Pre-Payment for Services and Social Security

I keep seeing the argument that the way Social Security is funded — the young provide the funds needed for the retirement of the elderly — and the fact that tax collections can be viewed as one big pot of money imply that the government is not providing a service (insurance in this case) as you might see in the private sector:

The confounding problem is that many people believe the payroll taxes they pay go to fund the benefits they will receive, which is completely untrue. The payroll taxes go to pay current expenses of the US government. They are just a tax on labor. The government is spending every penny of those payroll taxes to pay for current expenditures. … the [government] is free to use your premia to buy fighter jets and space shuttles!!

Some go so far as to argue this means it must be welfare. I disagree.

Consider (and apologies for the example) a firm that provides funeral services. This firm sells burial plots to the young, those still working, and it issues a promise. When the time comes, you have a place to be buried, and your payment will cover the following services (which are listed explicitly).

However, the firm does not take your money and put it into savings for the next however many years. Instead, it uses the money to cover the expenses of current funerals. Your money is used to pay for the services of the old, those who have passed away.

So, the  money of the young is used to provide services for the old, just like Social Security. Does this mean that the people whose funerals were paid for when they were younger received welfare? Of course not. Does it mean they received no services from the firm? Again, no. It’s even possible that when your turn comes (and hopefully it’s far away), the funeral will cost more than you paid in advance — the firm may have not anticipated future costs correctly. In that case, there will be an income transfer from the young to the old (the young will be charged higher prices to reserve a plot in the future), but that still doesn’t mean it is welfare. Fundamentally, this is an advance purchase of a service.

Just because the payment for retirement insurance, i.e. Social Security, comes in advance of the consumption of the services does not mean that it is welfare. It doesn’t matter if your money is used “to buy fighter jets and space shuttles!!” anymore than it matters if the firm providing the burial services uses some of your prepayment to pay for electricity of security guards (and which particular tax dollar is used to make the payments doesn’t matter either since these monies are fungible). What matters is the promise of future services, and that the promise is honored. The payroll tax comes with a promise of future insurance services, it is no different than advance payment for services in the private sector, and people expect those services to be delivered (if you don’t think people believe the promise is there, try telling them they won’t get anything from Social Security when their turn comes).

I am not arguing that there is not transfer component to the Social Security program, there is. But, as I kept saying here, it is “mainly” an insurance program, not welfare (just like the transfers in the example above do not change that it is fundamentally a payment for a future service). When you pay the government each month, it comes in return for the promise of future services. When the government makes good on that promise and delivers the services you paid for, there is no welfare involved. It’s not welfare when you consume private sector services that have been paid for in advance, and the government is no different.

About Mark Thoma 243 Articles

Affiliation: University of Oregon

Mark Thoma is a member of the Economics Department at the University of Oregon. He joined the UO faculty in 1987 and served as head of the Economics Department for five years. His research examines the effects that changes in monetary policy have on inflation, output, unemployment, interest rates and other macroeconomic variables with a focus on asymmetries in the response of these variables to policy changes, and on changes in the relationship between policy and the economy over time. He has also conducted research in other areas such as the relationship between the political party in power, and macroeconomic outcomes and using macroeconomic tools to predict transportation flows. He received his doctorate from Washington State University.

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