The Myth That Elections Can Be Bought

One of the most popular myths in America today is that well funded political candidates can 'buy' an election by outspending their opponent while campaigning.

For example, here is a June 2014 article entitled 'Crony capitalists rule, and Cantor’s defeat won’t change that', that goes into detail about ad campaigns and large political contributions — though it is obviously biased, in that it emphasizes Republican donors, while ignoring Democratic donors — but the author fails to acknowledge the obvious point that it is the public that must be bought, since a candidate cannot win an election without popular support —
     http://finance.yahoo.com/blogs/daily-ticker/crony-capitalists-rule--and-cantor-s-defeat-won-t-change-that.html
     http://archive.is/bjxep

So how does buying an election work?  The author of the article above states that it can be hard to even find out who the incumbent challengers are in an election —

...
What that money buys is saturation media presence for the best-funded candidates, and sophisticated campaign ads that subtly smear underfunded challengers. In some races, it's hard for voters to even learn the names of challengers.
...

But the implication of that statement — that candidates with the most funding somehow make it hard for voters to find out who else is running in an election — is obviously absurd.  This often heard complaint that the best-funded candidates cannot be defeated, depends on the unstated condition that voters make little effort to find out what is going on, and rely primarily on political commercials they see during their favorite television shows — but that does not mean it is hard to find out who is running in an election.  And notice that limiting the campaign spending of well funded candidates does nothing to address the author's criticism, even if it is true, since it will not somehow make it easier to find out about candidates with less funding.

And limiting campaign spending will certainly have no effect on preventing poor choices by voters, since if voters are only even aware of candidates or election issues for which they have been bombarded with advertisements, it will be impossible for voters to make informed choices, even if similar ad campaigns are run for every issue and candidate — unless one wishes to argue that ads are educational and provide voters with critical information.  Which is not a claim that any reasonable person would make, and it certainly is not one the author of the article quoted above was making.

In short, unless voters at least take the act of voting seriously enough to do the necessary homework, the election process will never produce anything but varying degrees of failure, and limiting the ability of certain candidates to run campaign ads will not change that.  Implying that a well funded candidate can somehow prevent voters from educating themselves about an election, or stating that voters are easily manipulated by sophisticated ad campaigns, is attacking the integrity and intelligence of voters, and not the election process and campaign finance.   If the author's main point is true — that 'crony capitalists rule' as a result of political contributions, and will continue to do so — it means that voters do not take the act of voting seriously, and will never do the necessary homework.  In that case, only the voters are to blame, and we need to stop wasting time complaining about campaign finance.

Voters still control who wins elections, and so who takes office, and if they will not take the choice seriously and educate themselves, the process will continue to produce a garbage output.  The expression that arose years ago for information processing with computers also applies here — GIGO — 'garbage in, garbage out'.

Here is Milton Friedman explaining this beautifully, in his response to a questioner who raised the issue of bringing change to the U.S. Congress 'to get off the treadmill' —

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https://www.youtube.com/watch?v=ac9j15eig_w

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Friedman points out that all politicians are engaged in the business of vote buying — but what is vote buying?  It is promising the voting public something to get their vote.  Politicians have to pander to the public to gain and keep their office.  Here is the transcript of Friedman's response —

"No, we don't need to change Congress.  Excuse me.  You know, people have a great misunderstanding about this.  People in Congress are in a business — they're trying to buy votes — they're in the business of competing with one another to get elected.  The same Congressman will vote for a different thing, if he thinks that's politically profitable.  You don't have to change Congress.  People have a great misconception in this way — they think the way you solve things is by electing the right people.  It's nice to elect the right people, but that isn't the way you solve things.  The way you solve things, is by making it politically profitable for the wrong people to do the right things."

Friedman's summary for solving problems in government deserves repeating —

"The way you solve things, is by making it politically profitable for the wrong people to do the right things."

Of course, it is the voting public that determines what is politically profitable, so until the public makes it politically profitable for politicians to do the right things, it makes no difference how much money is or isn't spent on political contributions.  Politicians do the wrong things, because the public keeps them in office for doing the wrong things.


Here is another June 2014 article, entitled 'Addicted to Koch? New documentary traces influence of Koch brothers' money in GOP', which gives an absurdly biased take on spending in politics, in that it fails to acknowledge that the all time top political contributors are Democratic, and that the contributions of the Koch brothers have been trivial by comparison —
     http://news.yahoo.com/blogs/power-players-abc-news/addicted-to-koch-new-documentary-traces-influence-...html
     https://archive.is/zgY1g

The 'Center for Responsive Politics' shows the top political contributions by organization at the links below, including all contributions made since 1989.  Note that since that time, the 'Service Employees International Union' has contributed almost 8 times as much to Democrats, as 'Koch Industries' has contributed to Republicans.  So why haven't the subjects of the article at the link above made a documentary entitled 'Addicted to Service Employees International Union?', given that they are so concerned about money in politics?

And notice that this list of top all-time donors is dominated by Democratic contributors — mainly unions.  This is 'Director's Law' at work again —
   http://www.opensecrets.org/orgs/index.php

   https://www.opensecrets.org/orgs/list.php?cycle=ALL
      (Service Employees International Union #1, Koch Industries #50, as of 2/2015)

It is comical that the Koch brothers are singled out so often in this regard, given how small their contributions have been when compared with the top Democratic contributors.  In that vein, consider this quote from the article, that makes it sound like Democrats are just trying to keep up by 'falling in line with Republicans', when the opposite characterization is actually more accurate —

“The Democrats are certainly opening the floodgates with their money,” Lessin said. “They're falling in line with the Republicans and it's a trans-partisan issue. The problem is who loses when all this money gets pumped into the political process. I think we do.”

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https://www.opensecrets.org/orgs/list.php?cycle=ALL

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And here is Ben Cohen's website (from Ben & Jerry's ice cream) to start a movement to get money out of politics —
     http://www.stampstampede.org/
     http://archive.is/4PJlW

Here is a quote from the website —

The influence of money in politics is one of the biggest problems of our time because it impacts every issue and diminishes everyone’s voice. When politicians focus more on fundraising than legislating, the elite who can afford a lobbyist or cut big campaign checks gain access and influence while ‘we the people’ get left behind. That’s not right, and people everywhere are stepping up to do something about it.

Notice it is the same fallacy being repeated again, in that the implication is that voters are hapless pawns in a process for which they are responsible.  Politicians raise money to reach voters, since they must get a majority of the popular vote to get elected — that is, to repeat what Milton Friedman stated in the video above, politicians are responding to the incentives created by voters.

And what is even more fascinating about this obsession with money in politics, is that there are numerous examples to demonstrate that unpopular candidates cannot buy an election, regardless of how much they spend.

