Saving Social Security

Given that Social Security is unconstitutional, regardless of the U.S. Supreme Court’s ruling in Helvering v. Davis (1937), my interest in saving Social Security is merely pragmatic. I would prefer its abolition through a reversal of Helvering v. Davis. Because of the extreme unlikelihood of that event, I will settle for a legislative solution, one that preserves Social Security as a mandatory program, but converts it to a system of private accounts invested in private-sector securities and equities.

Die-hard defenders of Social Security want to preserve its essential character — a mechanism for transferring income from workers to retirees — and will resist any move in the direction of privatization. In fact, I expect the looming deficit in Social Security receipts to elicit calls for the following measures:

  • Elimination of the cap on the amount of income subject to Social Security taxes.
  • Reduction of benefits paid to retirees according to the amount of income they receive from other sources.
  • Increases in the taxes paid on benefits by retirees with income from other sources.

That these measures will cause slower economic growth and therefore yield lower-than-expected Social Security receipts will be of no consequence to welfare-state zealots. Their response will be to redouble the pain, ad infinitum. (We can expect to see a parallel treatment of health-care goods and services, as government control of those markets approaches 100 percent.)

Unlikely as privatization of Social Security may be — especially in light of today’s rush to nationalize anything and everything that involves risk and uncertainty — there are good arguments for privatization, and they must be made on the chance that they will be heeded when the present hysteria subsides. Accordingly, the rest of this post addresses the three  main objections to privatization:

  • The existence of the Social Security trust fund, which (on paper) will not be exhausted for perhaps another 30 years.
  • The transition cost, that is, the cost of funding private accounts. (It should be noted that the idea of a transition cost suggests, rightly, that the trust fund is not a real asset from which benefits can be paid.)
  • The uncertain returns to private accounts invested in private-sector securities and equities, given the gyrations of stock and bond markets, as compared with the manufactured “certainty” of returns to traditional Social Security accounts.

These rebuttable objections reflect an underlying bias toward a tax-funded system, especially a “fair” one (i.e., one that does not allow  some retirees to enjoy greater benefits “just because” they made better investment decisions). That bias, unfortunately, cannot be overcome by facts or logic. One can only hope that it does not decide the issue of privatization.

The Trust Fund

The Social Security trust fund exists because, for many years, receipts from workers outran payments to retirees. What happened to those surpluses? They were spent by other branches of the federal government. The trust fund, in other words, consists of IOUs issued by government to itself. Therefore, there is no trust fund, that is, no stock of unencumbered assets from which benefits can be paid when outlays begin to exceed receipts. There is only worthless paper or, more accurately, worthless accounting entries.

To understand why this is so, consider the following question. How much wealthier are you when you issue an IOU to yourself? Not a bit — nada, zero, zilch, zip. The same goes for Uncle Sam — a fact of life that not even Congress or the Supreme Court can repeal.

Digging deeper, let us consider the means by which the federal government could convert the IOUs held by the trust fund into benefits for retirees:

  • Borrow money from willing, private lenders.
  • Enlist the Federal Reserve in what amounts to a money-printing operation.
  • Increase Social Security taxes on workers and/or other kinds of taxes (e.g., income taxes).
  • Sell government assets to private buyers until the sum of such sales equals the nominal value of the trust fund.

This list of options simply underscores the chimerical nature of the trust fund. It can be redeemed only by passing the fiscal buck in one way or another:

  • Government borrowing from private lenders may crowd out private-sector borrowing and, in any event, has no net effect on governmental indebtedness — it just moves it around. (If your wife is in debt by $1,000 and you borrow $1,000 in order to pay her debt, your family is still $1,000 in debt.)
  • Printing money fuels inflation, which is a tax on consumers. It’s just a subtle way of shifting the burden.
  • Tax increases simply push the burden of Social Security onto taxpayers, some of whom are retirees on Social Security.
  • Government assets, unlike wholly-owned private ones, are encumbered by obligations to perform governmental services — even passive ones, such as conserving land. To the extent that government assets are sold in order to replenish the trust fund, some governmental functions must be curtailed, inflicting material and/or psychic losses on a substantial cross-section of Americans.

The trust fund would be a real, unencumbered asset only if it had been used to buy privately issued securities and equities, thus participating in the real returns that flow from economic growth.

