“It was the best of times; it was the worst of times.” Those, now infamous, words of Charles Dickens parlayed well with the first quarter of the twentieth century. The United States had just come out of, what was then, the “Great War.” Coupled with the troops return home, the government’s expenditures for the war lead to a substantial increase in Gross Domestic Product. This transition from a war-time economy into a peace-time economy lead to the “Roaring Twenties,” and a time of great economic prosperity.

Over the course of the decade, the ability of the American people to buy new cars, houses, and other good began to weaken. At the time, the weakening economy was masked by a bull market that gave the appearance that the increase in wealth, through stocks, would never end. However, that aura of invisibility did end. On October 29, 1929, known to many as “Black Tuesday,” the stock market crashed. Within a couple of months investors had lost nearly $40 billion dollars, uninsured deposits caused banks to fail and spending had nearly come to a halt. The “Great Depression” began.

In 1935, rather than letting the business cycle correct itself, President Franklin Roosevelt introduced an economic stimulus plan known as, the “New Deal.” The overarching goal of the plan was to sure up the economy, reform business and financial operations and give aid to the unemployed and worker’s who had lost their pensions. While many of the programs lasted only until World War II, one of the largest programs still in existence today is Social Security.

From its compassionate, early beginnings Social Security was an attempt to limit what some saw as the dangers of modern American life. This included providing benefits to retirees, the unemployed, and lump-sum benefits upon death. This social insurance act established the framework for the American welfare system.

Upon its inception, the Social Security program was meant to pay benefits out of a large reserve fund. However, an amendment in 1939 changed the system to a “pay as you go,” model. With the switch, the fundamental flaws and numerous problems of the Social Security program began to come into light. In addition to the problem of the pay as you go model, Social Security increased the size of the government, not only in expenditures but also in its encroachment on personal liberties. With the changing demographics of the public, and without major reform, Social Security is on a path to insolvency.

Unlike private insurance or private pension models, Social Security was designed (after the amendment in 1939) to pay out benefits before adequate contributions had been amassed. The monies were to be collected by a payroll tax known as FICA (Federal Insurance Contributions Act), under the guise of making it appear as though people were contributing to a fund that was designated specifically for them. In reality, nothing could have been further from the truth. Essentially, benefits of current retirees were to be paid for partially, and sometimes wholly, out of the contributions of current workers. Although a partial reserve was set up by investing surplus Social Security taxes into government bonds, those reserves were far from sufficient to cover accrued liabilities. Since the reserves were in government bonds, they amounted to little more than IOUs that would have to be redeemed by future taxpayers. When those workers eventually retire, their benefits, in turn, depend on the ability and willingness of the next generations of workers to pay. This threat was either overlooked or ignored, despite the final report of the 1937-1938 Advisory Council on Social Security proclaiming, “No benefits should be promised or implied which cannot be safely financed not only in the early years of the program but when workers now young will be old.”

As mentioned previously, when tax revenues exceed the paid benefits, the surplus funds are placed into the Social Security Trust Fund. In turn, the trust funds are invested in special government treasury bonds. This cash flow helps ease other financial pressures on the government and the general fund budget, but has created a perfect storm for failure in regards to the Social Security program. Based on the OASDI (old age, survivors, and disability insurance – official name of Social Security) Trustee’s report in 2007, the program cost will begin to exceed its tax revenues in 2017. When the time comes for the next generation to begin drawing on the trust funds to pay out benefits, the federal government will face a very difficult fiscal situation. If Social Security is to pay out the promised benefits, the government will have to find the money to repay what it borrowed from the trust funds, with interest. However, the federal government doesn’t have any cash or other assets with which to pay off the bonds. It can obtain the cash only by borrowing and running a larger deficit, increasing taxes, or cutting other government spending. By 2041, the Social Security Administration projects the trust funds to be empty, and the tax revenue to only be able to finance 78 percent of the scheduled annual benefits.

