Social Security - Of Pyramids and Pyramid Schemes

From the dawn of civilization, we human beings have been burying our dead, but it's only in the last century that we've begun entombing our living as well. The ancient Egyptian Pharos invested their excess wealth in building pyramids and other monumental tombs in which their mummies were placed after they died. We fill our hospitals and nursing homes with living mummies (and daddies), sometimes over the objections of all of the family members involved. The wealth we spend postponing the clinical death of our elderly by a few days or weeks dwarfs the amounts the Pharos spent on immortality.

So the Egyptians had their pyramids, and we have our pyramid schemes known as Social Security and Medicare. Unlike the Egyptian pyramids that have stood for thousands of years, our pyramids (as we know them) will collapse in the near future. Are there easy solutions to the Social Security and Medicare shortfalls? Sure, raise the retirement age and lower the benefits for both programs. It's going to happen eventually, but the the AARP will fight it until the programs are so far into the red that the it will be a miracle if the replacement programs allow senior citizens (like myself in 30 years) enough to rent a room and buy cat food for a thin fiction of a cat.

I'm sure I don't need to go into the details for my readers, but the Social Security system is officially broke in 2011 by normal business standards. In 2011, the benefits paid by Social Security will exceed the contributions made by all working Americans, at which point and ever growing portion of the Social Security benefits will become a budgetary line item for the government. Under the fantasy pushed by politicians, there's money in the trust fund to last another three decades, but in reality, there is no trust fund. It's just a filing cabinet full of IOUs issued by the government. In other words, the only way the government has to pay back the money "borrowed" from Social Security is to raise taxes or take it from other existing programs. Guess which they'll choose.

Despite the central role Social Security plays in the American social contract, most people, entrepreneurs included, remain woefully ignorant of how the program works, who it covers, and why if they're young and have a brain in their heads they'll support reforming the system. One common myth I've encountered amongst self-employed colleagues is that your ultimate Social Security benefit is calculated based on your best three or five years of employment. I even know one aging entrepreneur who plans to pay himself at an artificially accelerated rate during his last three years (reverse-laundering money from his savings) because he's convinced he'll get it back times ten through higher benefits. He won't.

Our eventual social security benefits are based on our average monthly earnings over the best 35 years of our working lives. This is used to compute how much we would receive at full retirement age, currently 65. Workers can choose to start collecting retirement benefits at an earlier age, 62 in the current implementation, but it doesn't make much sense unless you are part of a high risk group, like single, unmarried men (statistically slices six years of your life). If a currently retiring person continues to work after retirement age, the benefit increases until age 70, after which it's a wash.

There's a worksheet for figuring your actual benefit on the Social Security site.

Just don't count on collecting it:-)

Somebody famous once said, "Big government grows biggly." Alright, maybe it was me, but the principle is a sound one. The Social Security system was initially proposed as the centerpiece system for ensuring Americans a regular check in retirement. It was never a savings scheme, it's actually an insurance program where the premiums paid by current workers pay the benefits of retired workers. Thanks to people living longer, the program would have gone broke sooner or later in any case, but it's been hastened along by an expansion of benefits beyond retirees. You can argue whichever side you like as to whether or not some of the non-retirees receiving benefits should be getting supported by direct government expenditure, but including people who have never worked in a retirement system was a bit of a stretch.

In the year 2001, the government paid out a little over 1.1 trillion dollars in direct benefits to individuals. That comes to around $4,000 per citizen, but of course, most of us aren't getting any of the money. A little under half the amount ($450 billion) went to retirement and varied disability payments, and a slightly greater amount ($476 billion) went to direct medical payments. Income maintenance benefits (a combination of Supplemental Social Security, Family Assistance, Food Stamps and grab bag of other needy programs) accounted for $111 billion and unemployment benefits came in at a mere $32 billion. Veterans benefits were second to last on the big ticket list at $26.5 billion and Federal Education and Training came last at $13 billion. All other little pork barrel boondoggles together came to just $3 billion. 2001 was in fact a milestone year, the first time medical benefits outstripped retirement and disability.

Some Americans are saving for retirement outside the Social Security system, though fewer than you might think. A little less than half of American households have an IRA of any type, in 2002, around 33 million had a traditional IRA, 12 million had Roth IRA's and under 8 million had the self-employed styles, (SEP, SAR-SEP or Simple). There are over 300,000 401K plans out there, but they probably represent less than 40 million participants (not counting single participant plans).

To give a broad sweep of the benefits for the really needy, about 5% of American households received food stamps in 2000, down from a high of around 8% just a few years before. About 4.5% of households lived in public housing, up from 3.4% two decades earlier. 13.5% of American received Medicaid assistance in 2000. Over 18 million Americans are considered "work disabled" by the U.S. Census Bureau, with 3.5 million of those under age 34. Just under a third of work disabled Americans get Social Security benefits, two thirds are covered by Medicare, one in six receives Food Stamps and one in ten reside in public or subsidized housing.

