What Is Social Insurance?

By James Kwak

“We do not believe that in this country, freedom is reserved for the lucky, or happiness for the few. We recognize that no matter how responsibly we live our lives, any one of us, at any time, may face a job loss, or a sudden illness, or a home swept away in a terrible storm. The commitments we make to each other – through Medicare, and Medicaid, and Social Security – these things do not sap our initiative; they strengthen us. They do not make us a nation of takers; they free us to take the risks that make this country great.”

Many liberals have been heartened by these words, spoken by President Obama during Monday’s inaugural address. Indeed, they represent one of the few times when anyone, including the president, has even attempted to defend our major social insurance and safety net programs. The usual posture among the type of centrist Democrats who make it into the administration is some combination of (a) simply attacking, as self-evidently evil, anyone who proposes benefit cuts and (b) saying in serious tones that we will have to cut spending one way or another.

Unsurprisingly, most Americans are split between various misconceptions of what Social Security and Medicare are. Many, particularly right-wing politicians and their media mouthpieces, see them as pure tax-and-transfer programs: they gather money from one set of people and give it to another set of people. This feeds easily into the makers-vs.-takers line, with payroll taxes on workers going to fund benefits for non-workers. From this point of view, they are bad bad bad bad bad and should be cut.

Many others, particularly beneficiaries and people who hope to see beneficiaries, see them as earned benefits. The common conception is that you pay in while you’re working, so you earned the benefits you get in retirement. You didn’t “earn” them in the moral sense that people who work hard should get benefits; you “earned” them in the accounting sense that you’re just getting back “your” money that you set aside during your career.

Both of these perspectives are wrong, the latter more obviously so. Most people, during their working careers, do not pay nearly enough in payroll taxes to pay for their expected benefits. This is most obvious for Medicare, since the Medicare payroll tax only covers a small fraction of total Medicare expenses; in addition, given health care inflation, payroll taxes from decades ago would make only a small dent in today’s medical costs. But it’s also true for Social Security: the way initial benefits are indexed (according to average wages, not average costs) pretty much guarantees that the average retiree in some generation will get back more than the average worker in that generation put in.

The problem with the tax-and-transfer argument is only slightly more subtle. Sure, at any given moment some people pay taxes and others collect benefits (and many do both, since Medicare is funded by general revenues). But most of us will both pay and receive at different points in our lives. So both programs are really more like income-shifting arrangements, where we spread income from our working lives into our retired lives—or like repeating intergenerational transfer schemes, which can continue indefinitely (making everyone better off) under the right conditions.

In chapter 6 of White House Burning, we devoted a fair amount of attention to the question of what these programs are. In the inaugural address, I think the president got it basically right. They are risk-spreading programs. You don’t get back exactly what you put in: they have a certain degree of progressivity (although less for Social Security than is commonly imagined). Their main function is to protect people against extreme outcomes by pooling a limited share of our resources.

Yes, rich people end up paying payroll taxes for insurance they end up not needing. But that’s how insurance always works: you pay the premiums hoping you won’t need it. And the key fact is that most young people, whey they start paying payroll taxes, don’t know what their own personal outcomes will be. Social Security and Medicare effectively transfer money from the futures where they turn out rich to the futures where they turn out poor, which makes them absolutely better off. Like any insurance scheme, you can make everyone better off simply by moving money around between different states of the world.

These particular insurance schemes, as the president said, have a moral element to them. They are a way of expressing out solidarity with each other as Americans, people united, however loosely, in a common endeavor. They also have an economic element to them. People protected against bad outcomes are more willing to take the risks needed for a vibrant and prosperous society. They are something to celebrate, not something to be embarrassed about whenever the Republicans come after them.

30 thoughts on “What Is Social Insurance?

  1. This partly explains why Sweden has surpassed the USA as a better place to start a business. I remember giving advice to a Swedish friend contemplating starting a technology company 5 years ago and thinking an American in his shoes can’t take this risk on the health care issue alone. He did and it has been wildly successful.

