On August 14, 1935, President Franklin Delano Roosevelt signed the Social Security Act. With the stroke of his pen, FDR established the Social Security program that we know today. Social Security was initially created as a safety net for the elderly during the Great Depression, many of whom lost their savings, jobs, and family support. Over time, Social Security became a source of supplementary retirement income. It has also faced increasing criticism, including here at Libertarian Jew. It drew enough of my ire that I listed it as one of the twelve reasons we should all dislike FDR. What makes Social Security so terrible?
Why Social Security Is Fiscally Unsustainable
Social Security is insolvent and fundamentally unstable. Why fundamentally unstable? In part, it has to do with its pay-as-you-go mechanism. In spite of what most Americans believe, recipients do not have their personal account with their own funds. Current workers pay the benefits of current retirees through the pay-as-you-go mechanism. Social Security's pay-as-you-go mechanism shares structural similarities with Ponzi schemes in that current contributors fund current recipients. Although Social Security is legally sanctioned (unlike a Ponzi scheme), this structure of transferring income instead of saving it raises sustainability concerns. No one has money saved in a personal Social Security retirement account because money is transferred from current taxpayer dollars to current beneficiaries. The only difference between a Ponzi scheme and a Social Security is that when the payout pyramid collapses, no one goes to jail. Taxpayers simply pay more.
Because Social Security relies on current workers' contributions to pay current retirees, its stability is directly tied to the number of workers supporting each beneficiary. When the ratio is high, the system can function smoothly, like it did when the worker-to-beneficiary ratio was 159.4 to 1 in 1940 (SSA). With the Baby Boomer generation retiring, that ratio has decreased to 2.7 in 2023 and is expected to decrease to 2.1 workers by the end of the century (Pew Research). This decreasing worker-to-benefit ratio means that there are fewer workers shoulder the burden of a growing system, thereby putting greater financial strain on Social Security.
When the demographic shifts are combined with the pay-as-you-go mechanism, the payroll tax becomes a more unsound funding source of the Social Security program. Over time, the deficits add up and will deplete the Social Security Trust Fund. The most recent SSA annual report predicts depletion in 2034, although it is likely that one of the negative effects of the "Big, Beautiful Bill" is accelerating that date to 2032. Once that Fund is depleted, statute dictates that Social Security payments are limited to incoming revenue. According to the bipartisan Committee for a Responsible Federal Budget's (CRFB) estimates, that will translate into a 24 percent cut in Social Security benefits (see below).
To maintain this behemoth that is 21 percent of the federal budget and the single largest item in the budget, the government needs to find a way to fund $25 trillion in unfunded Social Security obligations. Right now, the current Social Security tax rate is 12.4 percent: 6.2 percent paid by the employer and the other 6.2 percent by the employee. If you are self-employed, you pay the 12.4 percent. Historically, Social Security taxes have increased, not decreased (Tax Policy Center). Given that the worker-to-beneficiary ratio is expected to decline, do not be surprised to see the payroll tax increase as a response from Congress to try to "fix" Social Security.
The Burden on Younger Generations
Younger people especially get harmed if politicians decide to fund Social Security program in perpetuity. How much will it cost the median worker entering the workforce to keep Social Security going indefinitely? According to a Cato Institute analysis, it would cost $157,000, which is the equivalent of giving up 29 months of pay over a lifetime, which is more than two years' worth of salary. Despite paying more, these workers are expected to receive reduced benefits compared to current retirees, or even have reduced or means-tested benefits. In short, younger generations are being asked to pay more for less.
What is the Return on Investment?
And what does a taxpayer, regardless of age, get for paying all that money? A low return on investment, or ROI for short. The SSA publishes internal real rates of return (IRR), which act as a measure of ROI. Using a simple midpoint estimate of the IRR from its most recent IRR report, the ROI for Social Security is 2.7 percent, while the Treasury bond real rate of return is about 2-3 percent (nominal is closer to 4-5 percent). In contrast, the average stock market return in the last five years was 8.9 percent when adjusted for inflation; 8 percent in the last decade; and 6.3 percent in the last 30 years.