On the bright side, over 88% of American households surveyed in the year 2000 contributed to charity. The leading recipient was religious institutions, garnishing contributions from over 60% of giving households. Health oriented charities were next (they have excellent fundraisers) at 38% of giving households, followed by Human Services, Youth Development and Education. We won't give the whole list here, but Adult Recreation came in last, I didn't even know it was a charity.

The Modern Version of the Subsistence Farming

Back around the time of the revolution, the republican ideal of citizenship (that's republican as in "republic," not the political party) was a man owning and working a farm. Ownership, in those days, extended not only to the land and the animals, but human beings as well, most notably, members of one's own family. A man's wife and his minor children were thought of as his property and were an invaluable part of the workforce. Women's sufferance and child labor laws have put pretty strict limits on the modern application of that economic model, but the ideal that a citizen should be his own master lives on amongst the self-employed.

The number of sole proprietorships filing taxes in the U.S. reported by the IRS has been growing steadily over the past decade, at a rate of a few hundred thousand new businesses a year. At the end of the 2000 tax year, there were almost 18 million sole proprietorships in the U.S., just over 5 million corporations (many of them S-corps, or family corporations) and around 2 million partnerships. The total reported income of the sole proprietorships  was just over 1 trillion dollars, compared to over 2 trillion for the partnerships and almost 20 trillion for the corporations.

The growth of corporate income over the decade was almost double that of the growth of sole proprietorship income. Net income (profits) tell a different story, with sole proprietorships reporting approximately 20% of their gross proceeds as profits, while corporations reported around 5% of their receipts as profits. One suspects that corporations have much better tax attorneys than small entrepreneurs.  Partnerships fell in the middle, reporting around 12% of their sales as net profit, but it's more interesting to look all the way back to the 80's when partnerships (in total) sometimes averaged out to a loss for the year. Can you say loopholes, tax shelters, and out-and-out fraud?

It's also interesting to look at the average size of the take from IRS statistics. In the year 2000, over 10 million non-farm sole proprietorships (2/3 of the total) had gross receipts less than $25,000. The average net income for all sole proprietorships was a hair over $12,000 dollars that year, not much of a living for those doing it full time. The number of sole proprietors earning more money trails off steadily with each increased bracket, and only 57,000 earned over 1 million dollars. Well over half of corporations filing taxes earned over 100,000 dollars in the year 2000, and nearly a million corporations earned over 1 million dollars. Almost a quarter of corporations, however, came in at the low end, reporting under $25,000 in profits. The average corporation reported $184,000 in net profits, so you can see how much the low end drags down the curve:-) The average partnership reported $116,000 in profits.

Staying with sole proprietorships (which reflect the greatest number of self-employed), the greatest number of returns filed were for "Professional, scientific and technical services," at nearly 2.5 million businesses, with "Retail trade" following just a hundred thousand behind. The next in line, right around 2.25 million businesses was "Construction," with nearly three quarters of these filing as "Special trade contractors." Other categories with over 1 million filings were, "Health care and social assistance," at just under 1.6 million businesses, "Administrative support and waste management and remediation systems," at 1.5 million (don't ask how they got lumped together in a category). "Arts, entertainment and recreation," filings were nearly identical with "Personal and laundry services," at about 1.075 million businesses each. Makes you wonder if each of those entertainers employs a personal assistant to do laundry. The funny thing is that the personal services filers actually out-earned the entertainment filers by over 40%. That agrees with the old truism that the boarding houses, grocers and laundries made all the money during the gold rush, not the miners.

If you've ever wondered what other businesses do when they fill out their Schedule C deductions, the following data published by the IRS should fill in the gaps. In the year 2000, sole proprietorships reported just over 1 trillion dollars in gross income. The leading deduction, at $387 billion (cumulative) was "Cost of Goods Sold/Operations", of which the three highest components were "Purchases," at around $269 billion "Materials and Supplies" at $43 billion, and Labor costs", about $29 billion. The next biggest deductions were "Salaries and wages," at almost $63.5 billion, "Car and truck," expenses at just over $45.7 billion and "Rent paid," and "Depreciation," nearly tying at $33 billion and $32 billion respectively. "Utilities," clocked in at $19.4 billion, "Taxes paid," just missed $14billion and "Insurance," followed at $13.6 billion. "Repairs," came in just under $12.3 billion, "Interest paid," came in at $12.2 billion, and "Commissions," a surprising (to me) $11.6 billion. The lowest three deduction categories were "Office Expenses" at 10.5 billion, "Advertising," at $10.1 billion and "Pension and Profit sharing plans," came in last at less than $900 million.

