Are Social Security Benefits a Form of Socialism?

Socialism is a loaded word in the United States—a country where capitalism is the prevailing economic system and is the basis for the system of government. One situation in which the word tends to come up is when Americans look at government programs, especially Social Security. To understand what the debate is about, let’s first review some terms.

Socialism as Government-Based Economic Production

Socialism is a form of economic production whereby workers co-own and co-produce goods and services and share in the profits. But the definition has recently been conflated with statist forms of government. Under this definition, the government owns and controls major industries, while the economy is centrally planned. As such, the government provides the majority of goods and services for its citizens.

Contrast this with capitalism, where businesses and private individuals own the tools and other means of production. They keep all the profits while paying workers a wage. As such, the market controls the economy.

In most modern countries, a free or market-run economy is subject to federal and state legislation and regulations, and so these countries do not practice pure, laissez-faire capitalism. Some countries, such as Norway and Sweden, have mixed systems wherein providers of goods and services enjoy private ownership of resources, while citizens benefit from social-needs–oriented public services. This is known as social democracy or democratic socialism.

Though the U.S. is clearly a capitalist country, the government plays a role in economic and financial affairs. One of the hallmarks of its federal system is Social Security, a government-run benefits program instituted in 1935 during the Great Depression. Let’s examine the key components of Social Security benefits—specifically, the extent to which they might be considered a form of socialism. 

Who Runs the Social Security System?

The U.S. government runs the Social Security system—not individuals or businesses. It tracks earnings and benefits, runs the website that lets people check their benefits records, approves or denies retirement benefit applications, collects Social Security taxes, and distributes retirement, disability, and other benefits.

While the government hires independent contractors, such as Lockheed Martin, IBM, Dell, and others, to provide telecommunications, data storage, and other services, the government is in full control of Social Security.

Who Decides How Much To Contribute and When?

The U.S. Congress decides how much of your paycheck is taxed in order to contribute to the Social Security fund. Here's how it works for 2022:

• A total of 6.2% of your gross pay goes to Social Security, and your employer typically kicks in an equal amount.
• If you earn more than $147,000 in 2022 ($160,200 in 2023), you don’t have to pay Social Security taxes on any additional earnings above that amount.
• If you’re self-employed, you pay the whole 12.4%, though that amount is reduced slightly when you take a tax deduction for the employer portion of that tax.

It’s not unreasonable to consider whether, even if you work for someone else, you’re effectively paying the whole 12.4%—“bearing the incidence of the tax” because if your employer didn’t have to make Social Security payments on your behalf, it could instead include that money in your paycheck.

The government also decides when you contribute. If you’re an employee, the taxes are taken out of each paycheck. If you’re self-employed, you generally pay a quarterly estimated tax and reconcile your tax payments when you file your annual return.

Social Security vs. Private Retirement Accounts

Individuals with private retirement savings accounts have more control over how much and when to contribute than they do with paying Social Security taxes. For example, if you work for a company that offers a 401(k) plan, you can decide what percentage of each paycheck (if any) to redirect to that account—although government regulations place restrictions on how much you can contribute.

The annual limit on 401(k) contributions is $20,500 in 2022. This amount increases to $27,000 if you are 50 or older, thanks to the $6,500 catch-up contribution allowed by the government. You cannot contribute to a Roth IRA if your adjusted gross income (AGI) is $144,000 or higher for singles and $214,000 or higher for married couples filing jointly.

Who Decides What To Pay Out and When?

With a private retirement account, such as a 401(k) or Roth IRA, you decide when to withdraw money from your account, and how much to take out. With some retirement accounts, the Internal Revenue Service (IRS) will make you pay penalties if you take out money before you reach a certain age or don’t withdraw enough money each year after reaching a certain age. Still, there’s much more flexibility here than with Social Security retirement benefits.

With Social Security, the government decides how much to give you and when. You can decide when to start receiving benefits, but it can't be until age 62 (where you collect the lowest benefit) and age 70 (where you collect the highest benefit).