Consider the 2010 election in California, where Meg Whitman lost to Jerry Brown in their race for governor.  Whitman spent almost 5 times as much as Brown on the election ($177M vs. Brown's $36M), and Brown still won easily, receiving a million more votes than Whitman (close to 54% of the vote, to Whitman's 41%) —
     http://www.mcclatchydc.com/news/politics-government/article24609709.html
     http://archive.is/pliqD
     http://www.huffingtonpost.com/2010/11/02/meg-whitman-spending-wher_n_777644.html
     http://archive.is/iZQe3
     http://articles.latimes.com/2011/feb/01/local/la-me-governor-money-20110201
     http://archive.is/UZoLZ
     https://duckduckgo.com/?q=jerry+brown+meg+whitman+campaign+spending

I once gave the Brown/Whitman example to someone who is upset about campaign finance (especially the Supreme Court decision, Citizens United), and they dismissed it by saying, 'Oh, that's an anomaly' (of course, they could not give an example where an unpopular candidate was able to win an election by outspending their opponent).  But even if you agree that the Brown/Whitman race is an anomaly, it still devastates the argument that campaign finance is a problem, since it proves that voters will not simply elect someone because they dramatically outspend their opponent.

Of course, there are other examples that undercut the idea that the best-funded candidate can 'buy' an election.  Here is just one more — Steve Forbes.  Forbes is reported to have spent $69 million on his two runs for the White House in 1996 and 2000, and he never came close to even receiving the Republican nomination, let alone winning a presidential election —
     https://duckduckgo.com/?q=steve+forbes+presidential+campaign

Here is an interesting Freakonomics podcast on money and elections.  In the podcast, Stephen Dubner, the co-author of 'Freakonomics', points out that there is a correlation between money and success in politics, but not a causal relationship.  That is, the most successful candidates (those that can actually win elections) tend to draw the largest contributions, because the qualities that make them able to win are the same qualities that make them attractive to both contributors and voters.  Successful politicians are able to raise large amounts of money because they are popular — they do not become popular because they raised large amounts of money.  People like Meg Whitman and Steve Forbes (among others) clearly demonstrate that point.

Here is a quote from Steve Levitt, the other co-author of 'Freakonomics', who did a study in an attempt to measure the actual effect of differences in campaign spending (the quote is from the podcast, and the PDF shows the full study) —
     http://pricetheory.uchicago.edu/levitt/Papers/LevittUsingRepeatChallengers1994.pdf
     http://archive.is/WZeFX
     http://freakonomics.com/2012/01/12/does-money-really-buy-elections-a-new-marketplace-podcast-full-transcript/
     http://archive.is/3kmO9

Steve LEVITT:  When a candidate doubled their spending, holding everything else constant, they only got an extra one percent of the popular vote.   It’s the same if you cut your spending in half, you only lose one percent of the popular vote.   So we’re talking about really, really large swings in campaign spending with almost trivial changes in the vote.

The obsession with money in politics that is expressed by many Americans, amounts to little more than a comfortable avoidance of the responsibility of voters to inform themselves about all the choices available in a particular election.  The belief that money, by necessity, corrupts the election process, requires the precondition that voters are incapable of making rational, informed choices when they have seen a large number of ads — that is, it requires the precondition that voters have no control over how they respond to an ad campaign.  If this is true, even completely eliminating money from politics by publicly funding elections will accomplish nothing, since it will not magically endow voters with the mental capacity and motivation to make informed choices.  It is a complete non sequitur to argue that eliminating money from politics will cause voters to make more informed choices.

In essence, many people are really arguing that voters are so fundamentally incapable of making a reasonable choice, that if those voters see too much of one candidate's advertising campaign, they will inevitably vote for that candidate.  So to those who oppose money in politics, the solution is obvious — do not let voters get too much exposure to any one candidate in the media.  But there is no reasonable way to argue that this will engender better choices from voters — if voters take the choice seriously, a candidate's campaign will be among the least important inputs in making their selection, since what the candidate has actually done is more important.  Of course, this is the diplomatic description — many people use the issue of money in politics as a cover to justify silencing others in a politically correct way (they can pretend it is somehow good for democracy).

Members of the main stream press, along with the voting public, refuse to acknowledge that the public at large must be grossly irresponsible for well funded campaigns to dominate elections.  This can only be true if the electorate is cavalier and lazy when they vote.

Director's Law: Alive And Well

'Director's Law'  is a law of public expenditures named for economist Milton Friedman's former brother-in-law Aaron Director.  In the April 1970 issue of the 'Chicago Journal of Law and Economics', George Stigler stated 'Director's Law' this way —

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http://www.jstor.org/stable/724835   (requires registration to access full article)

Almost a decade ago Aaron Director proposed a law of public expenditures: Public expenditures are made for the primary benefit of the middle classes, and financed with taxes which are borne in considerable part by the poor and rich. ...
     The philosophy of Director's law is as follows.  Government has coercive power, which allows it to engage in acts (above all, the taking of resources) which could not be performed by voluntary agreement of the members of a society.  Any portion of the society which can secure control of the state's machinery will employ the machinery to improve its own position.  Under a set of conditions to be discussed below, this dominant group will be the middle income classes.

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Here is a video of Milton Friedman explaining 'Director's Law', which he stated this way —

Director's law is that almost invariably government programs benefit the middle income class at the expense of the very poor and the very rich.

https://www.youtube.com/watch?v=5Wx5PYZIWcQ

Without mentioning or attempting to defend 'Director's Law', here is Robert Samuelson pointing out the government expenditures that demonstrate the law —

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http://www.washingtonpost.com/opinions/robert-samuelson-repairing-the-middle-class-in-2015.html
https://archive.is/QmLGy

Reparing the middle class in 2015
By Robert J. Samuelson | December 28, 2014

What is curious about the present understandable preoccupation with the middle class is the assumption — both explicit and implicit — that the system is “rigged” (to use Sen. Elizabeth Warren’s favorite term) against this vast constituency of Americans. In reality, just the opposite is true. The system is rigged in favor of the middle class. That’s a natural result for a democracy in which politicians compete more for votes than for dollars.

If you look at how the federal government spends and raises its money, the bias for the middle class and poor becomes plain. In fiscal 2014, about two-thirds of the $3.5 trillion federal budget went for “payments to individuals.” This covers 59 million Social Security recipients, more than 54 million Medicare beneficiaries (overlapping with Social Security), 68 million Medicaid recipients, 46 million food-stamp recipients — and many more.

Meanwhile, government raises most of its taxes from the upper middle class and the wealthy. In 2011, the richest 1 percent of Americans paid 24 percent of all federal taxes (income, payroll and excise) and the richest 20 percent, including the top 1 percent, paid 69 percent of taxes, says the Congressional Budget Office.