Just for fun (groan) I figured out what percentage each listed business deduction on Schedule C amounted to, though the total doesn't add up to 100% due to unlisted items. And we have:

Schedule C year 2000 Items	Percentage of total deductions
Purchases (Cost of Goods)	33.3%
Labor Cost (Cost of Goods)	3.6%
Materials & Supplies (C.O.G)	5.3%
Advertising	1.3%
Car and Truck Expenses	5.7%
Commissions	1.4%
Depreciation	4.0%
Pension and Profit Sharing	0.1%
Insurance	1.7%
Interest Paid	1.5%
Office Expenses	1.3%
Rent Paid	4.1%
Repairs	1.5%
Salaries and Wages	7.9%
Supplies	2.7%
Taxes Paid	1.7%
Utilities	2.4%

One of the most obvious facts to fall out of this data is that most sole proprietorships are in fact self-employed entrepreneurs with no payroll. Otherwise, the salaries and wages would have come in at higher than 7.9% of total expenses, but I suppose this was also obvious from the average gross income of these businesses being just $57,000, and average net income at $12,000. Clearly most of these businesses are involved in selling something material rather than pure services, as shown by 48% of deductions being for goods purchased, so there just can't be much left for paying employees.

One of the greatest challenges the entrepreneur faces is if and when to transition from pure self-employment to taking on a hired hand or two. The ability to hire contract workers (1099's) for specific jobs as defined by the IRS gives the entrepreneur the option to remain self-employed while accessing skills and manpower that would otherwise be unavailable without hiring employees and taking on all of the burdens of tax reporting and other social contract responsibilities.

I haven't received a W-2 (Employee Compensation) since 1992, and for sixteen years now I've been subsistence farming without a farm (though I've often thought about buying one). My goal was always to be manufacturing, rather than service, though service paid the bills in the early days. The problem with doing service work as a self-employed entrepreneur is that you are selling your time. The only way to grow the business is to sell more time, and while you're on the clock, it's just like being a wage slave. For me, manufacturing meant developing a product, a way to produce it, market it and sell it. I invested some serious time and what little money I had into developing educational CD-ROM's in '94 and learned my most important lesson about self-employment from the failure to complete a product. If you have to take on partners, you aren't self-employed, you're in a partnership. I entered into two content development partnerships that year without any legal agreements and got left holding the bag in both cases - my stupidity.

Waiting for Bernanke Fed Capitulation

One of the big buzz words on the financial circuit these days is "capitulation." It's shorthand for a fantasy where panic selling of equities means that a bottom has been reached and equities will then rise in a new bull market. Of course, capitulation, like many other cherished financial indicators, can only be identified through a rear view mirror. What we end up with is a string of "false" capitulations, where the last one that occurs before markets go back up in a bull run is termed the real one. In other words, capitulation is just another one of those baloney terms that brokers and analysts repeat like a mantra to try to build their own confidence to sell stuff to suckers. Confidence men is what they are.

The capitulation I'm waiting for is when Ben Bernanke and his greek chorus figure out that inflation is bad, and that they are the ones causing it. Currently, Ben and his buddies look at the soaring prices of commodities and kid themselves that their rate policy would be correct, if only the commodities weren't behaving abnormally. And Congress, the least respected institution in the United States, is keeping busy calling in speculators to try to lay the blame for commodity inflation at their door. They should be calling in Bernanke and asking him for his resignation.

Real interest rates below the real inflation rate, about 5 points below the rate perceived by the average American, are like a mugging to people saving money. The phony savings rate measured by the government is a crying shame for anybody with a tear. Like most new Fed chiefs, Bernanke sees his job as propping up confidence on Wall Street, lest the markets fall to fair value. In the meantime, the government is busy redistributing money from the middle class to the middle class, upper class and lower class, under the goofy headline of a stimulus package. Nothing like dropping money out of a post office helicopter to create inflation, as Ben can tell you.

Putting tears aside, I read something funny today in the Wall Street Journal, in an article comparing the investment bank crash to the high tech crash. The reporter mentioned like it was a well known fact that the investment banking business is more important to the economy than the high tech business. Wrong you are. The invest banking business is how a lot of smart folk in NYC and other financial capitals get rich, but in terms of the real economy, they don't add any value. The investment bankers exist to take a skim of the real economy, a skim that was over 30% of the S&P profits just a year or two ago. Banks are important like sewers are important. They fill an important role in the infrastructure and nobody wants to be around when they fail. I vote that we give investment bankers a cushy municipal pay package, they can even join the trash haulers union if they want, and maybe that will tone down their greed that runs capitalism into bubble after bubble after bubble.

But don't take my word for it, listen to her:-) I don't agree with half of it, but I don't agree with half of anything. The point is, I'm hardly the onlint one waiting for the Fed to capitulate.