Why the low ROI? The reality is that Social Security reserves are mandated to be invested in U.S. government securities only. Treasury bonds are essentially IOUs from the federal government to itself, which means that Social Security will never be high-yielding in its current form. A Tax Foundation study confirms that it is the combination of these investment choices, a lower birth rate, and a lower worker-to-beneficiary ratio that contribute to this low ROI (Entin, 2016).
For Social Security proponents, they see Social Security as a safety net that provides baseline financial protection. But what good is that safety net if it fails to meet the financial needs of retirees, especially those who depend on it as their primary or sole income source? With rising costs and increased lifespans, seniors need an investment tool that allows them to maintain a dignified standard of living. Social Security fails spectacularly on that front, especially when compared to the average ROI of the stock market. That safety net mentality of prioritizing insurance-like protection over investment-like returns is what has gotten the American people into hot water, much like it has with Medicaid. If retirees had the ability to invest their Social Security taxes elsewhere, 27 percent of Americans would not have to rely solely on Social Security for income (Pew Research).
Structural Flaws and Moral Hazards
In case fiscal insolvency, a low return on investment, or disproportionately harming young workers was not enough, here are more reasons to take issue with Social Security:
- There is no ownership or inheritance of Social Security. If someone dies, they cannot pass on their hard-earned savings to heirs as they can with a 401K. Even the Supreme Court has recognized that individuals are not guaranteed Social Security contributions (Flemming v. Nestor).
- Despite its progressive formula, Social Security is not means-tested. High-income retirees can still collect full benefits, regardless of need. This feeds into the program's entrenched safety net mentality, which prioritize broad, guaranteed payouts over investment-like returns or personalized savings. This undermines both its financial sustainability and its ability to efficiently target those truly in need. The fact that it fails on both counts undermines its rationale for existing as a government program.
- Social Security hits the poor harder with its flat tax, i.e., everyone pays the same rate. However, the tax cap at $176,100 effectively makes it regressive. The reason why it hits hard is that the 6.2 percent cuts into one's expenses when struggling to make ends meet. This tax takes a significant share of income that would otherwise go to basic needs or personal savings.
- Social Security is designed as a lifetime, inflation-adjusted annuity. The longer one lives, the more one can collect through Social Security. Although lower earners receive a higher benefit as a percentage of their earnings, it is not so helpful because the structure disadvantages demographics with shorter average lifespans (e.g., Bostworth et al., 2016), such as low-income workers and certain racial minorities (e.g., African-Americans, Native Americans).
Alternatives and a Case for Privatization
Reform is always kicked down the road because the myopia of the election cycle disincentivizes long-term thinking. As this report from the Cato Institute shows, reform is possible. Other countries have implemented social security reforms, whether it is transitioning to a basic benefit structure (New Zealand), reducing excessive benefits for higher earners, implementing automatic stabilizers (e.g., Sweden's age-indexed eligibility), or voluntary Universal Savings Accounts (e.g., Canada). Countries like Sweden and New Zealand have adopted innovated reforms that improve solvency and fairness, offering models that the U.S. could adapt.
Changing demographics and increasing obligations make the current system outdated in terms of serving the needs of the retirees of today and in the future. Since Social Security is the "third rail" in U.S. politics, U.S. politicians lack the willpower to do anything aside from kicking this volatile can down the road. Rather than more incremental reforms, I would prefer privatization, in no small part because the Organisation for Economic Co-operation and Development (OECD) found that private accounts lead to broader economic growth.
Individuals need greater control over their retirement savings, potential for higher returns, and flexibility in retirement goals to help avoid poverty in their old age. In short, they need autonomy over their future quality of life. If U.S. politicians stay mired in the inertia that is the myopia of election cycles and buying votes, future retirees remain vulnerable to government stupidity. It is time for politicians to embrace privatization instead of keeping retirees trapped in a subpar retirement system.
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