The Macro Economics Social Security - Part Two

How someone views Social Security is often based on what they think it is. How many times have you seen the quote "social security was never intended to be..."? And then the writer puts in what they do not like about it today. I am not sure that it matters what it was intended to be, but it does matter what its impact has been on individuals and the economy for the last 75 years and how that impact has affected us today.

Most individuals consider Social Security as a saving program or as a "welfare program for seniors and the disabled. Either choice gives them a reason to criticize as discussed in the next two sections. I will offer an alternative view in the following section.

Is it a Saving Program?
If Social Security is a saving program then we think that we are paying in contributions while working and then received benefits when we retire. We have paid for our benefits. A problem with this at the individual level is that it has not been equitable. For example, the generations who retired 40 to 50 years ago put little in and received benefits in far greater than the amounts they contributed. Also those who live long lives do better than those who die at age 62.

By contrast, today's workers will probably receive a small return on their contributions to the program and lots of them do not even believe it will be there when they retire. They think that if they could opt out, they could do better on their own.

Economists such as Martin Feldstein have another criticism of Social Security as a saving program. They say that Social Security created less private saving and thus the economy grew slower than it would have without Social Security. Without making contributions to Social Security, they feel that the workers would have invested this money in the private sector. I think they are wrong as I explain below.

Is it a "Welfare" Program?
If Social Security is a welfare program then we think it is designed to help the elderly and disabled. This is particularly true for the depression of the 1930s when this program began since the highest level of poverty was among the elderly. I do not imagine anyone wants to return to seeing masses of senior citizens begging on the streets or living in almshouses.

Whatever the intent was at that time, the program is no longer well designed for this purpose either. The benefits are paid even if the recipient is wealthy and not in need. If this program were truly aimed at helping lower income participants, it would not be financed by a payroll tax that is regressive to workers and a burden for employers to pay. It would make more sense to finance the program with an income tax.

It is an intergenerational "Insurance" Program
The best way to see Social Security is not as a saving or welfare program, but as an intergenerational insurance program. Social Security is actually called "old age and survivors insurance." But the insurance should be thought of as for the children against their parents living too long. Social Security is a way for the working population to pay into a fund that relieves them the burden of using their own money to pay for their parent's (and even grandparent's) needs if those parents became old and dependent. Whether the worker's parents live until they are 63 or 93, their benefits will be covered by this insurance. Instead of having to house their parents in the spare room and buy groceries for them, workers pay part of their own wage to a fund that gives their parents enough to do these things on their own.

Under this interpretation, Social Security did not crowd out private saving; it was a public substitute for interfamily transfers. It is not a saving plan that gives you a return, but an insurance plan that pays off well if your parents are survivors. When you retire, your (or at least someone's) children will pay for this insurance on you. This has been going on for three generations, so the current workers are providing benefits for their parents who in turn had provided benefits for their parents. Workers cannot opt out of the program, because they are (collectively) obligated to pay for their parent's benefits now and in the future.

Under this interpretation, it also makes more sense that benefits are the same for all retirees regardless of their income. We do not say that when we have a car accident that the amount get from the insurance company will be dependent on our income. We get what we insured it for.

Once we view Social Security as an intergenerational insurance program, we can see why many of the current criticisms are no longer valid. Workers should stop thinking that they should be able to opt out because they incorrectly think it is only about them. Critics of the way benefits are determined should not complain either. Since they are taxable, it is not necessary to means test these benefits when they are received. We can change the income tax rates if we choose if you want to reduce net benefits. Finally, since all workers had parents, but many workers do not pay income taxes, the payroll tax is a more inclusive way to collect the "insurance" premiums.

Under this interpretation, the system first put in place for our parents and grandparents 75 years ago was a contract that has been passed on to the current generations whether we like it or not. It is a small price to support these previous generations given all they have done for us by first winning WWI and then building the schools and universities that we attended and which enabled us to earn the incomes we have.