It seems that just about every politician has an ambitious plan to “save” Social Security. Indeed, the program initiated by President Franklin Roosevelt and expanded in the Johnson administration as a part of the Great Society is in very bad shape. The Social Security subcommittee of the House Ways and Means Committee held a hearing this week on the burdens of an aging society. Among the witnesses was Vincent J. Truglia of Moody’s Investor Services, who said that most world governments including the United States’, would default on their current pension promises. In addition to being insolvent, the program does nothing to alleviate poverty among the elderly, provides inadequate retirement for a great majority of Americans, and is especially unfair to minorities and the poor. Instead of “saving” this public policy aberration, we should focus on providing a quality retirement system that will provide the retirement hard working Americans deserve.
I make no claim to originality in advocating a proposal most closely associated with the Cato Institute but also advocated by the American Enterprise Institute, the Mercatus Center and other market liberal think tanks in Washington DC. The motivation to come up with a different approach to retirement insurance lies in the many flaws of the current system. By 2015, the program will begin to run a deficit. That is, it will start paying out more funds than it receives. Benefits will either have to be cut or the payroll tax raised to cover a gap, which at current demographic trends is set to continue widening for the foreseeable future. The thought of fewer and fewer working adults sacrificing more and more of their income to finance the retirement of a larger and larger class of retirees (who incidentally vote in large numbers) is a sad one for anyone who values independence, freedom and self sufficiency.
Another major problem is that benefits are not inheritable. A Supreme Court decision declared that the Social Security tax and the Social Security program were two very different things. This means that you are paying a tax against a promise that when you retire politicians in the future will be generous enough to let you have a decent standard of living. Feel good yet? You could be paying all your life and die before you ever see even a fraction of the money you paid in. This is unfair in more ways than one. If you are poor, your life expectancy is much shorter than if you are rich and when you die your (presumably disadvantaged) children get nothing. Furthermore, Social Security benefits are a much higher proportion of income for the elderly poor (almost 100 percent for those at the poverty line) than the rich. This is because the wealthy have much more disposable income that they can invest on the side during their working years. The consequence of this (even if you factor in the progressiveness of the system) is social stratification. At Williams most of us stand to inherit our parents’ investment assets, those who are not so fortunate get nothing because their parents’ social security benefits are not inheritable. Notice that many of the poor are Black and Hispanic and that hence this system works to widen the racial socioeconomic divide. In not so many words, you could say it’s racist.
The next problem is that Social Security as a form of retirement insurance is a very bad deal for everyone. Average rates of return have been steadily declining. If you were born in 1940, your expected rate of return according to the Social Security Administration, Office of Research and Statistics, is three percent. The rate goes down to around two percent for those born in 1960, and is predicted to be less than one percent for those born today. Many private institutes feel that the rate of return could very well be negative in the United States for our generation, as is the case in most European countries.
Compare this to any other forms of investment you could possibly imagine, and Social Security would lose out. Since 1926, the stock market has compiled an average rate of return of 7.7 percent a year despite the 1929 crash, a World War, the Cold War and several oil shocks…(Gokhale and Kotlikoff, “Social Security’s Treatment of Postwar Americans,” p. 15.) In fact there’s never been a twenty-year period this century where Social Security has outperformed the stock market (And most people spend 30 to 40 working years investing in their retirement). In fact you could say that your being forced to pay into Social Security costs you dearly compared to other alternative investments, even the most conservative, like bonds. Michael Tanner of the Cato Institute estimates that a single-earner couple, whose wage earner is 30 years old in 2000 and earning $24,000 per year, can expect to pay more than $134,000 in Social Security taxes over their lifetimes and receive $292,320 in lifetime Social Security benefits (including spousal benefits), assuming that both husband and wife live to normally expected ages. Had they been able to invest privately in index funds (a mutual fund that tracks all stocks in a given stock market) their return would have been $875,280.
The solution becomes obvious. Let people create private retirement investment accounts with their payroll tax. The system doesn’t have to be unregulated (to satisfy the risk averse), you could let people choose between different government chosen portfolios of managed risk (stocks, corporate bonds, government bonds). One significant problem remains however, and that is the transition. We’ve promised people who have been paying the tax for years that they would get a secure retirement. The phasing out of Social Security therefore must be gradual and cautious to make sure than no senior citizen will be left behind. And to your dismay perhaps, there is only one candidate this fall who has smart enough advisors to propose the privatization of two percent of your 12.5 percent Social Security tax, and that’s George W. Bush.