More Sowell: Social Insurance
Posted: 19 March 2009 at 23:42:55
This book-- Applied Economics by Thomas Sowell-- is just chock full of gems. A lot of this stuff I already was aware of, but Sowell frames it exceptionally well.
Here is another blurb from the chapter on insurance which addresses social insurance (e.g. social security), which isn't a real insurance at all:
Government-run social insurance programs seldom have enough assets to cover their liabilities, but rely instead of making current payments out of current receipts. These are called pay-as-you-go programs-- and sometimes they are called pyramid schemes. Pyramid schemes are privately run pay-as-you-go plans-- and they are illegal because of their high risk of default and the opportunities for those who run them to take part of the money for themselves. The most famous pyramid scheme was run by a man named Charles Ponzi, who went to jail back in 1920. He used the same principles behind the pension plans of many Western governments today.
Ponzi had promised, within 90 days, to double the investments of those who paid into his program. The first investors who were not deterred by warnings from skeptics were in fact rewarded by having their investments pay off double in 90 days. Ponzi simply paid the first wave of investors with money from the second wave of investors, and the second wave from the even larger number of those in the third wave, as enthusiasm for his plan spread. So long as the number of people attracted to this plan formed an expanding pyramid, both the earlier investors and Ponzi profited handsomely. But, once the pyramid stopped growing, there was no way to continue to pay off those who sent Ponzi their money, since his scheme created no new wealth.
The American Social Security pension system and similar government pension systems in the countries of the European Union likewise take in payments from people who are working and use that money to pay the pensions of people who have retired-- paying the first generation who paid into these pension plans with money received from the second generation, and so on.
...
Those who warned that these government pension plans were essentially Ponzi schemes without enough assets to cover their liabilities-- that they were "actuarially unsound" in the financial jargon-- were either not believed or were brushed aside for having made objections that were theoretically correct by in practice irrelevant. One of those who brushed these objections aside was Professor Paul Samuelson of MIT, the first American winner of the Nobel Prize in economics:
The beauty of social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in... Always there are more youths than old folks in a growing population. More important, with real incomes growing at some 3% a year, the taxable base upon which benefits rest in any period are much greater than the taxes paid historically by the generations now retired... A growing nation is the greatest Ponzi game ever contrived.
By the end of the twentieth century, however, the day of reckoning began to loom on the horizon for these government pension programs, as it had for the original Ponzi scheme. Contrary to Professor Samuelson's assertion, there are not always "more youths than old folks." As birth rates declined in the Western world and life expectancy increased, vastly increasing the number of years in which pensions would have to paid to growing numbers of people, it became painfully clear that either tax rates were going to have to rise by very large amounts or the benefits would have to be reduced in one way or another -- or both-- or the system would simply run out of money.