  2. The tax-and-transfer view is completely wrong because the FICA payments as a matter of law may be used solely to fund benefits and run the program. As a matter of law, there is no such thing as a unified budget — which is why, as a matter of law, cutting Social Security cannot affect the budget deficit. The earned benefits view is mostly correct because (1) the tax does go solely into the program as a matter of law, which makes it virtually identical in that sense to a defined benefit pension plan, where there is a common pot and not individual account segregation, and (2) there is a high correlation in a relative sense between an individual’s taxes paid over the course of a lifetime and later benefits. Yes, unlike a private retirement plan but consistent with its public purpose, the benefit schedule is subject to progressive adjustments to assure a minimum amount to those at the bottom. But still, if you contribute more, you get more back. That’s the social contract that Americans expect to be honored.

  3. Not true if you contribute more you get more back. I never realized how much of an income restriibution plan SS was if you are middle class or higher. Just started SS and my wife continues to work. Eight-five per cent of my SS will be taxed. This is money, of course, which already was taken from me by tax. It will take many years for me to get my money back. SS benefits mainly the truly poor by taking money from the rest of us. Whether that is good or just, I don’t know but it is accurate.

  4. I would point out that the bend points for Social Security make it a fairly strongly redistributionist program. Social Security calculates benefits by finding the wage indexed average of the highest 35 years of earnings, then from that calculates the benefits as follows:
    90% of the amount up to 791 32 % from 792 to 4768 and 15% from there to the wage limit. so it does favor the lower income, in addition if you have a non working spouse they get 50% of that benefit without ever working, at all. (This is a part of SS that no private plan could ever implement).

  5. How do you think the level of your benefits was set? Pulled out of a hat? Of course it will take many years to “get your money back.” It’s pegged to life expectancy. Social Security is retirement income insurance. If you die early, you don’t “get your money back.” You get an income for as long as you live. That’s the deal. “Getting your money back” is irrelevant, but you likely will luck out if you live much longer than your life expectancy.

    You think you “get your money back” a whole lot faster under a defined benefit private plan? Some, yes, because there is no need to make sure some retirees who made little in their working lives have at least a minimum income out of the program.

    This sure sounds like whining.

  6. “I would point out that the bend points for Social Security make it a fairly strongly redistributionist program.”

    That is moderated quite a bit by the difference in life expectancy of different wage earning classes. Upper wage earners live significantly longer than lower wage earners thus collect benefits for several more years. For example, the current average life expectancy of all men in the US is 75.6 and 80.6 for all women. However, two low-income groups for example, white women who didn’t finish high school can expect to die 6 1/2 years earlier at 73.5, earlier than black women (those blacks fare worse than whites in all other categories), and black men overall can expect to only live to 70 1/2. White men without a high school diploma can expect to only live to 67 (the minimum age to collect benefits for those who are now 53). A college degree adds 10 years to white women’s life expectancy and about13 years to a white male. Hispanics actually fare the best of all ethnic groups across all educational levels, with women overall averaging life expectancies of 86 yrs and men averaging 85 years.

    As pointed out above, single income couples fare the best in terms of collecting the maximum lifetime benefits as percentage of contributions, as the non-working spouse is entitled to 1/2 the benefits of the working spouse. IIRC from a recent trustee report, the actuarial tables are set such that average lifetime benefits as a percentage of money paid in run on the low side of about 93% for those who make maximum contributions and 110% for those who make minimal contributions. It ends up that you collect closer to what you paid they in than you think (assuming you live exactly as long as expected). In addition, your contributions include disability insurance and survivor benefits for your dependents during your working years.

  7. It is beyond amazing that something that has been taken for granted in Germany since the 1880s (German Empire under Bismark) should still be controversial in the USA over 120+ years later. Time for the US to catch up with the rest of the developed world, is it not?

  8. In order for the “We recognize that no matter how responsibly we live our lives, any one of us, at any time” absolutely correct principle to really hold water, I guess one should perhaps define what living out lives in a responsible way means.

    For instance from what I have read in this blog I can gather that many would opine that “banksters” should not have access to Medicare, Medicaid and Social Security. Or does that only refer to the “successful banksters”?

    To me “Social Insurance” is a must, as long as it is kept from turning into an aspirin in order to cover up for bad economics and other public policies or politics that could be wrong.

    For instance to me bank regulators should perhaps not have access to Medicare, Medicaid and Social Security, because they, by discriminating against “The Risky” and favoring “The Infallible”, have not behaved correctly or responsibly.

