Paul Krugman is exhibiting signs of schizophrenia.  A few years back, as the Bush tax cuts were being debated, he argued vehemently that such cuts were irresponsible in the face of a looming Social Security crisis.  More recently, however, he has adopted an Alfred E. Neuman expression and asked, “What crisis?”  On the other hand, John Konop, of Control Congress.org, has consistently argued that the system faces such a crisis that prolonged economic disaster waits just around the corner.  Who’s right?

Neither of them.  But it’s interesting to note what is right about their assessment of the situation, before going into what’s wrong.

Krugman is essentially conceding the very point that those predicting difficulties are making.  If the Social Security system is jeopardy because of tax cuts unrelated to the collection of payroll taxes, his position explicitly concedes that program can only be funded by additional revenues collected for the general fund.  While arguing – completely contrary to history – that retaining or returning to higher tax rates would make funds available for this later use, the concession that such funds would be needed to pay Social Security benefits highlights the inadequacy of the existing funding source.  Thus, the system as it now exists is in crisis (as elaborated last time) and Krugman’s current stance is completely disingenuous. 

John Konop’s point, on the other hand, is based on a basic accounting assessment of that funding source.  He simply forgets that the whole reason that the Ponzi scheme has lasted for seven decades is because the government is not constrained by basic accounting or contract rules.

According to the trustees of the program, the un-funded liability of the Social Security system is currently $15.6 trillion dollars – an amount larger than our current GDP.  The un-funded liability for Medicare is currently $76.5 trillion, five times larger even than that – in no small part due to the prescription drug benefit foolishly added by the current administration - but, while many of the same points made here (and in the last column) are relevant to Medicare as well, my focus, at present, is on the system that, among other things, helped prolong the Great Depression.

For all the money paid in and all that additional debt incurred, this program, amazingly viewed by many as one of the most successful programs ever devised by government, those paying into the program get a truly dreadful return – far below any market rate investment, even essentially risk-free instruments, and for a huge number of participants, particularly minorities, the return is negative.  Wow!  What a deal!

But I have argued that, while the system is clearly in crisis, and simply cannot survive in its current form, it is not the looming economic catastrophe that some have predicted.  How can I make such a prediction given the sheer size of the numbers involved?  It comes down to two things: a) the constraints, or, more specifically, their lack, on government and b) the responses of actors in the marketplace to current economic conditions.

Social Security was originally sold as an insurance program, not a retirement program or a social responsibility - in fact, Roosevelt himself argued against it being any such thing - though that, in and of itself, is debatable, since an insurance program would involve policyholders (in this case workers) paying the cost of some defined benefit to be provided under a given set of circumstances. If you want, you can go to an insurance company today and purchase an open ended annuity to begin at age 67 (or any other age, for that matter) and you can do so for less than the current system costs you.  Moreover, you can transfer that asset to someone else if you so choose. You could even cash it in at an earlier date in an emergency if you needed to based upon the value of the assets invested up to that time.  The notion that the current system is either a real insurance program or unduly risky if privatized in some manner is utter nonsense.

A quote I considered for my previous column highlights the point.  When asked whether there was a Social Security Trust Fund, CNN expert Dr. Allen W. Smith, PhD, noted, “Every dollar of the Social Security surplus has been borrowed by the government and spent for other government programs. The only thing in the Social Security Trust Fund is government IOUs called ‘special issues of the Treasury’.  These ‘special-issue’ securities have no commercial value because they cannot be sold in the market place. In essence, these IOUs represent a promise by the government that, in order to pay Social Security benefits, it will obtain resources in the future equal to the value of the securities.”

I have only one objection to Dr. Smith’s comments: no such promise exists.

Like the issue of whether or not the police are obligated to protect you, the courts have determined that the United States government is not obligated to honor any previously made promise to provide you with Social Security or anything else.  The history of the program is rife with such changes.  It was initially funded with a 3% tax on the first $3,000 of a worker’s paycheck and now siphons off more than 12% of the first $90,000.  In addition, the age at which benefits are received has changed numerous times over the years.  I suppose if it collected 80% of the first $350,000 and restricted payouts to centenarians, a surplus, albeit an incredibly short-lived one given the economic consequences, would appear and the program could be said to “work”, but the point is made.  Those promises are only as good as the willingness of the politicians in office to honor them and, since actually paying those astronomical sums is impossible, the chances that all of those promises will be honored is precisely nil.

That’s the bad news.  The good news is that not everyone has his, respective, head in the sand.  Overwhelmingly, individuals have factored Social Security out of their future financial plans.  Polls indicate that fewer of a third of people who have not yet retired believe they will ever actually receive Social Security benefits.  As Harry Browne once put it, “In the under-30 age group, more believe in flying saucers than in the survival of Social Security. And, of course, their skepticism is well founded.”

What this means is that when – not if, mind you: when – the federal government reneges on its earlier promises and changes the program, it will not be acting in a way materially different from the rational expectations that have already been factored into current economic decision-making.  That is, from an economic perspective, there is no impending hyperinflationary disaster ahead because the devaluation of the currency associated with those expected future liabilities has, to a large extent, been reflected in the value of the dollar already.

This does not mean that the inevitable change will not have negative economic consequences by any stretch of the imagination, nor does change the fact that whatever pain there will be is only increased by delay in addressing the issue, but it does mean the gloom and doom scenarios of massive economic collapse are overblown.