, while the so-called trust funds reserves—$3 trillion of fictional treasury bonds accumulated in earlier decades—are mere promises to use the general taxing powers of the US government to make good on the rising tide of benefits.

The New Deal social insurance mythology of “earned” annuities on “paid-in” premiums that have been accumulated as trust fund “reserves” is thus an unadulterated fiscal scam. In reality, Social Security is really just an intergenerational transfer payment system.

Moreover, the latter is predicated on the erroneous belief that new workers and wages can be forever drafted into the system faster than the growth of benefits. During the heady days of 1967, for example, Paul Samuelson and his Keynesian acolytes in the Johnson administration still believed that the American economy was capable of sustained growth at a 5 percent annual rate. The Nobel Prize winner thus assured his Newsweek column readers that paying unearned windfalls to current social security beneficiaries was no sweat: “The beauty of social insurance is that it is actuarially unsound. Everyone ... is given benefit privileges that far exceed anything he has paid in ...”

Samuelson rhetorically inquired as to how was this possible and succinctly answered his own question: “National product is growing at a compound interest rate and can be expected to do so as far as the eye can see. ... Social security is squarely based on compound interest ... the greatest Ponzi game ever invented.”

When 5 percent real growth turned out to be a Keynesian illusion and output growth decayed to 1–2 percent annual rate after the turn of the century, the actuarial foundation of Samuelson’s Ponzi game came crashing down. It is now evident that Washington cannot shrink, or even brake, the fiscal doomsday machine that lies underneath.

The fiscal catastrophe embedded in the New Deal social insurance scheme was not inevitable. A means-tested retirement program funded with general revenues was explicitly recommended by the analytically proficient experts commissioned by the Roosevelt White House in 1935. But FDR’s cabal of social work reformers led by Labor Secretary Frances Perkins thought a means-test was demeaning, having no clue that a means-test is the only real defense available to the public purse in a welfare state democracy.

When the American economy was riding high in 1960, Paul Samuelson’s Ponzi was extracting payroll tax revenue amounting to about 2.8 percent of GDP. A half century later, after a devastating flight of jobs to East Asia and other emerging economies, the payroll tax extracts two-and-one half times more, taking in nearly 6.5 percent of GDP. So the remarkable thing is not that wooly-eyed idealists who drafted the 1935 act succumbed to social insurance’s Faustian bargain at the time. The puzzling thing is that 75 years later—with all the terrible facts fully known—the doctrinaire conviction abides on the Left that social insurance is the New Deal’s crowning achievement. In fact, it is its costliest mistake.

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Kreditanstalt's picture

"...the so-called trust funds reserves—$3 trillion of fictional treasury bonds accumulated in earlier decades—are mere promises to use the general taxing powers of the US government to make good on the rising tide of benefits."

 

Good way to look at it.  Payouts backed by nothing more than government's "monopoly on violence within a given territory".

Pay up (labor for us!) or we steal your property, jail or kill you.

Mr. Hudson's picture

FDR pretended to be crippled so he wouldn't have to have sex with Eleanor.

ChanceIs's picture

If he wasn't crippled before he cheated on Eleanor, he would have been afterwards.  Eleanor was smart.  She took her revenge.

Hillary used to run around the White House pretending to "channel" Eleanor.  Must have been during MonicaGate.  Gag.  Nixon used to talk to the portraits near the end.

rubiconsolutions's picture

The fact that none of us can opt out of Social Security trumps everything else. I'm 58 and would be happy to sign a document indemnifying others from supporting me in the future if I could opt out right now and take what has been stolen from me by way of FICA "contributions".

And on David Stockman, where the hell was he when he was in a position to do something about all this? He's like any other government hack that sucks on the public teat but then feels free to badmouth it after they retire.

 

samsara's picture

Well,  If you worked for the Rail Road (like the NYC...)  they have their OWN pension. And they don't pay into Soc Sec.

 

 

ISEEIT's picture

Ever hear of maturity?

Learning?

changing?

Growing?

 

Umh's picture

Politicians are well known for creating problems that appear after they leave office.

ISEEIT's picture

And even better known for creating 'problems' as a justification for being in office.