It is possible to argue that, reflecting the growing inequality of market incomes, taxes on the rich and affluent should be higher or that middle-class subsidies should be more generous. It’s also possible to complain that some programs aimed at helping the poor and middle class have gone awry: College student loans, now worth about $1.1 trillion and facing 11 percent delinquency, are a current popular example. These are legitimate views, as are (of course) the opposing positions. They’re the stuff of responsible debate.

But if you accept these numbers — which I have cited many times — it is not possible to pretend that the whole superstructure of government has somehow been turned against the middle class. This is not just a distortion of reality; it is the converse of reality.

Likewise, the financial crisis and Great Recession are typically blamed on the miscalculations and greed of financial institutions and their overlords. There is much evidence for this, but it ignores the deeper cause: an intellectual, political and social climate that legitimized lax lending policies in the name of promoting middle-class well-being. This was reinforced by a parallel conceit (which now seems foolish) that our enhanced economic understanding enabled us to enjoy prolonged expansions and brief recessions.

What the middle class faces today is a crisis of faith. Being middle class is more than attaining some threshold income. It also involves embracing a set of beliefs that, unfortunately, have been severely shaken.

Middle-class Americans believe in opportunity, stability, reward for effort, a brighter future and the ability to control their lives, as sociologist Herbert Gans showed in his 1988 book “Middle American Individualism.” Big government and big companies are distrusted, because they might impose their own imperatives on individuals’ personal preferences. But government is also expected to provide economic security — a contradiction that’s widely accepted.
...

We overestimated our ability to control the economic environment. What we have learned is that outside events — here, the financial crisis and Great Recession — can overwhelm collective protections and discredit conventional beliefs. The economy is more random, unstable and insecure than we imagined. It is less susceptible to policy engineering. The fact that the upper classes can better shield themselves against its upsets naturally breeds resentment.

...

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As one would expect, Samuelson's column received a large number of derogatory comments from those who wish to ascribe a victim status to the middle class — but what is fascinating about such responses is that they demonstrate the root cause of 'Director's Law'.  That is, while being unable to refute the easily demonstrable point of Samuelson's column — that the bulk of the U.S. government's budget is consumed by transfer payments to the middle class, and that the wealthy pay the bulk of all taxes, including payroll taxes — the typical responder still claims members of the middle class are victims, and should receive more.

The letter quoted below is a good representation of the typical response to Samuelson's column.  Notice that this letter does not contradict the points Samuelson made in his column, but only adds that the rich make a large share of the national income (of course), and that wages have not kept up with productivity increases — the reader's comments on the greed of financial institutions in the last paragraph elaborate on a point Samuelson acknowledged in his column above (though Samuelson claimed it was not the root cause of the Great Recession) —

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http://www.washingtonpost.com/opinions/no-the-us-economic-system-is-not-rigged-in-favor-of-the-middle-class...html
https://archive.is/lRgyM

Robert J. Samuelson, in his Dec. 29 op-ed column, “Repairing the middle class,” wrote that the economic-political system is rigged in favor of the middle class and to believe otherwise is “a distortion of reality.” But he relied on a slim slice of reality to support his thesis that most taxes come from the wealthy and go to the middle class and lower-income earners. Reality is much more nuanced.

Mr. Samuelson counted Social Security and Medicare as subsidies of the middle class. Federal revenue generated from payroll taxes and returned to the taxpayer in retirement is a much-needed national annuity structure managed by federal agencies.

Any discussion of who pays the bulk of federal taxes also must include an assessment of who earns the bulk of taxable income and who benefits most from the tax code in terms of earned income and asset-generated income. Mr. Samuelson neglected this. Based on data analyzed by the Tax Policy Center, the top 1 percent of income earners pay 26 percent of all federal taxes and earn 24 percent of all national income. In 2013, the top 1 percent earned, on average, $1.12 million after federal taxes; the bottom 20 percent earned $13,300.

According to a 2012 Economic Policy Institute study, since 1948, productivity increased 254 percent while real wages increased 113 percent. If wages had kept up with increases in worker output, there would be (in theory, at least) little or no poverty, all those pesky subsidies of lower-income earners would be eliminated and tax revenue would explode.

Finally, was the underlying cause of the “Great Recession” really “lax lending policies in the name of promoting middle-class well-being”? Was the fact that the homeownership rate in the United States went up a few points the cause of a worldwide recession? Or was the cause more along the lines of lenders making loans they did not service, collecting up-front fees while shifting risk downstream, creating risky derivatives and purchasing desired ratings from the rating agencies, concocting exotic hedging structures based on a foundation of arrogance and greed, and sending traders around the world pushing investments in portfolios the details of which they knew almost nothing about?

The importance of this discussion, acknowledged by Mr. Samuelson, begs for balanced analysis sans blinders.

Gregory Diercks, Alexandria

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The second paragraph in the letter quoted above, describing Social Security and Medicare as 'a much-needed national annuity structure', provides support to Samuelson's premise that the system is rigged in favor of the middle class.  That is, stating that federal agencies are providing programs that are a forced annuity to support the middle class — especially when those programs transfer debt to future generations — obviously supports the premise that government has been captured by the middle class, and not the reverse.

The third paragraph quoted above regrading who earns the bulk of taxable income is obvious, and, again, does nothing to undercut the premise of Samuelson's column and the idea that the middle class has captured government.  Of course, the rich earn a large share of total taxable income — if this were not the case, how would the top 1% be able to pay 26% of all federal taxes?  And it's fascinating that this reader considers the small 1% minority, who pays 26% of all federal taxes, as 'benefiting most from the tax code'.  That is a pretty bizarre twist on the concept of a 'benefit'.

The fourth paragraph quoted above regarding productivity and wage increases is an old fallacy that gets repeated over and over again, despite being absurd.  There is no reason that wages should increase in direct proportion to productivity increases over time, since productivity increases often come from capital improvements that make businesses less reliant on labor.  For example, if a farmer spends many thousands of dollars to purchase a combine, and that combine, say, doubles the productivity of his farming operation, should all of the farmer's employees have their pay doubled?  Of course, the fallacy is obvious — worker output is not simply a function of the skill and labor of the worker.

The last paragraph quoted above, regarding lending practices leading up to the financial crisis, is a common and fascinating evasion.  The letter writer states that 'lenders making loans they did not service' was part of the cause of the financial crisis, but fails to mention the responsibility of borrowers for taking out, and then defaulting on, loans they could not afford.  That is, why is it important for lenders to service the loans they originate, if borrowers are not attempting to borrow more than they can afford, with the same 'arrogance and greed'  the letter writer ascribes to financial institutions?  And the letter writer dismissed 'lax lending policies' as being a principle cause of the Great Recession, but how is making lenders service the loans they originate not an attempt to prevent 'lax lending policies'?  In the same way, the mention of 'risky derivatives' and 'purchasing desired ratings from the rating agencies' avoids stating that unworthy borrowers created the risk that justified low credit ratings.  It is such an odd extreme denial — Wall St. is the whipping boy for creating risky investments derived from mortgage loans to borrowers who were the source of the risk, and yet the borrower's roll in the financial crisis is almost never mentioned.

