The Roosevelt Administration created Social Security in response to the Great Depression. In 1935, the poverty rate among the elderly was over 50%. Social Security is now the main source of retirement income for millions of Americans. Many writers credit Social Security with dramatically reducing the poverty rate among the elderly.
Proposals to change Social Security typically meet with strong resistance and often hyperbolic rhetoric. For this reason, many call Social Security the third rail of American politics.
What is this program? Why do we have it? What has its impact actually been? We explore these questions here. Finally, in a forthcoming article, we will consider reforms to make the program more efficient and fairer. We believe a new system can replace Social Security and become an effective tool in fighting inter-generational poverty among the working poor.
What is Social Security?
The Social Security Act of 1935 created a variety of programs still in place today. These include retirement benefits for the elderly, unemployment benefits, Aid to Families with Dependent Children, support for the blind, and others.
When people talk about Social Security, they typically are referring to retirement benefits. Congress added survivor benefits in 1937. Congress amended the Social Security Act in 1956 to create disability benefits. Here, we will consider these and touch on some issues related to Medicare. Congress created Medicare as part of the Social Security Act of 1965.
Old Age and Survivors Insurance (OASI)
Old age and survivors benefits are actually two different types of benefits. The same trust fund finances both of these benefits, so we will consider them together here. Retirement benefits are the first thing that people typically think of when thinking of Social Security. We will start there.
Funding
A tax equal to 5.3% of wages or salaries is deducted from each worker’s pay check. For 2025, earnings above $176,100 are excluded from the tax. The cap on earnings that can be taxed is adjusted for inflation each year.
In addition to the employee’s tax, the employer pays 5.3% of total payroll. There is no earnings cap on this tax. Self-employed persons pay both parts of this tax.
Use of Funds
The OASI Trust Fund receives all OASI payroll taxes. The OASI Trust Fund pays Old Age and Survivor’s benefits.
Eligibility
A worker needs 40 quarters of coverage to be fully insured for retirement benefits. A worker earns a quarter of coverage (or, credit) for a calendar quarter with earnings that meet a minimum set by law. In 2025, that threshold is $1,810. Workers earn one credit for every quarter in 2025 with at least $1,810 in taxable earnings.
For people born in 1960 or later, full retirement age is 67. Congress requires that benefits be lower for someone retiring early. Conversely, late retirement can earn higher benefits.
Benefit Calculation
Earnings
When a worker retires, benefits are based on the worker’s lifetime taxed earnings. The Social Security Administration (SSA) will look at the earnings history for the retiring worker. SSA calculates the annual earnings before the worker turns 60 in current dollars as of the year that the worker turned 60. Earnings are not adjusted for years the employee is older than 60.
For example, if the worker turned 60 in 2015, SSA adjusts each year of earnings up through 2014 to 2015 dollars. The SSA does not adjust earnings after 2015.
The SSA then finds the 35 highest years of adjusted earnings and calculates an average monthly earnings. This is called the Average Indexed Monthly Earnings (AIME).
Primary Insurance Amount
SSA then uses the AIME to calculate the Primary Insurance Amount (PIA). This formula is based on two bend points. SSA calculates these bend points each year, based on rules set in 1979. SSA uses the bend points for the year that an employee reaches full retirement age to calculate retirement benefits.
The general formula for the PIA is as follows, where the first and second bendpoints are represented by B1 and B2, respectively.
.90(AIME, up to B1) + .32(AIME between B1 and B2) + .15(AIME above B2)
For someone who reaches full retirement age in 2025, the bend points are $1,226 and $7,391. Assume the person has earned the maximum taxable amount of earnings for 35 years during his working years. The worker then has an AIME of $11,017.
In this example, SSA calculates PIA as follows:
.90($1226) + .32($7391 – $1226) + .15($11017 – $7391)
= $1103.40 + $1972.80 + $543.90
= $3,620.10
SSA then adjusts PIA for early or late retirement to determine the actual benefit paid. We will concern ourselves with just the PIA. We will not consider the calculations beyond the PIA.
Let’s consider a similar calculation for a low income worker. For this article, we will consider a low income worker to be someone that works 2000 hours every year at $7.25 per hour in 2025 dollars. The AIME for that employee would be $1,208. The PIA then is .90($1208) = $1087.20.
