How Social Security Makes Us Poorer
FEBRUARY 25, 2014 by BRENTON SMITH
When you read that Social Security lifts 50 percent of seniors out of poverty, keep in mind that it was largely the cost of Social Security that put them there. It's the perfect example of government incompetence creating higher costs and misguided incentives—and delivering exactly the opposite of what it promised.
The contradiction stems from the cost of Social Security, which has exploded. In 1950 Social Security cost 2 percent of the first $3,000 of income (in 2013 dollars, that would be 2 percent of roughly $29,000, according to the BLS calculator). In 2013, the retirement portion of Social Security cost 10.6 percent of the first $113,700. On top of this cost, the government now takes another 1.8 percent of your wages to cover the cost of disability benefits, which were added in 1958.
What’s more, you get a lot less bang for a lot more bucks. A couple retiring in 1960 expected to collect $8 of benefits for every $1 of contributions. Today the return for average Americans is actually negative.
The process of rising costs and declining returns has continued for 80 years. We are now at a point where the largest investment in retirement planning of the vast majority of Americans loses money. No one should be surprised to find that people who invest their retirement savings poorly wind up in poverty when they reach retirement.
The Urban Institute’s “Social Security and Medicare Taxes and Benefits over a Lifetime” projects what a hypothetical worker will contribute to Social Security versus what they expect to collect. The "lifetime value of taxes" shows what would have happened if the accumulated taxes had been put into an account that earned interest. The research projects that an average worker who retires in 2030 will have lost more than $400,000 in savings in order to collect about $370,000 in expected benefits.
Here is where the system gets really ugly. The $370,000 isn’t guaranteed. In fact, the trustees project that in a good economy, this worker will only get 77 percent of his scheduled benefits because he will retire after the trust fund is exhausted. Mind you, the 77 percent of scheduled benefits is completely dependent upon the willingness of future workers to commit 12.4 percent of their wages to this system as it falls into collapse. Basically this worker only collects provided another worker gets a worse deal.
The government has compounded the impact of the problem by feeding the systemic dysfunction directly through our labor market. Social Security is financed with a tax on labor, so it penalizes work even though the best cure for poverty is a job. This tax also creates a disincentive to hire people and creates an incentive to move work to countries with a lower tax burden. Social Security introduces incentives to work less, such as early retirement.
Nobody wants to be poor in their old age. If workers did not have to spend their entire careers burdened with Social Security taxes, fewer would face that possibility.