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.

Rare Honesty On Social Security

I've written a number of posts on Social Security, because there are obvious fallacies about it that get repeated over and over again in the press.  Even professional economists will make ridiculous claims about the so-called 'trust fund', as if it's a great asset, ignoring the obvious fact that all government securities are a liability to taxpayers — including those purchased with surplus Social Security payroll deductions.

In one previous post I described all government social welfare programs (including Social Security) with the intentionally oxymoronic phrase 'forced charities', because such welfare programs must operate via coercion, given that governments can only provide to one individual what they have taken from another — whereas charity is voluntary.

If you recall the Bernie Madoff scandal, you know that Madoff made large sums of money defrauding wealthy investors with a Ponzi like investment scheme.  As with all Ponzi schemes, Madoff would pay some investors with the money he received from other investors — as long as new investors were opening accounts, Madoff could keep the fraud going.  Of course, with a private scheme of this kind, collapse is inevitable once the number of investors stops growing fast enough to make the necessary payouts.

In an attempt to restore victims of Madoff's fraud after it collapsed, courts have allowed the bankruptcy case trustee, Irving Picard, to 'clawback' some of the fictitious profits from Madoff's customers who withdrew more from their accounts than they invested.  Since Madoff investors with a positive return were paid with money Madoff received from other investors, rather than the returns from profitable investments, such investors had no right to keep those payments.

Note that a Social Security recipient is in an even worse position than a Madoff investor regarding a rightful claim to payment, in that they're also not paid from an account in their name that has earned a return over the years — they're paid by current workers — but their original investment can't even rightfully be returned, having long since been spent by government.  Social Security doesn't have vague similarities to a Ponzi scheme — it's identical in every respect.

In the case of Social Security, the government is Bernie Madoff, paying current retirees from the payroll deduction it receives from workers, and spending any money that is left over on whatever it wants, via the purchase of government bonds (the so-called trust fund) which puts the surplus in the government's general fund to be spent.

Here's a table from the 'CBO - An Update To The Budget And Economic Outlook: 2014 to 2024', which shows that mandatory spending — which is dominated by Social Security, Medicare, and Medicaid — accounts for about 60% of federal budget outlays.  Notice the budget deficit is projected to grow by over 40% (-$680B to -$960B) from 2013 to 2024.  There's no reasonable way to address that problem without making changes to those programs, including Social Security --

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http://www.cbo.gov/sites/default/files/45653-OutlookUpdate_2014_Aug.pdf

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There are some lonely critics of Social Security out there, but what they write is largely met with anger from the public.

Here's Walter Williams, John M. Olin Distinguished Professor of Economics at George Mason University, talking about the 'uglier mail' he gets when he writes about problems with government programs for the elderly.  He points out here what a terrible deal Social Security is for future recipients --

https://www.youtube.com/watch?v=30pjl3y_HLE

Here's Robert Samuelson pointing out that Social Security meets the definition of a welfare program, because it taxes one group to pay another.  He wrote this column in reply to angry responses he received for describing Social Security as 'middle-class welfare' --

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http://www.washingtonpost.com/wp-dyn/content/article/2011/03/06/AR2011030602926_pf.html

Why Social Security is welfare
By Robert J. Samuelson | Monday, March 7, 2011;

In a recent column on the senior citizen lobby, I noted that Social Security is often "middle-class welfare" that bleeds the country. This offended many readers. In an e-mail, one snarled: "Social Security is not adding one penny to our national debt, you idiot." Others were more dignified: "Let's refrain from insulting individuals who have worked all their lives and contributed to the system for 50-plus years by insinuating that [their] earned benefits are welfare." Some argued that Social Security, with a $2.6 trillion trust fund, doesn't affect our budgetary predicament.

Wrong. As a rule, I don't use one column to comment on another. But I'm making an exception here because the issue is so important. Recall that Social Security, Medicare and Medicaid, the main programs for the elderly, exceed 40 percent of federal spending. Exempting them from cuts - as polls indicate many Americans prefer - would ordain massive deficits, huge tax increases or draconian reductions in other programs. That's a disastrous formula for the future.

We don't call Social Security "welfare" because it's a pejorative term, and politicians don't want to offend. So their rhetoric classifies Social Security as something else when it isn't. 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.

Let's start with its $2.6 trillion trust fund. Doesn't this prove that people's payroll taxes were saved to pay for future benefits, disconnecting them from our larger budget problems? Well, no. Since the 1940s, Social Security has been a pay-as-you-go program. Most benefits are paid by payroll taxes on today's workers; in 2010, those taxes covered 91 percent of benefits. The trust fund's $2.6 trillion would provide only 3.5 years of benefits, which totaled about $700 billion in 2010.

The trust fund serves mainly to funnel taxes to recipients, and today's big surplus is an accident, as Charles Blahous shows in his book "Social Security: The Unfinished Work." In 1983, when the trust fund was nearly exhausted, a presidential commission proposed fixes but underestimated their effects. The large surplus "just developed. It wasn't planned," the commission's executive director said later. Even so, the surplus will disappear as the number of retirees rises.

Similarly, Congress has repeatedly altered benefits. From 1950 to 1972, it increased them nine times, including a doubling in the early 1950s. In 1972, it indexed benefits to inflation. People didn't complain when benefits rose, but possible cuts now trigger howls that a "contract" is being broken. Not so. In a 1960 decision ( Flemming v. Nestor ), the Supreme Court expressly rejected the argument that people have a contractual right to Social Security. It cited the 1935 Social Security Act: "The right to alter, amend, or repeal any provision of this Act is hereby reserved to Congress." Congress can change the program whenever it wants.