From this, we can see that the retirement benefit base amount will typically be between about $1100 and $3600. The exact PIA value depends on the income earned and taxes paid during the working life of the retiree.
Survivor Benefits
Family members of someone who dies may receive a portion of the retirement benefit that the deceased person would have received. Eligible survivors include a surviving spouse over age 60 (50 if disabled). A surviving divorced spouse can sometimes also receive benefits. A widow or widower caring for the decedent’s minor or disabled children can receive survivor benefits. Unmarried, minor or disabled children of the decedent may also qualify. Survivors can receive anywhere from 16% to 100% of the decedent’s available old age benefit.
Disability Insurance (DI)
A tax of 0.9% of earnings is deducted from each worker’s pay check. Only the first $176,100 of earnings for 2025 are subject to this tax. The cap on earnings that can be taxed is adjusted for inflation each year.
In addition to the employee’s tax, the employer pays 0.9% of total payroll. There is no cap on earnings here, so payroll above the maximum Social Security earnings is still taxed at 0.9%.
Self-employed persons pay both portions of this tax.
On a typical pay check, the OASI and DI amounts appear together as FICA taxes or OASDI.
Use of Funds
Funds collected from these payroll taxes are deposited into the DI Trust Fund, which is separate from the OASI Trust Fund. Disability benefits are paid out of the DI Trust Fund.
SSA also administers the Supplemental Security Income (SSI) program which provides income for non-working disabled people. General funds of the United States government finance the SSI program. Accordingly, its expenditures do not impact the DI trust fund. SSI is beyond the scope of our current discussion.
Benefits
Social Security provides disability benefits for those who have medical conditions that prevent them from working. SSA provides those benefits only for conditions expected to result in death or to last at least one year.
To qualify for disability benefits, someone must have worked for long enough to have earned the benefit. The worker must also show a disability.
Medicare: Health Insurance (HI)
A tax equal to 1.45% of wages or salaries is deducted from each worker’s pay check. Unlike the OASI and DI taxes, all earnings are subject to the HI tax. In addition, the employer pays 1.45% of total payroll. Employers withhold an additional 0.9% Additional Medicare Tax from employee annual income in excess of $200,000.
Self-employed persons pay both portions of this tax.
This may appear on a check stub as Medicare or HI.
Use of Funds
Funds collected from these payroll taxes are deposited into the HI Trust Fund, which is separate from the OASI and DI Trust Funds. Medicare Benefits are paid out of the HI (Medicare) Trust Fund.
Problems with Social Security
Social Security is intended to provide retirement, disability insurance, and life insurance benefits. It was created by the Social Security Act of 1935. It has been credited, with some justification, with reducing poverty among the elderly.
Social Security is a major source of retirement income for millions of Americans. Politicians are afraid of fundamentally changing it. We will provide a case for eliminating the system as we know it.
Discussion of what is wrong with Social Security leads to comparisons with alternatives. The comparisons here are to illustrate problems with the status quo. Consideration of an alternate system and how to get there will follow in a subsequent article.
Our indictment of Social Security centers around four primary objections. First, Social Security uses a dishonest taxing structure. Second, it is based on a dishonest claim of “saving” for retirement. Third, it uses government coercion to transfer wealth from low-wealth households to relatively higher-wealth households. Fourth, the structure is akin to a pyramid scheme. Other objections could be raised, but we will focus on just these four.
I. A Dishonest Taxing Structure
We previously noted that Old Age and Survivors Insurance (OASI) benefits are funded with a 5.3% tax on wages up to a maximum amount. For 2025, the maximum amount of wages and salary subject to the 5.3% tax is $176,100. The maximum tax for 2025 is $9,333.30.
A tax of 5.3% is also levied on the employer. This tax levied on the employer has no limit.
The disability (DI) trust fund is funded in the same way, with a tax rate of 0.9%.
Why is this tax structure dishonest? It advances the fiction that some of the tax is paid by the employee and some by the employer. In fact, it is all paid by the employee. The cost of the program is vastly understated for those who are actually paying for it.
