Social Security is once again a hot topic in the political arena. Democrats periodically try to scare older voters by claiming that Republicans want to make radical changes to the 87-year-old New Deal program, or eliminate it entirely. Some of that is going on now, although a new charge is being leveled. Currently, Republicans are claiming that Democrats want to reduce pension benefits so millions of illegal immigrants can be added into the system.
The last president who made a serious attempt to reform Social Security was George W. Bush, in 2005. He and many others said reform was essential because:
- Social Security’ had an unfunded liability of $25 trillion ($25,000,000,000,000) – indicating that its future benefit promises exceeded what it expects in taxes by that amount, under the present system. (Today the unfunded liability is $43 trillion.)
- The SS “Trust Fund” – supposedly bulging with all those Federal Insurance Contributions Act (FICA) taxes that we paid – actually holds only IOUs (T-bills) left by the Federal Government, which has borrowed those funds.
- In 2004 analysts estimated that by approximately 2012 benefits being paid out would start exceeding FICA taxes received each year. (But that didn’t happen. Instead, the system ran a surplus of $11 billion in 2021.)
- If (and when) the Social Security Trust Fund stops running a surplus, it will have to start calling in those IOUs left by the Federal Government. The Feds will have to borrow the money elsewhere – probably at higher interest rates.
- By approximately 2037, or 2040, or 2043, (depending on how it is estimated), all the IOUs will have been called in and the Trust Fund will be (truly) empty.
- Current new retirees will receive only a 2% or 3% annual return on the taxes they paid.
For a long time Social Security was called the “third rail of American politics,” because any politician who dared touch it would suffer instant political death. Barry Goldwater was an early victim. In the 1964 presidential campaign he talked incautiously about reforming or even dismantling the system. Subsequently he was buried by Lyndon Johnson in an epic landslide. The “third rail” was real because older voters guarded the system jealously. They loved it because it was a terrific deal.
The system is really an elaborate “pyramid scheme.” That’s a scam where the founder collects, say, $100 from each of 100 other people. Each of them, in turn, collects $100 from each of 100 other people who do the same; etc. All is well, as early “investors” easily find their 100 people and happily collect $10,000. But mathematicians know that by the fourth layer you need a million new people, and by the sixth layer you need 10 billion people. This exceeds earth’s population. Such schemes always collapse because of the simple arithmetic of exponential growth.
A 1920s scam artist named Charles Ponzi made pyramids so infamous that they are now called Ponzi Schemes. They are illegal under current law – except when the government runs them.
In his 1932 campaign, FDR explicitly promised to help people who had lost their life savings in the bank failures of the Great Depression. Social Security, designed by FDR’s Brain Trust, was their solution. Early beneficiaries made out great. My grandparents retired in 1952 under the 1950 Farmers Extension Act, which let self-employed farmers join the Social Security system. When the law was passed my grandfather was already 68. He died in 1959, but my grandma lived until 1971. Together they probably drew $30,000 in benefits – not a bad return on less than $200 in taxes paid. (No question that they needed that $100-a-month pension. They didn’t have a bean.)
Retirees in those early years prospered similarly. Later retirees fared less bountifully, but still made out very well. By 1964, when Mr. Goldwater got roasted on the third rail, the system was only 29 years old. By that time, no SS retiree had paid FICA taxes for his entire working life. Not until 1977 did workers begin retiring who had paid FICA taxes for all of their working years. It’s not a coincidence that major FICA tax revisions were enacted the very next year. Someone finally did the math.
In 1949 the FICA tax rate stood at 2%. Thereafter, Congress modified that rate twenty-one times, until the current rate of 12.4% was reached in 1990. My own records show that I paid FICA taxes on the maximum income subject to FICA-taxation every year from 1965 through 2002. My total FICA tax for 1965 was $348. For 2002, it was $10,528.
President George W. Bush was the first politician to survive after openly running on Social Security reform. Polls suggest that he actually gained votes from younger voters by advocating private investment accounts. So he had at least a partial mandate to move the system toward fiscal soundness, although that mandate did not furnish enough Congressional support to make changes.
All that reform talk made me wonder what return new retirees could expect on the taxes they have paid. The algorithm for calculating benefits is still very mysterious, but I did have some data. My wife began drawing Social Security pension in 2004, and I followed in 2005, so we knew what our starting pensions were.
The SSA sends a record of how much FICA-taxable income you earned each year. That allowed me to tabulate the data for my working lifetime – 1960 through 2003. For each year I calculated what I paid in FICA tax, and what that amount would have grown to if invested at prevailing rates through 2004. This gave me an estimate of what I might have accumulated, had I been able to invest those taxes instead of simply paying them to the government. I also wanted to measure the rate of return my pension represented.
