Politicians Presenting Proposals To Save Social Security

Politicians Presenting Proposals To Save Social Security

Robert Ferguson

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December 23, 1999

Financial Analysts Journal, Vol. 56, No. 1, 2000

Abstract:

The outlook for the U.S. Social Security system is poor. Benefit schedules that assure solvency probably require (1) politicians to give up power they are unwilling to give up, and (2) workers to contribute more of their future production than they are willing to. In contrast, the outlook for politicians presenting disingenuous proposals to save Social Security is good, because politicians fool enough of the people enough of the time to get elected. This paper shows that (1) the debate about funding Social Security with taxes or government debt is irrelevant, (2) if the Social Security system trust fund is invested in government debt, solvency is unrelated to the trust fund’s stated value, and (3) if the trust fund is invested in private securities, solvency does not depend on what it is invested in but is related to its value.

Politicians Presenting Proposals To Save Social Security – Introduction

This article puts these facts in perspective. It also shows why the Social Security system probably cannot be saved, explains why most of the discussion about saving it misses the mark, and provides workers and retirees the insight needed to evaluate legislative proposals for the system and prepare for the consequences.

First, a few preliminaries:

  • A retirement system defaults when a retiree does not receive what he or she was promised.
  • A retirement system is insolvent now if it will default in the future.
  • Think of Social Security recipients as retirees who consume but do not produce.

Funding Retirees’ Consumption

The goods that Social Security recipients consume come from two sources: real savings and transfer payments. Real savings are like something stashed away, as opposed to the acquisition of government debt. Transfer payments are something taken from one person and given to another.

Funding with Savings. Consider a simple illustration of real savings as a source of retirement consumption: Assume that the only consumption good is food. People work for 40 years, then retire for 20 years. Workers produce 100 cans of food weekly and receive them as salary. They consume only two-thirds of the food they are paid. They stash the other one-third in a closet. After the workers retire, they consume the food in their closets during their retirement.

In this scenario, the workers do not complain about being forced to pay for retirees’ upkeep because retirees do not expropriate any of the workers’ production. Workers and retirees are not adversaries. And insolvency is not possible.

A more realistic example of real savings as a source of retirement consumption introduces capital. For simplicity, assume the number of workers and retirees does not change. A new worker appears from nowhere to take a newly retired person’s place on the production line, and an older retiree dies. Food is the only consumption good, but it has to be produced with machinery (capital). Workers still earn 100 cans of food weekly for 40 years. Retirees still live for 20 years. Workers still consume two-thirds of their salary. But they invest the remaining one-third in capital-by buying food machines from existing machine owners and paying them with cans of food. The machine owners they buy from are retirees. New retirees own a substantial number of food machines. They have acquired them by forgoing consumption, as in the previous scenario. That is, people are now capitalists.

Workers are happy to pay retirees for their machines because the machines enable them to produce the same output in less time and with less effort than producing cans without the machines. Workers and retirees see the situation as fair. Consequently, workers do not complain that they are being forced to pay for retirees’ upkeep. Again, workers and retirees are not adversaries and insolvency is not possible.

In real life, both food and food-making machines are produced. Workers forgo consumption to invest in machines, thereby increasing the number of machines per worker (workers’ capital), food production and consumption per worker, capital per retiree, and food consumption per retiree.

In this situation also, relationships are not adversarial and there will be no complaints or insolvency.

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