The “I’ve paid in all my life” fallacy — Social benefits are often sold as insurance-based schemes. But they don’t work that way

If there is one thing that will get people worked up it’s talking about the real nature of Social Security.

Social Security is not an insurance product. It is pay as a society goes. Payroll taxes pay for people currently on Social Security. Then, one day the payers become payees. Or that’s how it’s supposed to work. But what happens when one generation (the baby boomers) is larger than the following generation?

And that’s just one of the giant problems that need to be confronted with Social Security.

(From The Economist)

The problem is made more difficult because of the way that such benefit schemes were established and marketed to the public—as insurance schemes in which what you receive in benefits relates to what you put in. When pension schemes were set up by Franklin Roosevelt (pictured, left) in the 1930s or in Britain, by David Lloyd George (pictured, right) in the Edwardian era, the insurance notion was something people could easily grasp (private schemes already existed) and could be seen as fair.

This was fine in the early years of such schemes when the number of people contributing was far greater than the number of people taking benefits. But as our societies age, the costs rise and the inadequacy of the “insurance approach” is made clear. When television or radio shows do a vox pop, people will often say “I’ve paid in all my life so why should my benefits be cut” or “why should my taxes rise” and so on.

The problem with this thinking is threefold:

  • What people pay in individually is not related to what they get out

  • What people have paid as societies, in aggregate, is not enough to meet the benefits they have been promised

  • In effect, despite the smokescreens, these schemes operate on a “pay as you go” basis in which benefits are met out of current revenues

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