“The problem with Socialism is that eventually you run out of other people’s money.” (Margaret Thatcher)

If financing of Social Security weren’t an issue, there is still the notion of the changing demographics of beneficiaries and tax payers. Longer life spans and changing birthrates have dramatically affected who retires, how many years of retirement are supported, and how many people in the work force provide the funds necessary to support the retirement system. Thanks to significant advancements in health care and standards of living, larger portions of the population are living beyond their adult years and into old age. When Social Security was first introduced only 54 percent of men and 61 percent of women born in 1875 would survive from age 21 to age 64 in 1940, the first year benefits were available. In contrast nearly 72 percent of men and 84 percent of women who were born in 1925 survived to age 65 in 1990. The Social Security Administration projects that the amount of years retirees will live past retirement age will approach 20 in the coming years, thus placing a larger burden on tomorrow’s tax payers.

The birthrate is another major demographic factor that strongly affects both benefits and taxes within Social Security. Following the baby ‘bust’ of the Great Depression, the post World War II baby ‘boom’ swelled the size of the labor force and increased Social Security taxes during their working years. Beginning in 2010, however, the leading edge of the boomers will start to retire. After that, the retirement population is expected to increase dramatically, while the size of the working-age population will have become rather stagnant due to the low birthrates since the mid-1960’s. By 2030, about one-fifth of the population is expected to be receiving Social Security benefits. Compared to the 16-to-one workers-to-retirees ratio in 1950, today that ratio is 3.3-to-one, and is expected to hit 2.2-to-two, putting a huge burden on workers as they pay for retiree benefits in an intergenerational transfer of wealth.

“Security will never come from a Social Security system in an expansive welfare state. It can only be realized when the source of security is discovered to lie within the individual himself.” (Hans F. Sennholz)

The annual cost of Social Security benefits represented 4.3 percent of GDP (Gross Domestic Product) in 2007 and is projected to increase to 6.1 percent of GDP by 2035. Further, the $500 billion spent on Social Security benefits made it the largest government program in the world and the largest expenditure in the federal budget at 20.9 percent, compared to 20.1 percent for military expenditures. This massive amount of spending does more than create financial burdens on tax payers it also encroaches on personal liberties, as it allows government to determine retirement ages, incomes, and investments.

Keep in mind that the government produces nothing. Thus, when it gives benefits to its citizen, whether ‘free’ or at a bargain cost, it must first had to have taken it from the citizens, in hidden or direct taxes. Then is returns a portion of the benefit at its discretion. If a welfare state truly worked, then as the nation became more affluent, you would expect the need for welfare to diminish, but in fact the opposite seems to be true.

One of the issues of infringing on personal liberties is the fixed retirement age. Cases can be made for both raising and lowering the retirement age. If the age were raised, more taxes would be paid in, and fewer benefits would be paid out, thus lowering the overall program cost. Likewise, if the retirement age were lowered, many workers may opt to retire early, while they have good health and can enjoy their leisure time, post-career. The United States has already seen a movement in that direction, especially in the more affluent, that choose to retire early. Another benefit of a lower retirement age is the potential job opportunities for unemployed youth.

In addition to the age itself, there is the so-called “retirement test,” that penalizes recipients of Social Security benefits that opt to supplement their income with additional work. If the program is truly a social ‘insurance’ rather than a means-tested benefit, recipients should receive benefits as a mater of right.

Another concept to consider is that Social Security is somewhat of a forced pension plan. Workers pay 7.65 percent of their income into the program which is matched by their employer, for a total of 15.3 percent. Self employed persons bare the entire burden. If an average college graduate made $30 thousand per year, and never received a raise, they could expect to pay $664 thousand in Social Security taxes over the course of their working life. For those taxes, they would receive $3.5 thousand per month in benefits. The rate of return is negative 1.85 percent. However, if they had been able to invest all of their taxes into a personal retirement account, and a conservative rate of return of 4.89 percent, they would have a total of $1.8 million when they retired, and would receive monthly benefits of $15.5 thousand dollars. Instead, they miss out on $11.8 thousand monthly, under the guise of ‘insurance.’

By giving workers the choice to determine their own retirement, they could yield a much higher rate of return. With that, the more money retirees made, the more they would spend, which ultimately would increase the total economic gain.

Without mentioning the rate of inflation and the decreased buying power of the dollar, it is easy to see that the Social Security program in America is flawed. From its inception it could be labeled as a pay as you go “Ponzi scheme,” that has greatly increased the size of government, created a welfare state, and infringed on the personal liberties of its citizens. Without drastic changes to the way the program is funded, or to the benefits that are received, the program will be bankrupt by the mid twentieth-first century.