This is a fascinating evasion that gets repeated over and over again, ad nauseam, because it is so satisfying to middle America to pretend that financial institutions were solely responsible for the financial crisis that led to the Great Recession.  It is an obvious contradiction, given that the 'risky derivatives' and the 'purchased ratings from agencies' would have been completely irrelevant had the majority of borrowers taken loans they could afford and so had no reason to default.  And it is a comical non sequitur to decry 'risky derivatives' as this letter writer does, in an attempt to pretend that the derivatives (like credit default swaps) were not derived from mortgage backed securities, and that any risk they entailed was not completely determined by borrowers.

It is worth stressing that the borrower has the most control in determining a loan's risk — not the financial institution originating the loan.  The borrower makes all of the choices that affect the risk in the loan — the borrower chooses the property for purchase, the borrower selects the loan terms, and, of course, the borrower is the only person that has intimate knowledge of their sources of income and the stability of those sources.  Of course, the lender has to scrutinize the borrower, but this is not done to eliminate the risk (which is not possible) — it is done to assess the risk to determine if the loan is even worth originating, and, if so, what charges are appropriate (such as the interest rate).  Financial institutions that make loans obviously have to reject loan applications for which the risk is too high, but the information provided by the borrower about themselves is what determines the risk.

In the most common comments on the financial crisis, it is as if people operate with both the unstated and unacknowledged assumption that borrowers are corrupt by default, and so it is up to financial institutions to ensure that loan applicants are trustworthy, reliable, and have not falsified any information in their loan application — this is the only reasonable interpretation of the often heard claim that 'lenders making loans they did not service'  was part of the cause of the financial crisis — if borrower's are not corrupt by default, then it is not important to create a special incentive for lenders to give borrowers extra scrutiny, by requiring lenders to service the loans they originate.  But however borrowers behave, only Wall St. will be charged with 'arrogance and greed'.

And here is a comment to Samuelson's column that is a fascinating display of dishonesty — this reader attempts to redefine what constitutes a progressive tax by making the claim that the U.S. tax system is not progressive because those with incomes among the highest 1% supposedly do not pay more in taxes than that group's share of the national income —

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http://www.washingtonpost.com/opinions/robert-samuelson-repairing-the-middle-class-in-2015.html (in comment section)

ianmac37
1/4/2015 10:41 AM PST [Edited]

When I was a young man working as an economist, I taught a course in basic statistics to a group of secretaries who were studying to upgrade their job skills. I volunteered for that task, of course. I used a text titled “How to Lie With Statistics,” not because I wanted to teach people how to misrepresent facts, but how to recognize such false representation. Robert Samuelson should study that small text because his column on the woes of the middle class is a good example of how to misrepresent data and still sound authoritative.

Samuelson states that the top 1 percent of American income earners paid 24 percent of all federal taxes, according to the Congressional Budget Office. True, but misleading. He is comparing a percentage of the population, a proportion of people, with a proportion of money. Those are not equal things, even though it sounds like a few people paying far, far more than their share of taxes, he left our the proper comparison: percentage of money income to percentage of taxes paid.

It turns out that the top 1 percent of American income earners also take in 24 percent of national income, so the fact that they pay 24 percent of all federal taxes seems proper and not even a little progressive, which our tax system is supposed to be. In addition, according to Nobel laureate Joseph Stiglitz, those same 1 percenters own 40 percent of all national financial wealth (that’s net worth less the value of homes). So, those who own 40 percent of everything only pay 24 percent of federal taxes.

While PolitiFact might rate Samuelson’s comment mostly true, because the facts as stated were correct, I rate it as an Attempt to Mislead, because any economist should be aware of this kind of false equivalence and be wary of expressing incompatible data in this fashion.

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The determination with which people construct rationalizations to justify forcing others to pay for the cost of some service they are using is absolutely fascinating.

Notice that the U.S. tax system is not only progressive, it has become more progressive in recent decades.  In a previous blog post I wrote about the IRS data that show that since roughly 2004 the top 1% have paid more in income taxes each year than the bottom 90%.

And notice this quote from the 'Congressional Budget Office' report, 'The Distribution of Household Income and Federal Taxes, 2011', that Samuelson referred to in his column, and that directly contradicts the statements made by both the author of the letter and the author of the comment above regarding the share of taxes paid by the top 1% in comparison to their share of the national income.  The top quintile is the only group that pays a larger share of Federal taxes than their share of before-tax income, exactly as 'Director's Law' predicts —

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https://www.cbo.gov/publication/49440
https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/49440-Distribution-of-Income-and-Taxes-2.pdf
https://www.cbo.gov/publication/51361
https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51361-householdincomefedtaxes.pdf
https://www.cbo.gov/topics/income-distribution

As a result of the progressive federal tax structure, households in the highest quintile of before-tax income paid a greater share of federal taxes in 2011 than they received in before-tax income, while households in each of the other quintiles paid a smaller share of federal taxes than they received in before-tax income (see Figure 1). Households in the highest income quintile received a little more than half of total before-tax income and paid more than two-thirds of all federal taxes in 2011. In contrast, households in the lowest income quintile received approximately 5 percent of total before-tax income in 2011 and paid less than 1 percent of all federal taxes, CBO estimates.

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And considering Social Security taxes — they seem regressive, because there is an annual maximum wage that is subject to the Social Security tax ($118,500 as of 2015) — but the wage cap on Social Security taxes is only fair, given that Social Security benefits are also capped, since wages above the annual cap are ignored when computing Social Security benefit amounts.  For example, the largest possible Social Security benefit check you could receive in 2015 is $3,501, provided you had the maximum-taxable earnings every year for the prior 35 years, and you retired at age 70 in 2015 —
     http://www.ssa.gov/oact/cola/examplemax.html
     http://www.ssa.gov/pubs/EN-05-10070.pdf
     http://www.ssa.gov/oact/cola/Benefits.html

And Medicare payroll taxes have no such limit.

But more importantly, notice this bizarre definition of fairness that people use when discussing taxes — that people who earn more are somehow automatically responsible for paying the costs incurred by others who earn less.  No one attempts to use this definition of fairness in their normal dealings, since few people would let them get away with it — certainly, no one wants to be treated this way, because they would see it as blatantly unfair to be forced to pay more for something than someone else who earned less.  It is only by pretending that one is in a group that has victim status that makes this pretense seem plausible.

For example, if you had a group of friends that you regularly went out to dinner with, and you normally divided a single check for the dinner based on each person's meal cost, how would you react if one member of the group suggested that as a rule the check be divided based on each person's income?

Most people I know would find this offensive — and most importantly, those with the lowest incomes would find it offensive, because they would not want to be treated as a dependent.  That is, they take pride in being self-sufficient, even if they do not earn as much as some others.

