Trust us, we're from the government

The one phrase which ought to make your blood run cold:

"Trust us, we're from the government."

That is what they seem to be saying each year when I get my "Social Security Statement" in the mail.

They seem to be presenting the situation as good new/bad news.

Let's start with the good news.

If I keep earning what I am earning now and keep paying into social security at the current payroll tax rate, I will be eligible for payments of $2,150 a month at my full retirement age of 67.

Being an analytical kind of person, I want to know how that compares to saving the same amount of money in my own account. I worked up a spread sheet which determines how much I would accumulate if I saved that payroll tax at a given interest rate, and how much income I could draw from that when I retire. Then I found the interest rate which would result in the same income that the Social Security Administration is promising to provide. This interest rate is the effective rate of return on my money that Social Security is paying over the course of my lifetime.

The effective rate of return provided by Social Security is -0.426%. Before inflation. In other words, for every dollar I pay in, I am assured to get less than a dollar back, thirty years from now when a dollar won't be worth nearly what it is today. Assuming the inflation continues at a typical rate of 3.5%, the value that I expect to get back from social security is less than one third of what I put into it. They are taking enough to buy three loaves of bread today and promising to give me enough to buy one loaf in 2038.

In real terms, this is roughly a -4% rate of return. Without taking any risk, you can get a +1% real return using inflation indexed treasury bills.

That is the good news.

The bad news is that we already know that the government can not deliver what it has promised.

By 2017, Social Security will begin paying more in benefits than it collects in taxes. This is a problem because Social Security is operated on a pay-as-you-go basis. The money I pay into the system each week does not go into an account to be invested for my future benefit. They take my money, turn around, and hand it to a retired person who is currently collecting benefits. The "Social Security Trust Fund" does not contain real money. It consists entirely of government Treasury Bills, or IOUs the government has written to itself. To understand this concept, pull out a piece of paper and write "I owe myself $1,000,000." Then sign it for good measure. Congratulations! You're a millionaire! The government will have to come up with some real money to make good on those IOUs, and where does the government get its money? From the taxpayers. That means we can expect a higher tax burden in the future.

But that is not the end of it. In 2041, three years after I reach retirement age, the Social Security Trust Fund will be exhausted. According to this year's statement, there will only be enough money to pay about 75 cents for each dollar of scheduled payments. So the bad news is that they can't possibly deliver on the good news, which really wasn't that good to begin with.

In 1935 the Government asked us to trust them with our retirement. It is clear that they were not trustworthy stewards of the trillions of dollars entrusted to them. Now they want us to trust them with our medical care. Based on their track record, I say hold tight to your wallet and run for your life.