All Social Security Taxes Actually Paid By Employee
Employers do not make hiring decisions based on the cost of salary alone. Decisions are made based on the total value of compensation. For simplicity’s sake, let’s consider the just the OASI tax. We will ignore the costs of other payroll taxes and employee benefits.
Consider someone earning $50,000 per year. The tax levied on the employee will collect $2,650 of revenue. The same amount will be collected from the tax levied on the employer. From the employer’s perspective, the cost of hiring the employee is $52,650 ($50,000 in wages and salary, plus $2,650 in payroll taxes). The employee has actually earned $52,650, since the employer has paid $52,650 for the employee’s services. Economists call the $2,650 income earned, but not received, by the worker.
Without the tax, the employer is willing to pay the employee a salary of $52,650. We know that because the employer is already willingly paying that much for the employee’s services. The tax levied on the employer is a straight reduction in wages and salary paid to the employee.
Making the Taxation Honest
The current system raises $5,300 for an employee with wages and salary totaling $50,000. What if the $52,650 were all paid to the employee and the false employer tax were eliminated? If the employee were paid $52,650, a tax rate of 10.1% would yield tax revenue of $5,317.65, essentially the same revenue that is collected from the current system.
Why is this better? Under the current system, the employee falsely sees a cost of $2,650 when the true cost paid by the employee is $5,300. Instead of hiding half of the cost, a tax levied completely on the employee accurately reflects the full cost to the employee of the program.
Honesty and transparency are virtues that are sorely missing from social security taxation.
II. The Savings Myth
Social Security is a massive transfer program. There is no account with “your” savings held in it for you. Taxes are paid into a trust fund. Benefits are then paid out of that trust fund.
A Transfer, Not Savings, Program
Individuals have no particular claim on the assets in the trust fund. People who have paid into the system have no property right claims on the funds. The funds are the property of the government. As the Supreme Court ruled in Flemming v. Nestor (363 US 603 (1960)), there are no contractual rights to receive benefits from the system. Congress can amend the program at will, including changing benefits calculations and eligibility rules at will.
A savings program would look very different. Workers would have an account with their name on it. You would own that account and the wealth in it. You would have property rights related to that account. Because of the Fifth Amendment, the government would not be able to arbitrarily take it away from you.
Accumulation Better Than Transfer
A shortcoming of the system is that any person’s benefits are dependent on collecting taxes from someone else. Nothing is saved. The truth of this is underscored by the fact that beginning in 2020, the OASI trust fund is being depleted. According to the The 2024 Annual Report Of The Board Of Trustees Of The Federal Old-Age And Survivors Insurance And Federal Disability Insurance Trust Funds (p. 13), the fund will be completely depleted in 2033. When the trust fund is depleted, benefits will face major cuts.
The impending day of reckoning has been known for decades, at least since the reform in the 1980s that pushed it back to the mid 2030s. While Congress can act to reform the program, there has been no substantial action taken to address the core problems. Raising taxes understandably draws resistance from workers who need to pay the taxes. Cutting benefits is seen as mean-spirited, with a massive amount of hyperbole heaped upon anyone who suggests looking at benefit calculations. Reforms necessary to prevent collapse of the program have been repeatedly delayed. This makes addressing the insolvency of the program much harder and the required changes much more extreme.
Radical Change Needed
It seems clear that changes in both funding and benefits need to happen. Resisting change only pushes us closer to a catastrophic cliff for those depending on Social Security benefits. That cliff is only eight years away.
A shift to individual wealth accumulation (i.e., real saving) instead of a transfer program would address most of the core issues with the program. A fair transition to such a program will be difficult. It also will get us into a better, more sustainable position with advantages beyond providing retirement income. It will involve a fundamental rethinking of how the benefits provided by the social security system can and should be provided.
A Thought Experiment: A Low Wage Worker
How could a wealth accumulation program be preferable to an income-transfer program? Consider someone earning minimum wage. Assume also that the person is starting his work life at the age of 20 and will work until retirement at age 65. At $7.25 per hour, working 2000 hours per year, the person will have an annual income of about $14,500. This comes to an average monthly income of just over $1200. OASI taxes, then, will be approximately $128 per month.
To simplify calculations in our illustration, we will assume either an inflation rate of 0% or that the person has wage growth exactly equal to the rate of inflation. This allows us to look at a constant real $7.25 real wage over the workers working years. This is a very pessimistic work history scenario and works well as a worst case scenario.