BidnessMan's picture

The issue is getting re-elected is all that matters to a politician. Giving away lots of money to lots of people attracts votes.

"We all know what has to be done. We just don't know how to get re-elected if we do it."

omi's picture

I was interested in researching some overview about how to go about computing mortgage prepaymnets, and I found this Yale course videos posted online interesting. Later I went and checked previous videos. Have a look at videos number 12 and 13.

http://www.youtube.com/watch?v=ecqWJ_7ERCI&list=PL6D3D85513B662773

In those videos, they go through a model calculation of utilities with and without social security. In any case, only the first generation wins. Every subsequent generation is worse off.

 

LongBallsShortBrains's picture

" the heavy taxation needed to fund the scheme has been made politically feasible by the mythology that participants are paying a “premium” for an “earned” annuity, not a tax. Consequently, payroll tax financing is deeply regressive because all participants pay a uniform rate regardless of income."

" At the same time, the prosperous classes have gotten a big slice of these transfer payments, and now claim they have earned them—when affluent citizens should have no proper claim on the public purse at all."

When you sell it (social security) as an insurance product, don't be surprised when people want that for which they have paid. It wouldn't have been swallowed if it's true commie results (intentional) had not been purposely obscured. Those who wanted it passed knew this, hence the deception.

Hail Spode's picture

Stick it Stockman.   The problem with SS isn't that it is not means tested.   The problem (for starters) is that it is unconstitutional and that politicians stole everything in the "trust" fund.     Now that outlays exceed inflows it is time to dip into that "trust" fund which isn't there.   So instead of delivering what is supposed to be in the "trust" fund to people who have been paying in all their lives, the neocons want to means test it.   That way, instead of blowing it on the people it was meant to go to ( who have been paying in all their lives monies specifically allotted to SS) the money will be spent on defense contractors so that they can give more weapons to Al-Queada, blow bridges up and rebuild them, and station U.S. troops in every mudhole on the planet.

It is all about the neocons who spent all the money from the trust fund trying to look for some out so that politicially they can get away with avoiding cuts to their budgets in order to make good on the promises.

401K of Dooom's picture

Hey everybody, here are some fun questions to ask the old codger who screams that his social security payment is his money:

 

1.)  What statute enacted and covers Social Security?

2.)  What is the correct name for Social Security?

3.)  How much compensation are you entitled to receive under Social Security?  This I ask because there does not seem to be a limit to the amount of money that Social Security can give to a single person. 

4.)  What is the current ration of recipients to contributors?  What was this ratio when Social Security was enacted in 1935?

 

 

Escapeclaws's picture

Ponzi or not, it's the only thing for most retirees between them and the wolf at the door.

AnAnonymous's picture

The payroll tax has become an anti-jobs monster, but under the banner of a universal entitlement organized labor tenaciously defends what should be its nemesis.
____________________

Nopey, nopey. The anti jobs monsters are depletion of resources. Work consumes resources. And concentration of wealth. As wealth is concentrated in an area, certain jobs are no longer valued enough to allow living in wealth concentrated areas.

'Americans' at best try to mitigate those effects with their tax policies.
Which amounts to taking a one mile walk once in a week in order to burn all those joules you get by eating ten super meaks a day.

TheFourthStooge-ing's picture

Dopey, dopey. More fantasy from AnAnonymous. Should anyone be surprised by that?

Chinese citizenism or the art of making no sense.

Flakmeister's picture

Ahh, all those Hedgies who would gladly suck Paul Ryan's cock are out in full force for this one, no surprise...

Don't forget to bring your copy of Atlas Shrugged so he can sign it for you....

Totentänzerlied's picture

You of all people should really know better. This was just another idiotic Ponzi scheme predicated entirely upon the cheapness of energ, or a specific effect of that - rapidly growing populations and rising standards of living/per capita wealth.

Flakmeister's picture

There *were* a lot of built in assumptions, but they apply to *every* aspect of the "American Way of Life", not just SS...

BTW, I am not debating the Ponzi nature of SS, only pointing out the intellectually bankrupt failing the realize that those assumptions are very broad and extend beyond SS. Haters gotta hate, I guess....

Totentänzerlied's picture

... tell me something I don't know?