The True Cost

By James Schaefer.

There is an enormous cost to taxpayers — and to the American economy, and to government — by having the Social Security system structured and administered the way it currently is.

Holding the Social Security Trust Fund in safe but low-yield U.S. Treasuries — “backed by the full faith and credit of the United States government” — is expensive relative to other options available.  It will cost taxpayers vastly more than it did to create the $2.5 trillion Social Security surplus in the first place.

1)  America’s Taxpayers Will Pay $2.5 Trillion Twice to Fund the $2.5 Trillion Surplus 

The trust fund was created from surplus FICA taxes above and beyond what was needed by the Social Security Administration to pay immediate monthly benefits.

How are the taxpayers paying twice?

Taxpayers pay the first time as FICA taxes levied on wages.  The surplus FICA revenue, by law, must be invested in special U.S. Treasury bonds.  Your FICA taxes go into the Social Security and Medicare trust funds, but they are immediately loaned to the federal government—which spends the money and promises to repay it at some far-future date.  A Treasury bond, after all, is a loan to the federal government, which only borrows when it needs money to cover a shortfall.  Nothing is actually saved for Social Security;  instead, the cash is immediately spent elsewhere, and all that remains in the trust fund vaults is an IOU saying that the government will some day pay the debt off—with cash raised from the taxpayers.

This has been occurring since 1935, when the Social Security system was set up.  Over the past 76 years, the surplus account has accumulated $2.5 trillion in IOUs issued by the Congress that carry the fine title of U.S. Treasury bonds.

(In 1969, the process was made more visible when Lyndon Johnson, Richard Nixon and the 1969 Congress created the Unified Budget, essentially acknowledging publicly what had been going on for the previous 34 years).

Taxpayers will pay $2.5 trillion a second time when the Social Security Administration goes to the U.S. Treasury and exchanges the Treasuries for cash to pay benefits.  The Treasury, in real time, will collect the money needed to redeem them from America’s taxpayers.

Thus, America’s taxpayers will pay $5 trillion to provide $2.5 trillion in benefits; some of the taxpayers will be different people, but many Americans will be paying their FICA taxes twice in their lifetimes, first as FICA payroll taxes, and later as income taxes to redeem the Treasuries.


2)  Taxpayers Will Pay the Interest on the Trust Fund

The federal government pays the Social Security Administration interest on the Trust Fund; and the interest rate is currently around 4.62%.

Translation: the taxpayer is paying the interest, because the government only has money that it collects, directly or indirectly, from taxpayers.


3)  Taxpayers Will Pay the Opportunity Cost

The foregone opportunity of the Trust Fund to earn a return on the stock market is enormous.

If we take the actual FICA surplus, year by year from 1937 to 2009, and calculate the market growth or loss, year by year, for the same years, we would now have a Social Security Trust Fund worth $3.02 trillion.

That $3.02 trillion is very close to the current size of the Trust Fund; as of the end of 2009, it was $2.54 trillion.  However, there is a significant difference.

Had the surplus been invested, the Trust Fund would be real assets in real companies; and it could still be drawn on as needed to pay Social Security benefits.

There is no reason why the returns under this proposed scenario could not be guaranteed by the federal government, the same way that they’re guaranteed today: as a promise of payment in the the event of market failure, with funds raised from future taxpayers.

The big difference between these two scenarios is that we know  the government will have to make huge future payments to the trust funds under the current system, while it’s unlikely that it would ever have to make any future payments on a gurantee to trust funds that were invested the same way all pension plans are now invested.

The benefit stream with the Social Security surplus invested in Wall Street would be two to three times larger than the monthly Social Security benefits currently offered, and would range from $2,000 to $6,000 per month, instead of the current few hundred dollars to $3,400 per month (this calculation is based on the payouts of the Alternate Plan, the alternative to Social Security that has been in place in three Texas counties since 1982, and which is invested in the market).


4)  Foregone Growth of the American Economy

That $2.5 trillion, had it been invested in stocks, mutual funds, and corporate bonds, would have flowed into the private sector to drive growth of the American economy, in the form of plant expansion, capital projects, product development, sales promotions and marketing plans, new hires, and pay raises and promotions and bonuses.

It would have driven the competitiveness of the American economy.

“But”, you may argue, “wouldn’t that put the government in the position of picking winners and losers?”

Well, the public employee pension funds are currently invested in the stock market, and they have fund managers who function exactly the way fund managers do at the brokerage houses: under the strict requirements of fiduciary responsibility.

CalPERS, the nation’s largest public employee pension fund at $230 billion, has around $80 billion in equities.  The Alternate Plan in Texas invests in the market as well.  Both pay monthly benefits to their retirees that far exceed the benefits paid by Social Security.

If the market is safe for public sector retirement funds, it should be equally safe for all Americans, and for the Social Security Trust Fund.


5)  Foregone Tax Revenue That Would Have Come from Economic Growth

A letter-writer to the Wall Street Journal stated, regarding the basis of a sound currency:

“A strong, growing economy is the only thing that backs the U.S. Dollar.”

Paraphrasing this slightly: a strong, growing economy is the only thing that backs the government’s tax base.

Absent a strong growing economy, the foundation for government taxation is weak, and the economy cannot fully support government programs, let alone growth of government.


Final Thoughts 

If we think of the Trust Fund as a retirement account into which we have invested $2.5 trillion for the past 60 to 75 years, and the fact that $2.5 trillion will have to be paid all over again, then it is no different from investing in the stock market for six or seven decades, losing everything, and having to start all over again.

The equivalent market scenario for investing the Social Security Trust Fund into U.S. Treasuries is a 100% market loss, and having to start over again at zero.

The hypothetical market loss is actually greater than 100%, if one also considers that taxpayers are paying the interest on the Trust Fund.

The hypothetical loss is two times that 100% market loss — if we value the Opportunity Cost at $3.02 trillion as the foregone value of the Trust Fund had it been invested in the market.

CalPERS has used 8% historically to project returns on their investments in the market; they lowered the rate a couple of years ago to 7.75%, and in early 2012 to 7.50%, to reflect current market conditions.  The federal government pays the Social Security Administration 4.62% interest on the Trust Fund.

One of these is paid by the market, and one is paid by taxpayers.

Using Einstein’s “Rule of 72” (i.e., divide the interest rate or market return into 72 to get the years it will take for the account to double), a 7.50% return will double a person’s investment in 9.6 years; a 4.62% return will double a person’s investment in 15.6 years.

The Social Security Administration, the American taxpayer, the U.S. economy, and the federal government would all be better served if a significant portion of the Trust Fund were invested in the market — yes, into Wall Street — or handed to CalPERS to manage, than to sit in U.S. Treasuries.

It would, of course, be backed by the same government (read: taxpayer) guarantee in the event of a market failure, just as it is now.

In a worse case scenario — a total market collapse — it won’t be any worse than the 100% market-loss-equivalent that is enshrined in current law; and the taxpayer would be on the hook for a lot less than having to pay $2.5 trillion a second time for something that has already been paid for once.

There is a better way.


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