Low Wage Worker Benefits Under a Wealth Accumulation System
Instead of paying OASI taxes, imagine the worker invests $100 per month over his planned 45-year work life. Given a constant investment of $100 per month and a consistent yield on the investments of 7%, the worker would have an account value of just over $379,000 when retiring at age 65. Yields of 8% and 9% would result in accounts worth $527,000 or $740,000, respectively.
From 1926 through 2024, the average annual return of the S & P 500 Index (originally the S & P Composite Index) is slightly more than 10%. If our hypothetical investor were to earn 10% returns on the $100 per month investment, his total account value would be over $1,000,000. That rate of return may seem overly optimistic, however, and we won’t assume returns that high. In the 45 year period from 1978 through 2024, the average return has been approximately 12%. We note these historical returns to observe that the goal of a 7%-9% return over the 45-year earning period is not at all unreasonable and is perhaps a cautious estimate of expected returns.
Market Benefits Exceed Socialized Retirement Benefits
We previously noted that our hypothetical minimum wage earner retiring at his official retirement age (67 for people born in 1960 or later) in 2025 would have a monthly benefit of about about $1087.20. Annually, this would be an Old Age benefit of just under $13,046.
Imagine instead of paying into Social Security that the worker earns a 7% rate of return on his monthly $100 investment. This gives him a nest egg of approximately $379,000 at age 65. If the low income retiree can earn a 4% income off of that nest egg (not an unrealistic goal for an income-oriented investment portfolio), he will have annual earnings of $15,160 – without drawing down the balance. That is an annual income HIGHER than from the existing Social Security program. That “extra” money could be taken as additional income or reinvested to provide for future income growth in retirement.
Our hypothetical minimum wage employee has a 16% higher income in retirement under this hypothetical, but realistic, wealth-accumulation program than under the current income transfer program, for a little less money paid into the system. Not only is the income higher with wealth accumulation, a nest egg remains that can be left to the worker’s heirs.
Survivor Benefits Under a Wealth Accumulation System
Someone might object that even if retirement income is higher, Social Security also provides survivor benefits to help the worker’s dependents if he dies. Note that we have only invested $100 of the monthly $128 the worker would have been paying in taxes.
A quick search using NerdWallet and policygenius.com finds that a 20-year $500,000 life insurance policy can be purchased for a healthy 25-year old male for about $18 a month, thus providing a nest egg to support dependents larger than the estimated nest egg at retirement. Longer protection for 30 years can be purchased for under $30 per month.
Some argue that the economy is rigged and that the marketplace works only for a few instead of for everyone. When it comes to retirement for low-income workers, being forced into Social Security does rig the system against the low income worker. That is, however, a consequence of socializing retirement, not a shortcoming of the market.
III. Transfer From Low Wealth to High Wealth Households
An argument in favor of Social Security is that it helps assure that people in retirement are not in poverty. This is a laudable goal. It is also fairly certain that there was greater merit for this argument in 1935 than there is today.
Income versus Wealth
To discuss how Social Security redistributes economic resources, we must be clear on two different concepts. Income is the amount of money (or perhaps other assets) someone receives in a given period of time, such as a year. Wealth is the value of what someone has at any given point in time.
Poverty is an income issue. Poverty is an insufficiency of income to meet the needs of the household.
Wealth can be expressed as net worth (the sum of what is owned, minus what is owed). Wealth can be a source for generating income through investments or savings.
A home typically does not generate income. Since the home does not typically generate income, our discussion will consider net worth excluding equity in a home.
Household Wealth Distribution by Age
In 2022, the median net worth (excluding home equity) of households headed by someone under the age of 35 was $18,300. For households headed by someone 35 to 44 years old, it was $47,040. For the age groups of 45-54 and 55-64, median net worth was $80,120 and $104,300, respectively. We typically regard 65 as retirement age, even though people collecting social security at that age may not be eligible for full benefits, depending on when they were born.
We might expect that in retirement, people burn through their net worth in order to live. What we see in the data, however, is not so simple. Median net worth for households headed by someone aged 65-69 is $122,300; for 70-74, $150,400; and for 75 and older, $96,000. What we seem to see here is that wealth continues to rise throughout someone’s 60s, climbs in early to mid 70s and then falls off.