In short, it is absurd to claim, as that comment author did, that you have to know a person's share of the national income to know their fair share of the cost of running government — just as it is absurd to claim that you have to know the income of a dinner party member to know their fair share of the check.

Why is it that so many people not only celebrate, but demand being a dependent of the more wealthy when it comes to financing government?

Notice that the authors of both the letter to the editor and the comment quoted above made disparaging remarks about Samuelson ('sans blinders' and 'a good example of how to misrepresent data'), even though they did nothing but reveal their own biases in their failed, fallacy-laden criticisms.

We do need an analysis 'sans blinders', but we will not get it any time soon when the caliber of the typical reader's response is so low.

'Director's Law' almost seems on a par with the Law of Gravity, but if it is, it means the vast majority of people are dishonest as a rule.

The 'Social Security Is Insurance' Fallacy

In a previous post, I commented on a blog post by an economics professor at the University of Oregon named Mark Thoma, where Thoma made the fallacious claim that Social Security functions like an insurance policy against economic risk.
     http://economistsview.typepad.com/economistsview/2011/03/social-security-is-not-welfare.html
     https://archive.is/8Y8Yl

In his blog post Thoma references another blog post that gives details of a hypothetical risk pool, in an attempt to prove that Social Security functions like an insurance policy.

One reader of Thoma's blog pointed out the obvious error of comparing Social Security to an insurance policy, and Thoma simply instructed the commenter to read this link he referred to in his article —
     http://angrybearblog.com/2004/12/social-security-part-i-insurance-and.html
     https://archive.is/FWRVE

The reader's comment is worth reading, since it gives a better description of Social Security than the one Thoma provides — and one that isn't countered by Thoma's blog post, or the post he instructs the commenter to read --

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Curt Doolittle said...

Pretty big error in logic you have going on there.

We can insure against fire, because not every house will burn.
We can, all of us, contribute a little, for the very few who need it.
If we require fire insurance, we do not create a moral hazard, we create a virtuous cycle of fire-reduction.

If we insure against old age, we must insure everyone, because nearly everyone will become old.
We must all contribute a great deal, because almost all people will need it.
If we require old age insurance, we create a moral hazard, whereby people do not save, and money is spent rather than saved and invested.

Social security is a transfer program.
If it were a forced savings program it would be a form of insurance.
It cannot be a risk mitigation program because risk mitigation requires a probability of less than 'certainty'. Therefore it is NOT a risk mitigation program.
It is an inter-generational, risk inducing, fragility-inducing, moral hazard.
if you want to make a social security program, enforce savings on everyone, and redistribute some portion of the very top to the very bottom.

Monday, March 07, 2011 at 07:22 PM

Mark Thoma said in reply to Curt Doolittle...

Read the AB link.

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So let's look at the blog post that Thoma keeps referring to, to see if it is as convincing as he seems to think.

The credibility of the author of this post is given away in the first paragraph quoted below, in the statement that Social Security is solvent 'conditional on minor adjustments'.  Social Security already earns a negative return when compared with other alternatives, so this language describing Social Security's solvency hides the obvious point that the only way Social Security can remain solvent is by making everyone who contributes poorer — given that they are already losing part of their retirement savings by contributing to Social Security at all --

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http://angrybearblog.com/2004/12/social-security-part-i-insurance-and.html
https://archive.is/FWRVE

...
As mentioned already, the basic solvency of Social Security (or solvency conditional on minor adjustments) is established, so I’d like to instead address the basic merit of the program. My argument centers on the fact that Social Security is really insurance. In fact, the phrase “Social Security” is typically used as shorthand for “Social Security Retirement Insurance.”

What’s so special about insurance? As it turns out, the vast majority of the population dislikes risk, and will pay money (e.g., insurance premiums) to avoid the consequences of risk. I’ve surveyed my students and asked whether they would prefer a job that has equal odds of paying $75k or $125k (expected income = $100k) to a job that paid $90k with certainty. Almost all prefer the $90k, meaning they would pay up to $10k (by having an expected income of $90k instead of $100k) in order to not have to face income swings of +/-$25k; many would pay more.(*)
...

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Pay special attention to the use of the phrase 'equal odds' in the description above of the risk being insured against in this hypothetical risk pool — given that the author is attempting to make the case that Social Security is insurance, there is already a large potential problem in his argument.

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http://angrybearblog.com/2004/12/social-security-part-i-insurance-and.html
https://archive.is/FWRVE

...
In such a situation, if people can pay less than $10,000 to avoid such risk then real economic value is created. And in fact, this happens in the real world all the time. Consider a group of 100 people, each of whom faces this hypothetical gain or loss of $25,000. Let’s see how they can benefit by pooling risk.

First, what is the social cost of the risk faced by this group of people? By hypothesis, it’s worth $10,000 to each of them to avoid the +/-$25,000 risk. So the mere presence of this risk creates a cost of 100 * $10,000 = $1,000,000. If we can figure out a way to reduce this risk, there’s the potential to create an additional $1m (100 people at $10,000 each) in value for this group.

How does a risk pool work? With just 100 people, there is near mathematical certainty (about .997, based on the sum of 100 Bernoulli draws, which follows a binomial distribution) that a minimum of 35 people will “win,” gaining $25k. The vast majority of the time at least 40 will win and, on average, 50 will win and 50 will lose. Should only 35 people gain $25,000 while 65 lose $25,000, then the group will have lost (35 – 65)*$20k = $600,000. Thus the simplest form of insurance entails each member paying a premium of $6,000, creating a pool of 100 * $6,000 = $600,000 to cover the group’s potential losses.
...

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Notice that there is a huge problem in the calculations in the last paragraph quoted above, which are intended to show an unusually high payout from the risk pool (a worst case example), where 65 participants made $75,000 (vs. 35 making $125,000), and so well over 1/2 of the risk pool participants had to file a claim against the pool for that lost $25K.  The 35 people who had the optimum outcome and 'won' the $25K won't file a claim against the risk pool — they'll simply pay their premium again, assuming they wish to continue their coverage to avoid the worst case outcome of only earning $75,000 (following the assumptions given in the quotes from the blog post).

So, to compute the payout from the risk pool when 65 people file claims, you simply multiply the number of claims by the dollar amount of those claims — in this case, 65 * $25,000, or $1,625,000.

In short, this risk pool of 100 policy holders will pay out on average 50 * $25,000, or $1,250,000 every policy period, given the assumption that each participant had equal odds of making $75,000 in a given period, and so incurred the hypothetical $25,000 loss.

This would require each member of the risk pool paying a minimum policy premium of $12,500, since it would be unreasonable to assume that fewer than 1/2 of the policy holders would file claims, given that it is equally likely that each policy holder earns either $75,000 or $125,000 (again, per the hypothetical example).

