This year, the president put forward the idea of changing the way benefits in Social Security are calculated. The change acknowledges what the program's trustees have said for years: Social Security is in trouble.
The fact that Washington is doing something is a plus. At the same time, the president's proposal and the critics' response pretty clearly demonstrate that Washington does not understand the size or even the nature of the problem with Social Security.
The experts in Washington express the problem facing the Social Security system in terms of cash flow. It is true that Social Security expects to draw in less money than it spends. The corresponding insolvency is however an outcome rather than an actual problem, somewhat like how a fever is an outcome of the flu. The fact that Social Security is running out of money is the visible outcome. The disease is the fact that Social Security is a terrible investment.
The mix of what-you-pay and what-you-get makes the question of solvency an unavoidable outcome. It should surprise no one that a terrible investment runs out of money. People avoid bad investments whether it is on Wall Street or in Washington. It is a matter of economic gravity that poor returns drive capital out of any financial system.
Social Security works like insurance. While all insurance is an asset, the economic returns of insurance are not measured in nominal values because no one knows whether they will collect anything. Insurance is measured by the present-value expected future benefits versus the present value of past contributions. According to the Social Security Administration, some younger workers can expect to get back as little as 40 cents on the dollar of contribution on a pre-tax basis. That means that Social Security isn’t terribly different from spending quarters to buy dimes.
In response to the cash-flow shortfall, experts argue that raising taxes and lowering benefits on future generations are the only two solutions. Comically enough, their cure treats the symptom and feeds the disease. It is impossible to fix poor returns by making the return worse. As returns drop, so does participation. As participation drops, the system will see greater and greater cash shortfalls.
The experts argue that payroll taxes are mandatory — which is true. The problem is that wages are not mandatory. People can stop working. People can shift wages into benefits which are not captured by payroll taxes. Businesses can shift wages into stock options which are not part of the payroll tax equation. This is not evasion. It is the sound of people fleeing a failing system.
The experts do not believe in economic gravity. In their world, no one retires earlier because of lower compensation. No one acts in their own self interest to avoid the tax. And no one loses a job because of the higher cost of employment. In the mind of the academics in Washington, the economy is a frictionless system where rising costs have no consequence.
The problem is that Social Security is spending quarters to buy dimes. The experts tell us that the solution to this problem is for us to convince our children to spend quarters to buy nickels. This is lunacy. These solutions make the system less appealing to the working generation, without whom the system fails in spectacular fashion.
The problem with Social Security is what you get what you pay fir. As long as the system generates terrible returns, you should expect to see people flee the system — until there is no system left to flee.