If we focus just on the value of retirement accounts, we see a similar pattern. Those immediately before retirement (age 55-64) have median retirement account values of $150,000. Those in early retirement (ages 65-69) have median retirement account values of $180,000. This continued rise in the mid to late sixties may indicate a prevalence of working past 65. In the early 70s, median household retirement account continue to rise to $190,000, and for those 75 and older, retirement accounts fall to $128,000.
The Lifetime Wealth Cycle
We see a general pattern here that we would expect. Young households have little net worth. This makes sense. A new high school graduate, for instance, often will have no net worth at all. If the new graduate continues education, student debt is likely to come in, forcing net worth to be negative. Net worth becomes negative as the student takes on debt but does not yet have significant assets to offset the debt.
When the student graduates and enters the full time work force, income rises, making the person better off. Only by paying down debt and saving or investing can net worth rise. Purchasing a home initially has little impact on net worth, but as a mortgage is paid off, net worth rises. Incomes tend to rise with age as people get more experience in their chosen fields. Rising incomes provide additional resources to pay off debt, save, and invest.
The median net worth (excluding home equity) for all those over 65 was $117,100 in the United States in 2022. No younger age group had comparable net worth. That leads us to the conclusion that the workers paying for Social Security, as a group, have significantly less net worth than the recipients of social security, as a group.
Immoral Socialized Wealth Transfers
In the name of fighting poverty, Social Security actually transfers substantial wealth from lower-wealth workers to higher-wealth retirees. This is backwards. Indeed, it is immoral for government coercion through taxes and income redistribution to take from low wealth households simply to transfer that wealth to high wealth households.
This moral problem with Social Security’s redistribution is due to its structure as a transfer payment program, rather than a wealth accumulation program. Socialized retirement funding is morally indefensible for this reason.
In our example above of the minimum wage worker investing the bulk of his social security taxes at a fair market rate of return, we see that the worker can enter retirement with a nest egg of over $375,000. This nest egg is just over 2.5 times the median retirement account balance of 55 to 64 year olds. A market-based wealth accumulation system holds out prospects for increasing wealth at retirement by more than $225,000 for low income workers.
IV. Social Security as a Pyramid Scheme
It is a contentious statement to say that Social Security is a pyramid scheme. We contend that any private entity running an operation like Social Security would face criminal prosecution for bilking the contributors out of their money.
Pyramid Schemes
So, what is a pyramid scheme? A pyramid scheme is a form of fraud in which someone recruits people to invest in a business opportunity. Often that opportunity does not involve much in the way of selling products. It does, however, depend on recruiting more and more people into the organization.
Membership or enrollment fees from those recruits are used to pay the people higher up in the organization. For anyone to get paid, new people must be recruited below them in the organization. If there are insufficient people being recruited, the cost imposed on new people coming into the system must increase to sustain payments to those higher in the organization.
At some point in a pyramid scheme, there are no longer sufficient new people entering the system to sustain payments to those higher up in the organization. Payments diminish. Payments to those just added to the system never materialize. People who joined early and were at the top of the organization made their money off of everyone joining below them. The pyramid collapses when the payments coming in can’t sustain the payments going out.
How is this similar to Social Security?
Social Security depends on having a pool of workers paying taxes into the trust funds. These are the new enrollees in the pyramid. Without their payments into the system, those at the top (the ones receiving or about to receive benefits) receive nothing.
The pool of workers must grow as the number of recipients grows. If the pool of workers does not grow as fast as the pool of recipients, the payments from the workers must be increased to allow payments to those at the top to continue.
Do we see a problem here that qualifies Social Security as a pyramid scheme? Yes, we do.
Declining Workers Per Beneficiary
According to the Social Security Administration, in 1940, there were nearly 160 workers paying taxes to support one beneficiary. In only five years, this fell to just under 42 workers to support each beneficiary. Another five years passed, and that had dropped to 16.5 workers supporting each beneficiary. By 1960, it was down to 5.1 workers per beneficiary. By 1965, the ratio dropped to 4 workers per beneficiary. At this point, the ratio began to level off. It took until 2009 to reach 3 workers per beneficiary. The number of workers per beneficiary is about 2.3 now, on a projected trend to bottom out at 2.