It makes sense that the policy premium for the average case would be 1/2 the coverage amount, given the assumption of the hypothetical example that each policy holder has equal odds of filing a claim for any given period — so in order for the risk pool to even have a chance of remaining solvent, it must at a minimum collect 1/2 of the coverage amount from every policy holder, since in most policy periods at least 1/2 of the policy holders will be forced to file a claim for the coverage amount.

The example calculation in the blog post of 65 losers and 35 winners, showing a group loss of $600,000 makes no sense (for consistency the blog post should show the group loss as (35-65)*$25k = -$750,000, but it still wouldn't be meaningful), since the 35 who 'won' only share in the loss with the policy premiums they paid — the risk pool must pay for the covered losses from the premiums already collected, and so the policy holders who did not incur a covered loss are not filing a claim and have no effect on the payouts required by the risk pool.

For the example given in the blog post, where 65 claims were filed, the risk pool would have to pay $25,000 to 65 policy holders.  If the risk pool did not collect at least $1,625,000 in total premiums for all the policies ($16,250 per policy holder), or did not have enough capital in reserve to cover any shortfall, the pool would not be able to pay those claims, and it would become insolvent.

Why would anyone claim that an insurance policy premium of $6,000 dollars from 100 policy holders (for a total of $600,000), would cover a loss to 65 policy holders of $1,625,000 (65 claims for $25,000)?

A risk pool has to be managed to handle a worst case loss, so even a policy premium of $12,500 is too low for this hypothetical pool, given that this is the expected payout per policy holder — a risk pool has to collect more in premiums than the most likely payout to avoid going bankrupt, so the policy holders must pay more than $12,500 for this hypothetical pool to even have a chance of working.

So clearly, the first paragraph quoted below is false — $6,000 won't come close to funding a risk pool where every policy holder has a 50% chance of filing a claim for a coverage amount of $25,000 --

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http://angrybearblog.com/2004/12/social-security-part-i-insurance-and.html
https://archive.is/FWRVE

...
That is, if each member pays $6,000 for insurance, they can create a pool large enough to cover the group’s losses even in the worst of states. (Should the worst of states not occur, the balance can be repaid to the group as dividends, pushed into the next year’s pooled funds, or retained by the insurer as profits.) Stated differently, without insurance each member of the group faces a risk of income as low as $75,000. By pooling risk, no member of the group faces a risk of income below $94,000.

Moreover, as more people join the risk pool, the law of large numbers tells us that the risk is reduced further and further. In fact, with 10,000 people in the risk pool, the premium required to cover the group’s maximum total losses (in all but about 3/1000 cases) is only $500, instead of $6,000. That is, with a reasonably large group of people sharing risk, each can pay $500 and the risk is entirely eliminated. How much economic value is created by this? As I explained earlier in this post, real people in the real world are willing to pay amounts in the $10,000 to $15,000 range to avoid income swings on the order of +/-$25,000. But in the presence of insurance, these 10,000 people only have to pay $500. So in this hypothetical example, insurance — risk-pooling over a large group of people — creates $9,500 in economic value per person. (**)

What does all of this have to do with Social Security? Those who are hard-working, fortunate, and not too profligate will have a large nest egg at retirement and Social Security will account for only a small portion of their retirement portfolio. This is tantamount to paying for insurance and then not needing it. This happens all the time — every year someone fails to get sick or injured and, while surely happy in their good health, would have been better off not buying insurance. That’s the nature of insurance: if you don’t need it, then you’ll always wish you hadn’t purchased it. Only in the context of retirement insurance is this considered a crisis.
...

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Also notice that the second paragraph quoted above is false.

That is, the Law of Large Numbers tells us nothing that allows us to reduce the policy premiums as the number of policy holders increases, since the Law of Large Numbers simply states that if an experiment for a particular random variable is repeated a large number of times, the average of the results should approach the expected value.  For example, if you flip a fair coin millions of times, you will find that you get very close to an equal number of heads and tails — even though there can be long runs of consecutive flips that repeat one side of the coin.

If you estimated the probability of a real-world random event at 50% (as in this hypothetical risk pool), you could prove that your estimate was correct by performing (or observing) a large number of trials.  If as the number of trials grew, the average of all the results didn't trend toward your expected value, you would know your estimate was incorrect.  But even if an estimated probability matches the outcomes in the real-world, that doesn't mean a long sequence of outcomes can't happen that don't match the expected value.

Using the hypothetical risk pool as an example, the Law of Large Numbers tells us that after a very large number of policy periods has passed, the number of claims filed should get closer and closer to: (1/2 the number of policy holders * the number of policy periods) — that is, a claim will be filed on average 1/2 the time, if policy holders really do have a 50% chance of losing $25,000 (of earning only $75,000), as given in the quoted description of the hypothetical risk pool.  But this doesn't mean it's impossible for a large number of consecutive policy periods to pass where well over 1/2 the policy holders incur the $25,000 loss and must file claims.

So for the hypothetical risk pool, a policy premium of $12,500 is still too low, regardless of the number of policy holders, since with a real-world claim probability of 50%, after a large enough number of policy periods, it's highly likely that at some point there will be a run of consecutive policy periods where well over 1/2 of the policy holders file claims, and without a large reserve the risk pool will become insolvent, since in that case much more than 50 * $25K would be required to cover the claims.  The Law of Large Numbers tells us that over the long haul, the total amount paid by this risk pool will trend toward the expected value of a 50% payout rate, given the assumption of equal odds for a loss or a gain to policy holders.  That is, the total will trend toward: ((1/2 the number of policy holders * $25,000) * the number of policy periods).  The Law of Large Numbers does not tell us that a large number of consecutive worst case losses are impossible because the number of policy holders is increasing.

Assuming that a long run of a particular outcome for a random variable decreases the probability of that outcome in the future is called the 'gamblers fallacy'.

That is, consecutively flipping heads 10 times has no effect on the probability that heads will come up on the 11th flip, since each flip is an independent event.

In any case, it is clear that there is nothing in this hypothetical risk pool example to support the claim that Social Security is insurance.

Never mind that the numbers this author uses in his example do not make any sense, and are not supported by anything he wrote — why would he use a 50% probability for an example he was attempting to relate to a forced U.S. government retirement plan that pays to everyone who reaches the age of 70, when the life expectancy in the U.S. was estimated to be over 77 years, as of 2004, when that post was written?  Obviously, using 50% as the probability for a hypothetical event that you're attempting to relate to a real life probability that is close to 100% makes no sense.

This author's risk pool example does not work, because the numbers he uses do not cover the risk he described, but if you plug a 90% probability for filing a claim into his example it really blows up, and makes it obvious why this comparison is nonsense — you cannot use a risk pool to insure against a near certainty, because everyone who participated in such a pool must pay in the full cost of that outcome.