To make these calculations I needed the historical FICA tax rates. (Found on the Internet.) I also needed historical investment interest rates for those years, so I settled on the Prime Rate as a reasonable rate for serious investing. Those data were also readily available. The completed table had the following form, with a row for every year. Here we present only a few years because of space constraints. Totals shown are the actual sums from the full table.
| Year | Tax Rate | Income | Tax Paid | Prime Rate | Cumul. Factor | Amt. to 2004 |
| 1960 | 6.0% | 336 | 20 | 4.5% | 30.71 | 619 |
| 1961 | 6.0% | 1,014 | 61 | 4.5% | 29.39 | 1,788 |
| 1970 | 8.4% | 7,800 | 655 | 7.75% | 17.87 | 11,707 |
| 1980 | 10.16% | 25,900 | 2,631 | 15.9% | 7.50 | 19,748 |
| 1990 | 12.4% | 51,300 | 6,361 | 10% | 2.58 | 16,391 |
| 2000 | 12.4% | 76,200 | 9,449 | 8.9% | 1.21 | 11,472 |
| 2003 | 12.4% | 31,651 | 3,925 | 4.1% | 1.05 | 4,101 |
| TOTALS | 1,438,557 | 168,751 | 596,247 |
Columns 2, 3, and 5 are historical data, although for many of the years the prime rate shown is an average. (In 1980 the Prime Rate was adjusted 39 times – in case anyone is nostalgic for the Carter years.)
Column 4 was computed by multiplying columns 2 and 3.
Column 6 (the Cumulative Factor) involves a more complex calculation.
- For 1960, the CF = Prime Rates compounded for each year, 1960 to 2003.
- For 1961, CF = Prime Rates compounded for years 1961 to 2003;
- For 1962, CF = Prime Rates compounded for years 1962 to 2003;
- Etc., for every year through 2003.
Thus, the $20 tax I paid in 1960 would have grown to $619 by 2004, if re-invested at the Prime Rate each year. (i.e., Column 7 = Column 4 x Column 6.) And the $168,751 of FICA taxes I paid on $1,438,557 of taxable income, over those years, would have grown to $596,247 (we’ll call it $600K) by 2004, if so invested. This (virtual) amount, if invested in preferred stocks and bonds at 6% – realistic because I have owned bonds which actually paid dividends at that rate – could produce an annual income of nearly $36,000. Not a princely income, but a reasonable return that would enhance the retirement of many.
But my Social Security pension was less generous than this. My first-year monthly benefit was $1,394 – totaling not quite $17,000 a year – when I retired in 2005, at age 62. This represented an apparent interest of 2.8%, while the principal is kept intact.
Your Social Security pension is something like an annuity. It pays a benefit when you’re living, but nothing remains at your death. And if you die before retirement, your entire investment is lost. A real $600K investment would survive after your death and produce income indefinitely.
On the plus side, the SS pension is inflation-adjusted each year. For 2005 the increase was 2.6%, while annual increases through 2020 hovered around 2%. Now, of course, the Biden gang has been proclaiming that Social Security pensions will be increased by 8.7% for 2023 – without mentioning that it’s because of inflation caused by their deficit-spending. Even with this substantial increase, the math shows that my monthly benefit has increased by just 40% over seventeen years. This works out to a 2% increase per year, compounded.1
If my retirement lasts 25 years (taking me to age 87), and my pension goes up by 2% a year over that span, it would increase to $2242 a month. Under these assumptions, my lifetime Social Security benefits would total $535,800 – i.e., as though I had received no interest on my virtual accrued amount, but instead paid a 10% “fee.”
Inflation confuses the issue. It looks like your income is growing, but the dollars buy no more. If inflation were zero, and my benefit remained static, my monthly benefit of $1394 would represent a negative return – like an annuity paying zero interest which extracts a yearly 2.8% fee for 25 years. No one in his right mind would put his money into such investments.
For comparison, I duplicated these calculations for my wife’s Social Security data. (Table not listed.) Her earnings picture is less robust, since she spent many years of her working lifetime raising our children. She paid FICA taxes of $11,931 on $106,770 of income. By the same compounded Prime Rate calculations, those taxes would have grown to $57,682 by 2004, when she retired. Her annual SS pension for that year was $5,064, which amounted to interest of 8.8% on the $57,682, with the principal left untouched. With inflation of 2% a year factored in, she stands to come out ahead, over 20 years, by 181%. It’s a pretty good deal.
Obviously the system is tilted toward low-income earners. (Remember, “Social” – as in “socialism” – is part of the name.) It’s unlikely that any private investment could produce a pension as generous as the one Social Security gives to lower earners. But for people earning the maximum FICA-taxable income each year, the pension-benefit is mediocre.
Changes in the system can’t help old guys like me, but my children and grandchildren need a fair shot at building retirement wealth. They will pay hundreds of thousands of dollars in FICA taxes over their working lifetimes. But they won’t be able to live on the “benefits” they will receive under the current system. A new New Deal is needed.
Higher earners who understand the current system will want reform. Lower earners won’t. Both sides will try to argue for or against reform without showing the other side how unbalanced the system is. It promises to be a real political scrap. But beyond the entertainment value, the financial futures of millions of people will be riding on it.
My working readers – especially those making good money – can read the numbers and weep. This New Deal Dinosaur will gyp you, big time, so I hope you will urge your Congressmen to get working on major restructuring without delay. Even if you get to privately invest only a few points of the 12.4% FICA tax you now pay each year, the result would be hundreds of billions a year poured into investment markets – electrifying those markets and sending values soaring. Financial futures would be assured. There will never be a better time to do this. Let’s get cracking.
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- 1.02 is the solution of the equation x17 = 1.40, which becomes x = (1.40)1/17 or x = (1.40)0.0588 which solves to x = 1.02
