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Posts Tagged ‘Ponzi Scheme

Dear Mother Marshall, You Are Wrong; Really NPR, Really!?! And The Mystery Of The Missing Research Note

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A few days back NPR Marketplace ran a program on the US fiscal cliff which focused on the what the House of Representatives would do once the Senate passed its solution to the fiscal cliff.

During the course of the program, the correspondent, Nancy Marshall Genzer, uttered something which was so egregiously wrong, I was surprised that the most popular business program in the US could let it go without an immediate correction either from the anchor or the correspondent. Below is the audio of the program. Listen carefully starting at the 3’40” mark, when she starts talking about the payroll tax:

Now Sarah, I’m going to digress just a little bit here and I’m going to quote my mom. <Crosstalk> My parents own a small business and they have a couple of employees and the employees are concerned that the payroll tax is going up. But my mom said to them, “Keep in mind the money from that social security payroll tax goes towards your social security. So its really not such a bad thing that it is going back up to where it was because you’ll be saving more towards your social security. Your paycheque may go down a bit now but your social security cheque will be a bit higher when you retire.

Mother Marshall is telling her employees that the FICA tax (specifically the social security bit) the government deducts from the payroll is going into a pot with her employees’ name and when they retire they will get their pot. So if they pay more in tax now, there will be more money in the pot when they receive it. Unfortunately this does not correspond with reality.

Social Security is a pay-as-you-go scheme. In this system, the current beneficiaries are paid from proceeds obtained by taxing current workers. Since a picture[1] is worth a thousand words:

A pay-as-you-go system can be visualized as a pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end.

Thus current benefits are being paid from current taxes.[2] This means that the money taken from each worker’s paycheque is immediately paid to the current beneficiaries as their Social Security income.[3] So just because the payroll tax is going up does not mean that when the current employee retires (which could be as far as 40-45 years away) s/he will get a higher benefit.

At this point one may reasonably ask, what happened to all the money which was paid into Social Security, at the very beginning, by the then taxpayers? Wasn’t that tax money used to pay those taxpayers’ Social Security benefits when they retired? The answer is that the very first payroll taxes collected for social security were paid out to the very first retiree-beneficiaries! As Nobel Prize winning economist (and former Enron adviser[4]) Paul Krugman explained (in the context of explaining the different between the rate of return on private retirement accounts and Social Security):

where does the return go? The answer – which I guess isn’t that obvious – is that it goes to pay a hidden debt. When the pay-as-you-go system starts up, there is a generation of retirees who receive benefits without having made contributions. (What this corresponds to in the real world is the very high rate of return received on contributions by early recipients of Social Security.)

The Social Security Administration in its “Historical Background And Development Of Social Security” webpage gives two such examples:

  • Ernest Ackerman who

retired one day after the Social Security program began. During his one day of participation in the program, a nickel was withheld from Mr. Ackerman’s pay for Social Security, and, upon retiring, he received a lump-sum payment of 17 cents.

worked for three years under the Social Security program. The accumulated taxes on her salary during those three years was a total of $24.75. Her initial monthly check was $22.54. During her lifetime she collected a total of $22,888.92 in Social Security benefits.

Another of Mother Marshall’s misconception is that the she thinks the amount of a beneficiary’s benefit is completely determined by the amount s/he has paid in payroll taxes.[5] However Congress can change the law governing the calculation of benefits.[6] As the Social Security Administration’s Retirement Estimator states:

Your estimated benefits are based on current law. The law governing benefit amounts may change because, by 2033, the payroll taxes collected will be enough to pay only about 75 cents for each dollar of scheduled benefits.

Congress has also reserved for itself

The right to alter, amend, or repeal any provision of [Social Security] … 42 USC § 1304.

Thus Congress can alter the amount of benefits to be paid to the beneficiaries irrespective of the amount they paid into Social Security.

Finally, the US Supreme Court case Flemming v Nestor (1960) is quite instructive. The Court very clearly contradicts Mother Marshall when it says:

Of special importance in this case is the fact that eligibility for benefits, and the amount of such benefits, do not in any true sense depend on contribution to the program through the payment of taxes, but rather on the earnings record of the primary beneficiary.

The Court also makes an appropriate distinction between Social Security and retirement portfolios. Social Security is a form of social insurance where taxpayers pay premiums to cover for unforeseen and catastrophic losses in the future.[7] If I pay premiums to cover my property from fire damage and I then sell it at a later date, before any fire damage took place, then I do not have the right to recover the premiums paid. Those premiums help to cover the payout to those who actually suffer from fire damage. I don’t have a property right in the premiums I paid. And in the same way, those contributing into Social Security do not have some property right on their contributions. The Court says:

each worker’s benefits, though flowing from the contributions he made to the national economy while actively employed, are not dependent on the degree to which he was called upon to support the system by taxation.