In a previous post on Social Security, I mentioned the nonsensical example of 'Grocery Insurance', to illustrate the point that you would not try to create an insurance plan to cover a cost that everyone incurs all the time — it would make no sense, since it would do nothing but increase a cost that you had to incur by necessity, by adding the additional cost of managing the risk pool.

So no one would buy 'Grocery Insurance' (even if it existed), because such insurance would cost more than the covered groceries (such an insurance plan would not remain solvent, if this were not the case), and so purchasing such insurance would reduce the quantity of groceries that one could purchase.

Social Security has exactly the same effect.  Since the government does not invest surplus Social Security contributions into productive investments that earn a positive return to taxpayers (taxpayers must pay any interest on the government securities held in the 'trust fund', so those securities are a liability to taxpayers, not an asset), the costs to run the Social Security administration to perform the transfer payments only reduce the amount that retirees would have, had they been able to simply save that money in a private account.  That some contributors receive more from Social Security than they contributed in payroll taxes does not alter the situation — without a steadily increasing population, Social Security cannot pay more to any participants than they have contributed, without taking the difference from other taxpayers.  Social Security is a negative sum game — in that sense it is like insurance, but bad insurance that rarely covers the full cost of a loss — but that is a damning criticism, not cause for celebration.

And notice how the author attempts to dismiss criticisms of Social Security — as if people are calling it a crisis only because some had to pay into it, but ended up not needing it, rather than the real point, that the so-called trust fund only contains claims on future taxpayers — that is, U.S. government securities, which are a liability to future taxpayers, that do nothing to fund future retirement costs.

Given how bad Mark Thoma's blog post is, it is not surprising that a post he refers would be just as bad (if not worse).

Another Economist Misrepresenting Social Security

In a previous post, I commented on the rare honesty from the public regarding Social Security.  In that post, I pointed to an article by Robert Samuelson, because Samuelson correctly described Social Security as welfare, and because he received many angry replies in response —
     http://www.washingtonpost.com/wp-dyn/content/article/2011/03/06/AR2011030602926.html

Here's a shockingly bad blog post by Mark Thoma, an economics professor at the University of Oregon, in which Thoma attempts to rebut Samuelson's claim that Social Security has all the essential features of a welfare program —
     http://economistsview.typepad.com/economistsview/2011/03/social-security-is-not-welfare.html

In his attempt to refute Samuelson, Thoma uses an old fallacy in his blog post — that Social Security is an insurance program, similar to fire insurance.

I refuted the 'Social Security is insurance' fallacy in a previous post, since that fallacy is often repeated by people who wish to pretend that Social Security is a successful social program, and who can't answer legitimate criticisms of Social Security.

I called Thoma's blog post 'shockingly bad', because Thoma is an economics professor at a major university, and his post includes some obviously false statements, in addition to misuses of the term 'transfer payment' — which is a standard term, defined in introductory economics text books --

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http://economistsview.typepad.com/economistsview/2011/03/social-security-is-not-welfare.html

Social Security is *Not* Welfare

Robert Samuelson is making the same wrong argument about Social Security being welfare that he's been making for years:

Why Social Security is welfare, by Robert J. Samuelson: ...Here is how I define a welfare program: First, it taxes one group to support another group, meaning it's pay-as-you-go and not a contributory scheme where people's own savings pay their later benefits. And second, Congress can constantly alter benefits, reflecting changing needs, economic conditions and politics. Social Security qualifies on both counts.

Since he is rolling out the same old column (and apparently getting paid for it), I'll just roll out the same old response. This is from March, 2005, just a few weeks after I started this blog:

Fire Insurance is not Welfare and Neither is Social Security: Robert Samuelson, and many others, appear to believe that any time there is a transfer of income between individuals or groups it is welfare. This is wrong. According to Samuelson:

Welfare is a governmental transfer from one group to another for the benefit of those receiving. The transfer involves cash or services (health care, education). We have welfare for the poor, the old, the disabled, farmers and corporations. Social Security is mainly welfare...

Not it isn’t. Social Security is mainly a means of insuring against economic risk. It is fundamentally an insurance program, not a saving program, and as such it is not "mainly welfare."

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Notice how Thoma mocks Samuelson for supposedly 'rolling out the same old column', even though the only thing Thoma can do in response is make a false comparison between Social Security and an insurance policy.

If it's true that Samuelson keeps 'rolling out the same old column', that's a good thing, because it will help to remind honest people of the problems with Social Security — especially when a professional economist like Thoma can't provide an effective rebuttal, while still being convinced that he should write a blog post in response.

It isn't clear why anyone would believe that Social Security functions like an insurance policy, since there are obvious and important differences between them — so much so, that no useful comparison can be made between the two.

When you purchase an insurance policy you are paying a fee (the policy premium) to be in a risk pool, in order to receive a payment for some uncommon harmful event.  Thoma uses the example of fire insurance in his blog post, and a fire insurance policy only pays out in the unlikely event that a covered item (like your home) is damaged by fire.

Risk pools can only function by charging a fraction of the replacement cost of whatever is being insured, and by only paying out to a small fraction of the policy holders.

If every insurance policy holder of a particular insurance company were to suffer a significant loss that required a large payment from the insurance company, the insurance company would fail for dramatically underestimating the risk of the policies it issued, and the policy holders would receive only a fraction of the promised policy benefit — if they received anything at all.

None of these risk pool characteristics apply to Social Security.

Every working adult who lives past the maximum Social Security retirement age (70 in 2015) will receive Social Security payments, since the Social Security Administration automatically begins sending checks to contributors who reach age 70 — unless they apply to receive the payments even sooner, prior to reaching the maximum retirement age.

Not only do all Social Security contributors expect to receive benefits — they expect to receive more than they paid into the plan — just like a savings account.

That's the reason you can find studies like this, that compare Social Security to a private investment account — people expect their Social Security contributions to earn a positive return, not a negative return like an insurance policy —
     http://research.stlouisfed.org/publications/review/05/03/part1/GarrettRhine.pdf

In short, it's common knowledge that people who have been forced to contribute to Social Security expect it to perform as a pension plan or saving program, despite Thoma's insistence that people should view Social Security as an insurance policy.

Since every working person expects to draw on Social Security (and will, provided they live long enough), it can't function like an insurance policy, taking in small premium payments to make rare payments to a small group of policy holders in the event of a catastrophe.

And since people are happy to never collect on an insurance policy, since then they are spared the tragedy that would cause a payment under the terms of their policy, their view of Social Security stands in direct contradiction with their view of insurance.

Note that this comparison of Social Security with an insurance policy isn't just somewhat confused — it's completely absurd at its root, since becoming too old to work is not an economic risk from a rare occurrence, as Thoma wrote — it happens to everyone, which is why Social Security will pay to every contributor who lives long enough.

