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Friday, March 30, 2012

The Trouble with Retirement, You Never Get a Day Off

You hear it all the time, particularly if you read too many financial blogs:
    “I’m not counting on Social Security to be there when I retire, so I’m ignoring it in my retirement planning. If it’s still around, it’ll be a nice bonus.”
    In other words, to be prudent, we should treat Social Security like the inheritance we might get from an eccentric uncle with mysterious finances. When you hear someone say this, however, you can be sure that the speaker is (a) very wealthy or (b) doesn’t understand what ignoring Social Security actually means.
    The question I want to ask is: if you’re skeptical about the future of Social Security, do you think we should even have social security?  Is social security constitutional? Are you going to retire, if so when?  Lastly, how social security works; Are there any sources of market failure through inefficiencies, moral hazards and adverse selection.
    First, we must understand what being retired actually means.  Retiring would require us to quit working, and live off of our accumulated savings.  When we retire, we're deciding to no longer be a productive member of the economy.  We must understand retirement in order to understand social security: Old Age Survivors Disability Insurance; As you can clearly see social security is not a retirement or pension plan.   
    Secondly, How does social security work?  This is important to understand so we can explore whether or not social security is constitutional.  Most people believe that social security is a trust fund, that we invest our money through the government with our taxes.  Like it is a secret black box with saved money from our investments, that we plan on using when we retire so we can continue to receive money.  Sorry to break it to most Americans, but that's not exactly how social security works.  The government really buys treasure bonds with the excess tax money.  Which in turn, just becomes part of our huge outstanding National budget.  The government will tax more than they need so they can pay back the social security checks through buying treasure bonds, lastly leading to the government spending all of the money.  To clarify, Treasure bonds are a promise to pay the beneficiaries.  So now the T bills are the money promised to the beneficiaries.... Social Security is a big lie!  It's one government agency lying to another government agency.
    To fix this problem, we would need to make more money(causing inflation), Tax more(increasing money flow) and sale our T bills to foreigners(essentially borrowing).  The government by law is obligated to pay these T bills, but when the T bills run out then the government will us up to 70% of revenue.  What we really need to be saying is Social Security really is a "Income Redistribution Plan" and seems to be unconstitutional.  This is how social security really works, the question is though; Do we have a source of market failure within our own policy? 
  Thirdly, lets explore all possible market failures within social security and any possible productively efficient conclusions.  I personally don't see a positive externality, negative externality nor does it look like a public good.  What we need to ask is, "Is Social Security just?"  Remember it is a income redistribution plan from young to old, and it's important to look at HOW the government uses it's force in implementing this distribution plan.  The government uses its "force" by binding the next generation to pay for what you already received prior to him/her ever being able to vote.  Therefore, this is inefficient and intergenerationaly unjust.  
    This can be inefficient by modeling the opportunity cost of gaining more information.  The people in Washington, call it insurance.... This is part of the lie.  Insure is to cover the cost for the case of a BAD situation.  Recall, Social Security means: Old, Age, Survivor, Disability Insurance.  I don't see a BAD event, so why insurance then?  The bad event is what you will be insuring on, but what is that bad event?  The bad event I see that I would want to insure against is me running out of assets before I die.  So, we must insure against running out of assets before dying or out living our wealth.
    It's important to remember that insurance is correlated with moral hazard and adverse selection.  Moral hazard and adverse selection can be a source of market failure if found with in the policy.  Examples of moral hazard in our case would be: The insured choosing to be more risky, the idea of a pension and that the government backs you leads me to believe there is a market failure.  We could control the moral hazard through the deductibles though.
    Adverse Selection may also be a source of market failure in our model.  For instance, only the risky ones ask for insurance, making a risk pool but it's hard to make a profit with the risk pool.  Therefore, this can lead to a market failure but we can also control adverse selection through premiums.  Remember it takes two to tango, Supply and Demand.
  To conclude, we must insure against running out of assets before dying or outliving our wealth.  There may be a role for the government to place an insurance.  You would pay a premium  and they would pay you your benefits.  Fire insurance model may be better, and there will be an insurance pool (annuity).  Also, this plan will be much smaller so you don't pay out as much, and receive the same.  We want it to look more like insurance rather than a trust fund.  To be honest though, I don't know if we can solve this with a government plan.  Although, we maybe could tax consumption instead of income.  This would promote saving, which in turn generates capitol accumulation.  Furthermore, overtime we will be more productive, grow 4-5% a year and this would help social security and retirement.

The problem is more serious than you describe. If Social Security fails, you lose not only your benefits but those of your parents. You will need to save for both your parent's futures and that of yourself.

I work with www.FixSSNow.Org. We welcome third party commentary. Send something to me at JoeTheEconomist@Gmail.Com.

I hope you will take time to tell us where we are wrong.
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