    And when James Kwak writes “People protected against bad outcomes are more willing to take the risks needed for a vibrant and prosperous society. They are something to celebrate”, but then stubbornly keeps on being silent on the issue of how bank regulations explicitly discriminate against risk-takers, when these are perceived as “risky”, we might venture to ask whether Kwak should be able to keep his Medicare, Medicaid and Social Security.


  9. When the president talks about insurance schemes, I feel like I am at the crossroads of greed and corruption. Plus I have a dinner date tonight at the corner of greed and arrogance, it’s a straight 2 mile drive and I bring my own radio to drown out the noise at the end of the meal. It’s a sub-prime conversation that never grows old for them, but did for me some years back. Since we have known for some time that a true conversation will never take place in this life time, or the next.

  10. The alternative to social insurance is self insurance. The conservative argument is that if everyone had to self insure then they would have a stronger incentive to work harder and save more. The assumption is that hard work is rewarded with high income, but as the President and JK point out, high income is also dependent on luck.

    A much bigger failing of complete reliance on self insurance is that we do not have the capacity to productively invest the resulting savings. Everyone assumes that more savings creates more investment, creating more production. Yes, when an economy enters its industrial period there is a shortage of capital for the huge demands of factories and infrastructure.

    But what if every household saved $1mm for retirement by middle age, where would they put it? Would we buy equities, bonds, real estate, or commodities? Particularly if gov’t budgets are always balanced (no social spending) and there are no gov’t bonds to purchase. This conservative utopia would mostly result in speculation and asset bubbles, not in higher spending on increasing production because there isn’t the demand to consume higher production in our mature economy. Much of the demand for new capital is driven by new technology, but those new ideas come in fits and starts, and at great initial credit risk.

    Social insurance and public education create generational transfers via taxes from our productive ages to the elderly and the young without individuals having to find a productive place to save their fortune. So social insurance not only spreads the risk of outcome, but also greatly reduces the individual and aggregate credit and inflation risks of saving.

    The generational transfers also create high velocity of money, and a broad geographic distribution of money. How many cities would wither without government spending on healthcare, education, and to retirees? Paradoxically the Deep South would be destroyed without social insurance.
    Republicans mis-characterize social insurance as a free loader mechanism in order to lower taxes, but without social insurance our nation would implode.

  11. As James Galbraith has written, “Social Security and Medicare are government programs; they cannot go bankrupt, and they cannot fail to meet their obligations unless Congress decides … to cut the benefits they provide. The exercise of linking future benefits and projected payroll tax revenues is an accounting farce, done for political reasons. That farce was started by FDR as a way of protecting Social Security from cuts. But it has become a way of creating needless anxiety about these programs and of precluding sensible reforms, like expanding Medicare to those 55 and older, or even to the whole population.”

  12. You make a lot of interesting points about what I have often argued which is selling the illusion that if everyone had individual retirement accounts everyone could earn a real return sufficient to satisfy what has been promised.

    “Let us not forget that living in a society implies the continuous allocation and reallocation of resources. Should all our elders (myself included) become millionaires (in real terms) as a result of their investments in pension funds while the rest of the country lags behind and is not able to participate in this well being, let me assure you that future generations, in all their right, will certainly not allow us to peacefully enjoy our old age.”


    And more on the subject from my book Voice and Noise:


    But when you say “Paradoxically the Deep South would be destroyed without social insurance”, let me remind you that for some areas social insurance can turn into a “curse”, just the same way as oil revenues can signify a curse for other.

  13. The true point missed is the new insurance scam, the no fault one that has 2 definitions. The official and today on the books version is that the storm or flood was at fault for destroying your structure, and that means, your no fault insurance, will pay to replace your dream.

    But reality is that mother nature does not care that you built on her land, and that this structure is NOT insured by mother nature, or any one else who has a positive balance sheet for that matter, so that your self insurance is the only replacement insurance you have for the damage done to your structure. Get to far off track and the numbers on the fridge don’t even make sense.

