Cap'n Arbyte's

The Information Problem in Social Security

The original Social Security system in the United States was essentially an old-age pension. It was significantly extended in the 1950s but I only intend to discuss the retirement aspect here.

Under Social Security, each person would contribute money during his working years, and draw from those contributions in retirement. Payroll taxes were the means to force individuals to save for retirement.

Stated this way, the system sounds reasonable: Of course it's good for people to save for retirement, and the Social Security program simply enforces this good behavior.

But there's a problem. The government necessarily lacks important information about the people it's affecting. This causes it to treat everyone homogeneously, and such treatment is harmful to the very people it's trying to help.

UPDATE 2003-11-24 15:35:06 UTC: Clarified phrasing in this paragraph.

Individuals naturally adjust their saving and spending habits based on the circumstances of their lives. A person with credit card debt at 20% interest would favor paying that off rather than saving for retirement earning a rate of return around 7%. A person planning to start a family is more concerned with making a down payment on a house than saving for retirement. An entrepreneur may plan to start a new business and retire by selling it, never saving in traditional ways at all.

Free of government intervention, the typical pattern of savings would be that young people would save very little for retirement, but when they're older and the kids have left home and the mortgage has been paid, they would save very much for retirement.

That is the general pattern, but the actual circumstances of each person's life are as varied as the individuals themselves. It is impossible for the government to aggregate and process the information needed to fine-tune Social Security for each individual. To attempt to gather that information in the first place would be a gross violation of privacy — do you want the government asking you how many children you plan to have or what kind of college you'll send them to, and face accusations of gaming the system when you change your plans? What will you say to the government when you need a new car or a bigger house, and they ask you to justify that against saving for retirement?

Even if the information were available to the government, it still could not handle unpredictable circumstances such as expensive illnesses or automobile accidents that would normally change savings patterns. To give people the financial flexibility to deal with such circumstances, the government would need to let people control their own retirement savings — in short, it would need to leave people alone, making Social Security superfluous.

The government's lack of information causes it to treat everyone homogeneously. For example, payroll taxes are basically regressive, meaning low-income and high-income people contribute to the system on the same terms until very high income levels. Today the total taxes are 15.3%, including the portion paid by the employer, which are basically wages too.

In a sense this regressiveness is fair, due to the illusion that each person is saving for his own retirement. The critical point here is that the decisions about when and how much to save are not made by the individual, they are made by the government.

Retirement savings begins as soon as you enter the workforce. Everyone is treated the same whether they're 25 or 45, whether they make $30,000 a year or $70,000 a year. This is harmful. There is no reason for a 25-year-old to be forced to contribute 15% of their income to retirement savings. They have other priorities.

They may need to save for a down payment or to pay back college loans or to to buy a car or to feed their children. But those things are legally forbidden uses for that 15%. The government thwarts the individual's pursuit of their own happiness, because it believes 25-year-olds need to save for retirement.

To add insult to injury, money paid into Social Security no longer belongs to you. You cannot draw upon that money for any purpose. You can't use it to make a down payment or pay for your children's college expenses. Social Security isn't savings — it's theft. Legitimate savings remains the property of the individual and they can spend it as they see fit. Money paid into Social Security is gone, and you'll never see it again, unless you're lucky enough that the program still exists when you retire.

This is a grave injustice, and it makes me angry, and it should make you angry too. The government's homogeneous treatment of individuals forces you to make the wrong decisions regarding your money — you will have less income, be more in debt, and have less money available to cope with hard circumstances. Oh, you'll be saving for retirement, but if something more important comes along, too bad!

The treatment of benefits is homogenized, too. Benefits begin as early as 62, and full benefits no later than 67. A person in poor health in their 50s, no longer able to work and expecting to die soon, would wish to use their retirement savings to spend the twilight years of their life as comfortably as possible. Yet they are too young to access the money they paid into Social Security. Such people are true victims of the system, saving for retirement their whole lives but never being able to use that money.

Advances in medical technology threaten to make the opposite situation — longer lifespans — a problem, too. The next few decades of medical research promise dramatic increases in lifespans. I think it will soon be common for people to live to be 120. I expect to live that long. Because raising the retirement age is politically difficult due to a large single-issue voting bloc, in the future we may see people collecting benefits for 50 years, collecting far more than they paid in. Worse, healthy people in their 70s or 80s would have a reduced incentive to continue working, which would contribute to the already difficult demographic trend of fewer workers supporting more retirees.

If saving for retirement is a good and reasonable and commonly-held idea — as evidenced by the overwhelming popularity of Social Security — why does the government need to get involved? The citizens show every sign of caring passionately about the subject. They naturally possess the relevant information about their lives to enable them to make informed decisions about when and how much they should save for retirement.

The government doesn't have and can't get or realistically use that information, causing it to impose a one-size-fits-badly solution upon everyone. This is harmful, particularly to the poor and the young, whose priorities and pursuit of happiness the government stifles.

It needs to be said: Homogeneous Social Security policies are milking the American Dream.

UPDATE 2003-09-18 02:53:57 UTC: Fixed a typo and some grammar.

Tiny Island