A plan for Social Security

One of the fundamental problems that ails our Social Security system as it presently stands is its basic lack of definition. As conference after conference dragged by in Washington this summer, I became aware that much of the debate was not really about whether or not we have a “solvent” trust fund (we don’t) or whether privatization of some infinitesimal part of the system would disadvantage the poor (it leaves them significantly better off). The real scrap is simply that, since its inception, nobody has ever really agreed about the purpose for which the program was created.

It became evident to me that while those on the left see Social Security as a social insurance program, those on the right consider it an investment plan. Naturally, the criteria by which one judges the two are as different as the sun and the moon. Compounding the problem is that the program is immensely popular on both sides of the political spectrum. As an investment program, the current generation of retirees is benefiting from a phenomenal rate of return. As an insurance program, Social Security has redistributed a good deal of money from the wealthy to the indigent. While conclusions about its effects on old age poverty are mixed, certainly the Social Security promise is paying out a decent level of benefits.

Now, however, the tenuous compromise that has kept this program alive and kicking is shattering. Republicans are increasingly withdrawing their support from a program that can no longer fulfill its advantageous rates of returns that if left unchanged will certainly engender unpopular tax hikes and benefit cuts.

Democrats desperately want to keep the social insurance program intact, despite the fiscal realities of a system that, after the year 2016 will become an increasing drain on the U.S. Treasury if nothing is done in the meantime. Democrats understand that tax hikes will be bitterly contested and hence will be faced with the unenviable choice of having to either cut benefits or cut the budgets of other government initiatives. Partial privatization may be one solution, but perhaps there is another.

Republicans are concerned about the very poor rates of return of Social Security. Indeed, the rates cannot exceed the 2.5 percent that typical U.S. treasury bonds pay out. The way the program was front-loaded for those who retired early in its existence has caused a debt to be placed on future generations, perhaps hoping that economic growth would make this burden easier to bear. What is true is that those retiring now and into the foreseeable future will be getting on average returns on their taxes of much less than 2.5 percent. For current Williams College students, these returns are basically negative. Why, should we be forced into this plan when we could be investing in private stocks and bonds and securing ourselves a much better rate of return, thus ensuring ourselves even more comfortable twilight years?

Democrats are primarily worried about the financial security of the poor, whose natural savings rate isn’t very high to start with. Adding the promise of Social Security benefits, their average savings rate is zero or negative. Clearly it is necessary that they be made to save and, if possible, that some of their higher sensitivity to this lost income be made up by a progressive restructuring of the system, either in the tax collection process or in the benefits structure.

It is not impossible that a heretofore unforeseen deal may be struck that would satisfy in part both desires. One could imagine a plan that simply separates both parts of the system. It is clear that the current system is a horrible investment deal and a bizarre social insurance program. It’s a bizarre insurance program because everyone can collect, no matter what his or her income or wealth. Millionaires are entitled to their checks as well. Imagine unemployment insurance that doles out checks to non-working millionaires.

Means testing social security benefits might be one way of cutting the costs of reform (partial privatization or not). Everybody understands why Social Security is a bad investment. Simple calculations reveal that a couple earning $30,000 a year could retire millionaires if they simply invested 12 percent of their income for 40 years at an average market rate of return of seven percent. Not only that, but in the case of the premature death of the couple, the children would be entitled to the full amount of their parents’ savings (for college, to start a business. . .) and not some paltry survivor’s benefits up to age 18 (just to stay alive).

What could be done on the one hand institute a means tested welfare benefit for the indigent among the aged paid for by whatever tax necessary. This would ensure that no elderly Americans are left on the street. On the other hand, in order to counteract the perverse disincentives to save of such a scheme (already present in the current system), a relatively cheap program could be instated that would offer investment advice and perhaps targeted incentives for the working poor to save and thereby participate in the fantastic wealth creating possibilities of the market economy. One could imagine local investment cooperatives, union funds, etc. The point is to enable everyone to participate in the wealth creation process, and not leave the poorest among us dependent on political promises for their survival.

Such a system design neither abdicates government responsibility for the welfare of our elderly, nor traps millions of Americans into a singularly bad investment plan. Instead, more Americans will have to take time as their grandparents did to save for their retirement and start early. Since the government was responsible for the original substitution of private savings with public savings, one could easily imagine the institution of more or less temporary programs to help ordinary Americans rediscover the art of saving and investing. Americans have one of the lowest private savings rates in the world.

We will very likely pay for this in the long run if our rate of capital accumulation (the primary reason for economic growth) lags any further behind the rest of the world (currently foreign investment makes up some of the difference).

While this design would suffer from the same problems as all welfare programs, it is a much lesser evil than to effectively crowd out trillions of dollars in private savings that in the long run will increase growth and GDP many times more than the “public savings” of the Social Security Trust Fund. Economic reality has hit and the consensus behind Social Security has splintered. It’s now time to look beyond Social Security and into designing a system that helps create real inheritable wealth for everyone and doesn’t leave people dependent on handouts unless it’s absolutely necessary.