  14. This is a fair statement of the insurance benefits of these programs, and correctly notes the Rawlsian-type justice they create. It is a bit one-sided, however, in that it fails to recognize that such programs, in addition to providing a foundation for risk taking, also can create dependency, disincentivize effort, and generate excess demand. In the version of my life when I end up poor, I may, for example, have a choice of taking a second job or letting Medicare pay my bills, of seeing whether the pain in my foot will go away on its own or getting an MRI that most likely will reveal nothing, etc. The existence of these programs may lead to socially less desirable decisions in at least some, and possibly more, circumstances than they to socially desirable ones.

  15. Social Security does effect the national debt. Right now, the general fund is repaying the trust fund about $112 billion a year. Where is that money coming from? Remember, the general fund is borrowing almost 40 cents of every dollar it spends.

  16. Well, the only winners are government employees, they receive the best insurance and retirement plans. All this “risk-spread” programs are only an scheme for the always expanding rich bureaucracy class….

  17. I think there is one basic argument that stays for the social security. If the central government has money to spend on bailout of the banking sector, why it should not support taxpayers, real people made of flesh and bones, people with children etc.

    Obama is, despite all his wrongdoings, trying to solve one of the biggest problems of America. He also works well in the field of immigration policy (to legalize immigrants is a great move and will work in the favour of balancing our future budgets as well as it works for the Canada) and we can expect some important changes during his second administration. I don’t want to be overly optimistic, but things he says are at least correct for me. There isn’t much to do right now, we can just wait and see how the situation develops.

  18. The author is wrong that payroll taxes cover a small fraction of total Medicare expenditures. General revenues and payroll taxes cover roughly the same proportion (~40% each) of total Medicare expenses. The balance comes from Part B premiums (paid by beneficiaries), benefit taxation (paid by beneficiaries) and interest on trust funds from the treasury.

  19. @Popshobby, If there was no Social Security the government would have borrowed the same amount as was borrowed from the SS trust funds from some other source and would have paid the same amount of interest to that source. It is wrong to say SS has any negative effect on the deficit, the budget, or the national debt. With or without SS they would all be the same, except we would owe a great deal more to China instead of ourselves and general budgets probably would be a great deal higher (ergo the deficits and national debt) because we paid more in welfare and Medicaid to take care of the indigent disabled and elderly who are now sustained by SS. I would argue that SS and Medicare probably have a positive net effect on the deficit and national debt be cause they are more restricted, targeted tax programs directly linked to restricted, specified benefits. The general budget is a amalgam tax system linked to commingled line items that are much more ill-defined items lending themselves to pork modifications, political implementation account shifting and poor control and measuring of outcomes. Medicare and SS are, without question, the most administratively efficient and benefit precise programs in the Federal government. That being said, they both can improve administratively and absolutely must be modified to maintain their viability.

  20. what makes the US a great place to take a risk is not (and NEVER has been) our social safety net; it is our cultural acceptance of failure which is reflected in our bankruptcy law.

  21. @Arden – depends on what risk was taken and who gets bankrupt.

    Beating swords back into ploughshares, so to speak, is worth a risk because the failure is a learning moment :-) for everyone.

    But even still, the risks an individual takes doing that particular kind of recycling in the MATERIAL world is limited – meaning both damage and profit are not mathematically set to “infinity”.

  22. There is one over all compelling factual argument for for the “social insurance” model to cover all health services and most developed countries around the world have long recognized this. Look at the epidemiology of illness: In the USA, as in most developed societies, taking the population as a whole, 1% of the people consume about 25% of all medical spending, 5% consume about 50% and 50% of the population consume less than 5% of all medical care expenses. Insofar as severe illness can be pretty random, hugely expensive and is concentrated among a few people, it is wise to have a risk sharing mechanism which is universal including those at low risk. Universal health insurance or Medicare for All, or single payer financing is basically the most efficient and rational mechanism. There must be an insurance mechanism, but commercial, for profit insurance which is the mode in our country is hugely expensive and inefficient , adding 25 to 33% to health care expenses through administrative complexities, marketing and profit. Moving to Medicare for All and eliminating the commercial insurance model (which in 50 years has not controlled ever escalating medical prices) is estimated to result in $500 billion a year in savings which will go a long way towards financing medical care for the currently uninsured.