The demographic reality of the declining ratio of workers to beneficiaries suggests that Social Security cannot continue as it is. The declining ratio of workers to beneficiaries also suggests that we should have seen increasing costs to those entering the system if this is a pyramid scheme. This would be necessary to sustain the payments.
Rising Taxes To Sustain the Pyramid
Do we see an increasing cost to new members of the system (i.e., to the workers who pay the taxes to support the beneficiaries)? Looking at the OASDI tax rates, we certainly see that the system has imposed higher costs down the pyramid organization to compensate for higher payouts at the top and for fewer people entering the system relative to the payments being made.
The OASDI tax rate was 1% from 1937 to 1949. It increased to 1.5% (a 50% jump!) in 1950 as the worker to beneficiary ratio fell to 16.5. Taxes went up in 1954 to 2%, in 1957 to 2.25%, in 1959 to 2.5%, and in 1960 to 3%. Between 1937 and 1960, Social Security taxes tripled to try to compensate for the fundamental unsustainability of the transfer program, as the ratio of workers to beneficiaries dropped from over 159 to barely over 5.
By 1969, the OASDI tax rate had risen to 4.2%, an increase of 40% in only 9 years. Nine years later, the tax burden imposed by the OASDI tax had jumped another 20% to a levy of 5.05% on payrolls. The tax rate continued to rise throughout the 1980s until arriving at 6.2% in 1990, an additional 22% increase in the tax burden in only 12 years.
Impending Collapse: Depleted Trust Funds
As the worker to beneficiary ratio continues to drop, we see increasing pressures on the Social Security trust fund.
The Old-Age and Survivors Insurance (OASI) Trust Fund will be able to pay 100 percent of total scheduled benefits until 2033, unchanged from last year’s report. At that time, the fund’s reserves will become depleted and continuing program income will be sufficient to pay 79 percent of total scheduled benefits.
Status of Social Security and Medicare Programs: A Summary of the 2024 Annual Reports, p. 2
The OASI Trust Fund began paying out more than it was taking in from tax revenue in 2010. At that time, interest on the government securities held in the trust fund was sufficient to make up the difference. Beginning in 2020, payments out of the trust fund have exceeded the total of taxes and interest collected by the fund.
We can look at the impending collapse from another perspective. For January 2025, the average monthly retirement benefit is expected to be $1,976. With 2.3 workers per beneficiary, the average worker would need to pay almost $860 into the system, if we ignore survivor benefits. In the third quarter of 2024, median weekly earnings were $1,165. This translates to $60,580 annually, or $5,048 monthly. Monthly OASI taxes paid by the median income worker would be only $535, far less than the $860 needed to balance the trust fund inflows and outflows. Viewed from this perspective, the system remains unsustainable.
The Medicare Trust Fund is also in poor shape. Medicare is facing an 11% benefit cliff in 2036. Again, from page 2 of the summary report,
The Hospital Insurance (HI) Trust Fund will be able to pay 100 percent of total scheduled benefits until 2036, 5 years later than reported last year. At that point, that fund’s reserves will become depleted and continuing program income will be sufficient to pay 89 percent of total scheduled benefits.
Status of Social Security and Medicare Programs: A Summary of the 2024 Annual Reports, p. 2
Socialist health care as seen in Medicare and socialized retirement funding as seen in Social Security’s Old Age and Survivors Insurance are not sustainable. While the Medicare problem is beyond the scope of this article, it is a related problem we must acknowledge. The pyramid is not sustainable and is collapsing.
Moving Forward
People on (or about to come on) Social Security in 2034 will be left holding the bag unless dramatic changes are made. Those dependent on Medicare will be similarly left high and dry in about 2036 unless dramatic changes are made. For the sake of those dependent on these programs and for those paying into the system now, changes must be fundamental, not merely tax rate tweaking or benefit calculation changes around the edges. The fundamental redistributive aspect of the program must be jettisoned in favor of wealth accumulation, and a transitional period and plan must be in place to protect those whose opportunities have been limited by the misguided, though likely well-intentioned, Social Security system. We will present our proposal for change in an upcoming article.