Comparing Social Security with a risk pool is obvious nonsense, since drawing on any retirement plan in old age isn't a rare catastrophe — it's a necessary condition for every person who lives long enough.  If only a small minority of people ever wished to retire, or lived to an age where they could not work, comparing Social Security with an insurance policy would make sense, since then the condition it was intended to address would be a rare occurrence — like one's home burning down.

In the next several paragraphs, Thoma demonstrates more confusion over the term 'transfer payment', as well as attempting to strengthen his comparison between insurance and Social Security, by writing that different people will collect different amounts from Social Security, just as they do with insurance policies.  Different people will also collect different amounts from state lotteries — does that mean a lottery is also the same as an insurance policy and Social Security? --

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http://economistsview.typepad.com/economistsview/2011/03/social-security-is-not-welfare.html

Just because an economic activity transfers income from one person or group to another does not make it welfare. Fire insurance transfers income. Some people pay premiums for their whole lives and collect nothing. Others, the unlucky few who suffer a fire, collect far more than they contribute. Does that make it welfare? Of course not.

Social Security is no different, it is an insurance program against economic risk as I explain in this Op-Ed piece. Some people will live long lives and collect more than they contribute in premiums, some will die young and collect less. Some children will lose their parents and collect more than their parents paid into the system, others will not. But this does not make it welfare.

Is gambling welfare? Gambling transfers income from one person to another. Does that make it welfare? Loaning money transfers income when the loan is paid back with interest. Are people who receive interest income on welfare?

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Notice how badly Thoma confuses the definition of the term 'transfer payment'.

A 'transfer payment' is a redistribution of income, not a payment for goods and services, as Thoma states in his description of gambling and loan payments.  Here's a common definition —

A noncompensatory government payment to individuals, as for welfare or social security benefits.

One economics text I have defines transfer payments as —

payments made to individuals for which no goods or services are concurrently rendered.

The same economics text lists the three key money transfers in the U.S. system as welfare, Social Security, and unemployment insurance benefits.

Transfer payments are not counted in the national income, because they do not constitute an exchange of goods and services — money is simply being taken from one person and given to another, for no economic benefit — which is the main reason Samuelson called Social Security welfare.  Thoma's examples of gambling and money lending do not meet the definition of a transfer payment, because both examples constitute a payment for service — that is, a voluntary payment given for economic benefit.

In the quote below, Thoma acknowledges that welfare is a transfer payment (using the traditional definition) — but he attempts to isolate welfare in a special class of transfer payments he calls 'pure money transfers', which he acknowledges provide no economic gain, since they are a zero sum game — but Thoma hangs on to his false analogy that Social Security is insurance (even though, short of an early death, retirement is a certainty), in an attempt to pretend that Social Security does not fit his description of a 'pure money transfer' perfectly --

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http://economistsview.typepad.com/economistsview/2011/03/social-security-is-not-welfare.html

There is an important distinction between needing insurance ex-ante and needing it ex-post. Insurance does redistribute income ex-post, but that doesn't imply that it was a bad deal ex-ante (i.e., when people start their work lives). ...
Angry Bear agrees with me on this and the two of us have been independently saying the same thing (in fact, I first encountered AB in a Google search on Social Security, insurance, and risk). As AB said (the full text is well worth reading):

What does all of this have to do with Social Security? Those who are hard-working, fortunate, and not too profligate will have a large nest egg at retirement and Social Security will account for only a small portion of their retirement portfolio. This is tantamount to paying for insurance and then not needing it. This happens all the time -- every year someone fails to get sick or injured and, while surely happy in their good health, would have been better off not buying insurance. That's the nature of insurance: if you don't need it, then you'll always wish you hadn't purchased it. Only in the context of retirement insurance is this considered a crisis.
On the other hand, those with bad luck or insufficient income will not have a nest egg at retirement. Because of Social Security, instead of facing the risk of zero income at retirement, they are guaranteed income sufficient to subsist.
This is precisely like the insurance example I worked through above: people with good outcomes will wish they hadn't paid into the insurance fund; those with bad outcomes will be glad they did. Ex-ante, everyone benefits from the insurance. Overall, society is better off because risk is reduced; because people are risk-averse, the gains are quite large.

When I think of welfare, I think of pure money transfers from one group to another without any economic basis for the transfer. In such cases, one person’s gain arises from another’s loss. But economic activity that results in the exchange of goods and services is different. It is not a zero sum game. One person’s gain does not come at the expense of someone else.

The main feature of Social Security is not welfare as Samuelson asserts. The main feature is insurance against economic risks and as such it makes us collectively better off. Calling it welfare when it isn’t is misleading and causes unnecessary class distinctions and resentments from the losers ex-post. More importantly, it ignores and obscures the important role Social Security plays in society as insurance against the economic risks we all face.

If you think you are so rich and powerful that you don’t need such insurance, consider this. The stock market collapse of 1929 at the onset of the Great Depression wiped out substantial quantities of wealth. The typical stock was worth only one sixth its pre-crash value once the bottom was reached. Whatever insurance existed in the stock market evaporated as the crash unfolded.

It wasn’t the poor jumping out of windows on Wall street. If you think it can’t happen to you, think again.

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Notice that the supposed 'pure money transfer' quality that Thoma ascribes to welfare, does nothing to differentiate welfare from Social Security, even given his description of Social Security as a form of insurance against economic risk — it's just as easy to view welfare as an activity that results in the exchange of goods and services.  Welfare is more properly viewed as a form of insurance against economic risk than Social Security, given that the vast majority of people will pay taxes to support the economic assistance that welfare provides, but will never need that assistance themselves.

That is, welfare really can operate like a risk pool — an insurance policy against economic risk — because the condition for which it applies — the inability to support oneself at a subsistence level — is a relatively uncommon condition in society overall, whereas the need of individuals to retire from working to support themselves is not.  Welfare in any form would not be possible if poverty were the norm, since it would be impossible for a small minority of people to support a group many times their size at a subsistence level.

And notice that Thoma does not even address another critical point that Samuelson made regarding Social Security that makes it a welfare plan — there is no promise of any benefit.

Samuelson points out that Congress has repeatedly altered benefits, and that people only complain when they reduce benefits, as if a 'contract' (like an insurance policy) has been broken.  Samuelson then points out the 1960 Supreme Court decision Flemming v. Nestor, where the court explicitly rejected the argument that Social Security contributors have a contractual right to Social Security benefit payments.

How well would an insurance policy work, if an insurance company could change the terms of an existing policy at their whim?  No reasonable person would purchase such a policy, since it would not offer any real protection for the economic risk they were attempting to protect themselves against.  With this in mind, no government program can be viewed as insurance, since no government program makes a specific promise of a benefit that is enforced by law.

As I read Thoma's blog post, I kept having to remind myself that he is a professional economist at a major university.  I feel sorry for any students that must take his classes.