  23. That’s true: medicare and other government programs might seem irrevelant when you are young and energetic, but they will turn out to be super useful when you get retired or face some accident. That’s why most well-developed countries usually have the most thorough medical system

  24. @ Dr Gordon, the government (CMS) national health expenditures data estimates that $896 billion of our $2.6 Trillion national consumption of health services is paid by private insurance with an administrative cost of $156 billion. That’s more like 17% than 25 to 33% overhead. That’s a much higher overhead than Medicare ($7 billion on $522 of benefits ~1.3%). But Medicare for All certainly couldn’t save $500 million in admin expenses. Seems more like $135-140 billion. A good savings nonetheless, but not the magic bullet. I’d bet commercial health care insurance hasn’t had even half the negative effect on cost that for-profit health care delivery has had.

  25. For discussion purposes I will accept that insurance company overhead is 17%. One must then account for the additional massive administrative expenses throughout the system: (1) As a private practice doc I belong to a (very effective, patient oriented) medical group which negotiates with insurance companies for me and manages patient care (to save resources and improve quality). Its overhead runs 11 to 14% of income. (2) As an estimate most medical providers (hospitals, home health agencies, medical offices, etc) have billing and prior authorization departments that consume 15% of income at least. Thus this already adds up to an estimated 43% of premiums paid. Wasteful diversion of resources from medical care is not just attached to the functions of the insurance companies themselves. A recent detailed time and motion study of a large medical practice in San Francisco documented that $78,000 per doctor per year was spent dealing with insurance companies. In fact, our medical system diverts massive resources away from direct patient care and does not even then create an efficient market.

  26. @paradocs2, there is always office overhead to deal with. Dr. Gordon’s comment was that $500 million per year could be saved by going to Medicare for all. I have always been in favor of that, but the savings in overall costs don’t seem to me to be as great as he indicated. As I am a quibbler by nature, I see 17% insurance overhead and 15% office overhead as 32% rather than 43%, but I may have misunderstood something in your comment. In the case of your office practice, some portion of what you call overhead, namely managing patient care is, I would argue, a patient service and not truly overhead. If we’re focusing on Medicare for All, there would be office overhead savings since there would be one set of coverage standards and claim processing and appeal procedures, but after all is it very much cheaper for you to deal with Medicare than any other insurance company? If we’re focusing on administrative costs as a general matter, for a thought experiment, what if there were no insurance companies, including Medicare, to deal with. What would the overhead costs be for providers to collect fees directly from their patients? I suspect they would still be significant and I further suspect the incomes of physicians and facilities would be substantially less because patients would react more negatively to large bills than monthly premium payments – so much so that I would hazard a guess that the Sisters of Mercy and University Hospitals would still be run by the Sisters of Mercy and the Universities rather than being contracted out to HCA or other for-profit management firms and that there would be no shortage of primary physicians because specialty work wouldn’t be as lucrative if patients had to pay for a knee replacement or triple by-pass out of pocket.

  27. I appreciate your interest and cogent response.
    In reply:
    First to the amount of system overhead….I could not survive in the California market as a solo family doc without the assistance of a strong and vibrant medical group to negotiate with insurance companies – for patients and contracts, and to support and subsidize my expensive (ughj!) EHR rollout, etc. That intermediary organization spends 10-15% of premium dollar on administration. Thus a total of close to 50%.
    Secondly, of course there will be practice and provider overhead expenses in any case, but I cannot fully convey to you the immense time and effort I have to divert from seeing patients to deal with various insurance companies to get medication, MRI, specialist referral, and hospital admission approvals in the face of clinically obnoxious restrictions, not to mention problems with billing etc.
    Thirdly, here in California we are eager to get on board with the ACA health care low. It is astonishing to me that the California Endowment Foundation, the state, and the federal government together will be spending over $1BILLION just to establish and market our (one state’s) health insurance exchange. What a waste of money!!!!! that could all be saved by the simple ploy of universal enrollment.

  28. Hey Kurowski: Bankers should be allowed to take whatever risks they want without onerous government regulations as long as they do it without any government sanctioned leverage or any borrowed government funds and without any expectations of a government bail out. Absent that they are asking for a government franchise to never go out of business. Which, not surprisingly, needs to be protected from banker abuse by guess what? Regulation.
    “Catch-22 says they can do anything we can’t stop them from doing.”

Comments are closed.