A final defense of the trust fund goes like this: If a government bond (IOU) is a real asset to the individual who holds the bond, why isn’t it a real asset to the branch of government (Social Security Administration) that holds the bond? There are two answers, one of which I’ve already given: As you cannot make yourself wealthier by giving yourself an IOU, so government cannot make itself wealthier by giving itself an IOU. Spent money is gone.

The second answer is more shocking, but nevertheless true: A government-issued IOU is not a real asset, no matter who holds it. Private ownership of a government-issued IOU does not represent a claim on real wealth that has been accumulated by government through the provision of economically useful goods and services. A government-issued IOU merely represents the taking by government of resources that could have been used by the private sector to generate economically useful goods and services. As discussed above, the taking occurs when government borrows (crowds out private borrowers), inflates the money supply, or imposes taxes.

Oh, yes, government could confiscate private businesses and (with luck) run them at a profit, but that is simply the ultimate form of taking: socialism. Government, by its very nature as a taxpayer-funded institution with superior coercive power, can perform only one kind of service that  enables economic growth (among other things): defense of the citizenry against predators, foreign and domestic. But such defense is a negative service, one which preserves value and does not enhance it. Moreover, the returns to that service (the prevention of losses to liberty, life, limb, and dignity) cannot be quantified because the service is “purchased” by taxes (i.e., coerced), not freely purchased in market transactions. (Whether it could be and why it should not be are matters for discussion elsewhere — here, for example.)

Transition Costs

Given the foregoing, it should be obvious that there is no free lunch when it comes to Social Security, as it now stands. As long as Social Security remains a transfer-payment scheme backed by phony assets, retirees’ benefits will be extracted from their fellow citizens (and themselves), in one way or another.

One thing is true: If private accounts were established, made mandatory (to satisfy paternalists), and funded by investing workers’ Social Security taxes in stocks and bonds (that is, in ways that contribute to economic growth and yield real returns), there would be a (temporarily) larger gap between receipts and outlays. This larger gap — the so-called transition cost — would have to be filled by higher taxes (or the equivalent in borrowing or inflation). The so-called transition cost would continue until taxpayers are contributing no more to retirees’ benefits than they would have been contributing under the present system. At that point, the transition cost would become increasingly negative, that is, it would be a benefit to taxpayers. That benefit would reach its zenith when there is no longer anyone drawing Social Security benefits under the present system.

It should now be obvious that the so-called transition cost isn’t a cost. Rather, it’s a down payment on a better financial future for retirees and taxpayers. The only real issue is one of timing: how to spread the tax burden so that it doesn’t fall disproportionately on those who pay taxes in the years immediately following the establishment of private accounts.

Here, borrowing becomes a legitimate tool of government policy. The tax burden can be spread more evenly across generations if government arranges to borrow some of the down payment on privatization from willing lenders, who are then repaid with taxes levied mainly after the transition cost has becomes negative.

Returns on Private Accounts

Every time the stock market takes a dive, the die-hard defenders of Social Security point with glee to the negative returns implicit in the recent direction of the Dow Jones Industrial Average, S&P 500, and other prominent stock-market indices. The die-hards conveniently overlook three salient facts (of which most of them are probably ignorant):

  • Private accounts could be invested in a mix of stocks and bonds, at the discretion of each account owner.
  • Over the relevant time period (i.e., a working career of 30 years and longer), stocks and bonds have positive returns. For example, the inflation-adjusted return on the Wilshire 5000 (a total-market index of U.S. stocks) was 6.1 percent from February 1979 through February 2009 (when the index hit a low from which it has rebounded). For another example, the inflation-adjusted interest rate on Aaa corporate bonds has been hovering around 5 percent for the past several months.
  • There is no real return on taxes paid into Social Security, claims to the contrary notwithstanding. Those taxes are either paid out immediately to retirees or spent on unremunerative government programs. The so-called returns on Social Security taxes are illusory — they are nothing more than transfers of money coerced from current workers and other taxpayers (including retirees) and handed to current retirees.

Final score: Private accounts, 5 to 6 percent; tax- and transfer-funded accounts, 0.


Assuming that Americans, in the main, will not stand for complete self-reliance when it comes to retirement planning, the second-best solution is a mandatory system of private accounts invested in securities and equities. It is doubtful whether such a system can be established in the face of the perpetual fear-mongering and disinformation campaign against it. But there should be no doubt that such a system would be superior in every way to the present one.