All Commentary
Wednesday, October 1, 2008

Making Social Security More Harmful

Advocates of Social Security Defraud American Workers

Social Security is a fundamentally flawed system. If a private firm offered such a retirement system and made the same claims for it that the federal government makes for Social Security, that firm would quickly become a poster child for corporate fraud, and its managers would soon be convicted of criminal charges.

There are two fraudulent claims the federal government makes about Social Security that deserve special attention. By considering how these two claims interact with each other, it becomes clear that the politicians and pundits who defend Social Security are increasing the harm it is imposing on American workers.

Two Fraudulent Claims

Consider first that ever since Social Security was enacted in 1935 Americans have been told that their “contributions” are being deposited into their own account to pay for their retirement benefits. This claim has become more implicitly suggested than explicitly stated in recent Social Security brochures, but not in the statements of politicians when opposing any attempt to partially privatize the program. Al Gore, in his 2000 presidential campaign, assured the public that if he were elected our Social Security “contributions” would remain secure in a “lockbox” until our retirements. It was never made entirely clear whether we each had our very own lockbox or all the money was in one big lockbox.

We cannot find any serious study that estimates how many people really believe that the taxes they pay to Social Security are being saved and invested to finance their retirement, instead of being spent immediately by politicians, as is actually the case. But it is clear that many do believe that they have a personal Social Security account containing the money to fund their retirement benefits. Alan Greenspan recounts in his recent book, The Age of Turbulence, a story told by former House leader Tom Foley. When Foley tried to inform his mother that there were no lockboxes containing the money to pay for Social Security, she told him, “I hope you will not be offended at how surprised and shocked I am to find that the majority leader of the House of Representatives knows nothing about Social Security.”

The other fraudulent claim made about Social Security (again, from the very beginning of the program) is that employees pay only half the cost, with employers paying the other half. This claim is widely seen as plausible because the legislation authorizing Social Security clearly stipulates that the required payments are to be split evenly between employees and employers. If this were true, then employees would now be paying 6.2 percent of their before-tax income up to $102,000 a year; employers would match that amount.

As any good student in an economic-principles course should learn, however, the amount of a payroll tax actually paid by employees and employers has absolutely nothing to do with what politicians mandate in legislation. It is true that each worker has 6.2 percent of his after-tax income deducted from his paycheck and sent to the Social Security Administration (SSA) and his employer sends in the same amount. But by altering the wages employers pay and workers receive, these payments change the supply and demand schedules for labor—at a given nominal wage, different amounts of labor will be supplied and demanded than before. (In the lingo of economics, the supply and demand curves shift.) Until we know how wages and salaries change in response to these shifts, we cannot tell how much of the Social Security cost is paid by the employees and how much is paid by employers. For example, if a worker’s salary is reduced by exactly the same amount that the employer sends to the SSA for her, then the cost to the employer is nothing (what he pays for the worker’s Social Security is offset by the lower salary) and the worker ends up paying the entire cost.

We are not going to work out the details for determining how the Social Security cost is divided between workers and employers. But having worked this out with graphical analysis in an October 2006 article in Economic Inquiry, we can provide a simple verbal explanation of how those who defend Social Security are adding to the harm it inflicts on American workers.

The employer requirement to send a check to the SSA for each worker equal to 6.2 percent of salary revises downward the firm’s demand schedule for labor according to the amount of this check. This reduction in demand, considered by itself, obviously reduces the salary the firm is willing to pay each worker. Similarly, the Social Security deduction from each worker’s paycheck reduces the labor supply by revising upward the supply schedule by the amount of this deduction, assuming that there is no expected benefit from Social Security.

But this overstates the reduction in labor supply if workers believe they are going to receive some benefit from Social Security. The more benefit workers expect to realize from Social Security (in present-value terms), the less the labor supply will decline. And indeed, if they expect to receive more in Social Security benefits than the amount deducted from their checks, then labor supply will increase out from the original level.

But this means that even if workers are receiving benefits greater than the amount being deducted from their paychecks, they are not necessarily better off. The decrease in labor demand and the increase in labor supply can result in a salary reduction greater than the amount Social Security benefits are expected to exceed paycheck deductions. In fact, as we show in our Economic Inquiry article, workers are made worse off by Social Security unless the benefits they expect and actually receive are at least equal to the total amount paid for Social Security by both the workers and their employers.

Defrauding Workers

We are now able to nail down our main point—that advocates of Social Security are defrauding American workers in two ways. First, claims which leave the impression that money paid into Social Security is being saved for our retirements lead workers to believe their benefits are more secure than they are.

Second, persistent claims that workers pay only half the Social Security tax lead them to believe their benefits cost them less than they really do.

These fraudulent claims clearly increase the political viability of Social Security by misleading workers into expecting larger benefits than they will receive. But it is worse than this. By generating exaggerated expectations of Social Security benefits, the two claims are actually reducing the net benefits workers receive by increasing the amount they are paying for them with lower wages.

It is ironic that those pundits and politicians who oppose even the most timid moves to privatize Social Security by downplaying, or denying outright, its Ponzi-scheme nature are widely seen as protectors of American workers.

  • Dwight R. Lee is the O’Neil Professor of Global Markets and Freedom in the Cox School of Business at Southern Methodist University.