The Court provides an explanation for Congress’ reservation of the right to alter, amend or repeal the provisions of Social Security

[Social Security] was designed to function into the indefinite future, and its specific provisions rest on predications as to expected economic conditions which must inevitably prove less than wholly accurate, and on judgments and preferences as to the proper allocation of the Nation’s resources which evolving economic and social conditions will of necessity in some degree modify. To engraft upon the Social Security system a concept of ‘accrued property rights’ would deprive it of the flexibility and boldness in adjustment to everchanging conditions which it demands.[8]

Thus the Court, finally, held that

a person covered by [the Social Security] Act has not such a right in benefit payments as would make every defeasance of ‘accrued’ interests violative of the Due Process Clause of the Fifth Amendment.[9]

So dear Mother Marshall:

  • The money from your employees’ social security payroll tax is NOT going towards their social security. It is going to the social security of current beneficiaries (retirees, survivors and disabled). Current beneficiaries != Current contributors
  • Your employees’ are NOT saving more towards THEIR social security.
  • Your employees’ paycheques may be going down a bit now but nobody knows how much their social security cheque will be for when they retire.

Note: This radio segment was broadcast in Jan 1, 2013. Until this post was published there was no update or correction on the segment webpage regarding this issue. Does NPR think Mother Marshall was correct?

Further Reading: The Concise Encyclopaedia of Economics entry on Social Security, A Young Person’s Guide to Social Security

And one final thing. I cannot help but remember Schweddy Balls every time I hear the women of NPR.

And for those outside the US

Footnotes

[1] This picture is taken from the Ludwig von Mises Institute website. The von Mises institute is an organisation which espouses Austrian economics. Interestingly the Social Security Administration webpage this image has purportedly been taken from no longer exists. However, a search on the wayback machine indicates that this webpage was last indexed on November 10, 2010. Even more interestingly Research Note #25 (the subject of the missing webpage), prepared by the Social Security Historian’s Office and which compares and contrasts Social Security and Ponzi schemes, is no longer available at the current webpage for the Historian’s office. The von Mises Institute blogpost, from which I initially became aware of the comparison by the Social Security Administration’s of itself with a Ponzi scheme, is dated September 19, 2011. Around that time the comparison between Social Security and Ponzi schemes was in the public consciousness because Texas Governor Rick Perry analogized the two in the Republican presidential primary debate held on Sept. 7, 2011 at the Ronald Reagan Presidential Library. The Social Security Research Note (and associated webpage), which is the subject of this footnote was removed sometime after September 19, 2011. There may be a reasonable explanation for the removal, and I would be grateful if someone makes me aware of it.

[2] As Matthew Yglesias pointed out in the context of costs of transitioning from Social Security to private retirement accounts: [reporters] must ask [proponents of private retirement accounts] how we’re going to pay current benefits of this happens … current retirees can’t get benefits if my money is in a private account.

[3] Not ALL the contributions are given out as benefits. In the beginning decades contributions outstripped benefit payments and Social Security built up a surplus which it was (and is) required, by law, to invest in Treasury Bonds. Given the retirement of the baby boomers and thus the increase in the total benefits paid, the trust fund is anticipated to be exhausted by 2033.

[4] Thank you, James Taranto

[5] Now obviously there is some link. The more taxpayers pay into Social Security the greater the solvency of the program and the more assurance of receiving benefits (and higher benefits).

[6] Examples of such calculation can be seen here.

[7] Given that ageing and a concomitant reduction in income is not an unforeseen event, it does raise the question of how meaningful is it to “insure” against such events. One should also keep in mind that Social Security does insure against disability also.

[8] Just wanted to make it clear that the difference between Social Security and individual private retirement accounts is not that the former can be changed while the latter is unchanging. The latter fluctuates too, but according to market conditions while the former can be changed by Congress contingent upon changes to the economy and demographics. Note that there is a class of private retirement benefits called defined benefit plans where, like Social Security, the benefits are calculated by a formula known in advance. Defined benefit plans are being increasingly phased out in favour of defined contribution plans.

[9] The Court does say that Congress does not have arbitrary power to modify Social Security and that its actions will have to abide by Due Process. Presumably the level of scrutiny given to Congressional action would be Rational Basis Review. A tangential question which arises is, is the protection afforded to a beneficiary equal to the protection afforded to a property owner whose property is being condemned? At the time Flemming was decided maybe not but after Kelo v City of New London that question, for me, is up in the air.

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