Once you start claiming benefits, you’ll get a check for the same amount every month, based on your lifetime earnings and your age when you started claiming benefits. You can’t decide to withdraw more money in months when you have higher expenses and less money in months when you have lower expenses, as you could with an IRA or 401(k).

If you find yourself terminally ill at 40, you can’t claim retirement benefits early based on what you contributed over the years. Keep in mind that you may qualify for Social Security disability insurance.

But you can cash out your private retirement accounts at any time without getting anyone’s approval, albeit with a penalty in some cases. Brokerage firms won't make you prove that you can’t work if you want to take an early withdrawal from your traditional IRA (though the IRS might if you want to avoid penalties by claiming a withdrawal for a medically-related hardship).

Can You Opt Out of Social Security?

Few taxpayers can opt out of paying into the Social Security system. The Amish, Mennonites, and other religious groups that conscientiously object can sometimes claim a religious exemption from paying into the system as long as they also don’t receive or even qualify to receive any benefits. If you received any benefits, you may still qualify for a religious exemption if you repay them.

People who renounce their U.S. citizenship may be able to opt out, depending on their circumstances. Some nonresident aliens don’t have to pay into the system, depending on which type of visa they have. Foreign government employees based in the United States and college students who are employed by their university are also exempt.

What about opting in? Under a public retirement system or a Section 218 agreement, some state and local government employees are covered while not paying into Social Security. These employees aren’t allowed to opt into the program.

With private retirement savings accounts, it’s totally up to you whether to contribute. Even if your employer automatically enrolls you in its 401(k) plan in an attempt to nudge you into contributing, you can opt out if you wish.

How Are Social Security Funds Managed?

The Social Security system is set up as an intergenerational wealth transfer, which means that all contributions go into one collective pot, so the funds aren’t held in our individual names. The Social Security taxes the government collects from current workers pay for the benefits of current retirees.

Depending on when you retire, how much you earned, and your marital status, you may see a better or worse return in terms of getting back more or less than you contributed.

The Threat of Depletion

Because different generations are different in size, this structure leads to what could be described as timing problems with paying out benefits. Taxes from the immense baby boomer generation comfortably supported the retirement of the relatively small Silent Generation (born between 1925 and 1945, many of those years scarred by the Great Depression and war) and the greatest generation (whose members fought in World War II).

With more and more boomers reaching retirement—and the fact that Generation X, the next generation, is smaller—it is estimated that Social Security’s reserves, also called the Old-Age and Survivors Insurance (OASI) Trust Fund, could be depleted by 2034.

According to the 2022 annual report from the Trustees of the Social Security and Medicare Trust Funds, the estimated depletion date is 2034. Also, the report cited that the taxes being paid into Social Security beyond 2034 will only cover 77% of the scheduled benefits.

Millennials make up an even larger generation than the boomers, but it’s not clear how well their financial contributions will serve to support boomers and Generation X, and how large future generations will be.

The Bottom Line

It’s interesting to note that the U.S. got the idea for a social security system from 19th-century Germany. That very capitalist monarchy launched an old-age social insurance program in 1889 at the behest of Chancellor Otto von Bismarck, partly to stave off radical socialist ideas being floated at the time. The original social security was actually an anti-socialist maneuver by a conservative government.

Nevertheless, because the American government plays such a dominant role in the U.S. Social Security system—deciding how much and when employees and employers pay into the system, how much individuals receive in benefits when they get them, and preventing almost everyone from opting out—it only seems fair to say that Social Security is, in effect, a form of democratic socialism; however, it may also be considered a form of social insurance or a social safety net.

The program requires workers and their employers, along with self-employed individuals, to pay into the system throughout their working years. The government controls the money they contribute and decides when and how much they get back after—and if—they reach retirement age. Having such a successful and beloved socialist-like program at the heart of such a committed capitalistic society is perhaps the ultimate paradox. Or maybe it’s just good common sense.