All this makes Social Security "welfare." Benefits shift; they're not strictly proportionate to wages but are skewed to favor low-wage earners - a value judgment reflecting who most deserves help; and they aren't paid from workers' own "contributions." But we ignored these realities and encouraged people to think they "earned" benefits and that Social Security is distinct from the larger budget. Politicians, pundits, think-tank experts and journalists engaged in this charade to spare Social Security's 54 million recipients the discomfort of understanding they're on welfare.

A relatively small elderly population sustained these fictions. Now, this is no longer possible. Contrary to the Obama administration's posture, Social Security does affect our larger budget problem. Annual benefits already exceed payroll taxes. The gap will grow. The trust fund holds Treasury bonds; when these are redeemed, the needed cash can be raised only by borrowing, taxing or cutting other programs. The connection between Social Security and the rest of the budget is brutally direct. The arcane accounting of the trust fund obscures what's happening. Just as important, how we treat Social Security will affect how we treat Medicare and, to a lesser extent, Medicaid.

It is because these programs involve middle-class welfare that cuts could occur without inflicting widespread hardship. All the elderly aren't poor. In 2008, a quarter of families headed by someone 65 or older had incomes exceeding $75,000. No doubt people would be outraged. Having been misled, they'd feel cheated. They paid their taxes, why can't they get all their promised benefits? But the alternative is much worse: imposing all the burdens on younger taxpayers and cuts in other government programs. Shared sacrifice is meaningless if it excludes older Americans.

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Here's Walter Williams also making some of the same points — that Social Security is welfare, and that there is no promise of a benefit — but he also points out that Congress has changed the description of Social Security over the years, which has helped to create the false belief among Americans that individual taxpayers have a Social Security 'account', when that is certainly not the case --

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http://econfaculty.gmu.edu/wew/articles/13/CongressionallyDupedAmericans.htm
http://www.creators.com/conservative/walter-williams/congressionally-duped-americans.html
http://townhall.com/columnists/walterewilliams/2013/11/06/congressionally-duped-americans-n1736128/page/full

Congressionally Duped Americans

Walter E. Williams | Nov 06, 2013

Last week's column, "Is There a Way Out?", generated quite a few responses, some a bit angry. Some people were offended by my reference to Social Security and Medicare as entitlements or handouts. They said that they worked for 45 years and paid into Social Security and Medicare and how dare I refer to the money they now receive as an entitlement. These people have been duped by Congress and shouldn't be held totally accountable for such a belief. Let's examine the plethora of congressional Social Security lies. I'll leave the Medicare lies for another column.

The Social Security pamphlet of 1936 read, "Beginning November 24, 1936, the United States Government will set up a Social Security account for you. ... The checks will come to you as a right" (http://tinyurl.com/maskyul). Therefore, Americans have been led to believe that Social Security is like a retirement account and money placed in it is their property. The fact of the matter belies that belief.

A year after the Social Security Act's passage, it was challenged in the U.S. Supreme Court, in Helvering v. Davis. The court held that Social Security is not an insurance program, saying, "The proceeds of both employee and employer taxes are to be paid into the Treasury like any other internal revenue generally, and are not earmarked in any way." In a 1960 case, Flemming v. Nestor, the Supreme Court held, "To engraft upon the Social Security system a concept of 'accrued property rights' would deprive it of the flexibility and boldness in adjustment to ever-changing conditions which it demands."

Decades after Americans had been duped into thinking that the money taken from them was theirs, the Social Security Administration belatedly — and very quietly — tried to clean up its history of deception. Its website explains, "Entitlement to Social Security benefits is not (a) contractual right." It adds: "There has been a temptation throughout the program's history for some people to suppose that their FICA payroll taxes entitle them to a benefit in a legal, contractual sense.

... Congress clearly had no such limitation in mind when crafting the law" (http://tinyurl.com/49p8fl2). The Social Security Administration failed to mention that it was the SSA itself, along with Congress, that created the lie that "the checks will come to you as a right."

Here's my question to those who protest that their Social Security checks are not an entitlement or handouts: Seeing as Congress has not "set up a Social Security account for you" containing your Social Security and Medicare "contributions," where does the money you receive come from? I promise you it's neither Santa Claus nor the tooth fairy. The only way Congress can send checks to Social Security and Medicare recipients is to take the earnings of a person currently in the workforce. The way Congress conceals its Ponzi scheme is to dupe Social Security and Medicare recipients into thinking that it's their money that is put away and invested. Therefore, Social Security recipients want their monthly check and are oblivious about who has to pay and the pending economic calamity that awaits future generations because of the federal government's $100 trillion-plus unfunded liability, of which Social Security and Medicare are the major parts.

Pointing to the congressional lies and future economic chaos is not the same as calling for a cessation of checks going out to recipients. Instead, it's a call for the recognition that we've made a mistake that needs to be corrected while there's time to avoid a calamity. It's also a call for us to recognize that we all share in the blame and hence the burden to make it right. Politicians have little interest in doing something about an economic calamity that will happen in 2030 or 2040; they only care about the next election. Older Americans, who own most of the political clout, must lead the fight to get Congress to do something about entitlement programs. Of course, the alternative is continued belief in the Social Security and Medicare myth and the heck with future generations.

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