Hi KLP,
I have spent a couple of hours trying to find the other article in the link that I posted. You are correct that it expired, but I found it at another link and here it is
below: Please share this article with whomever you think
might be interested. Thank you!
Warm Regards,
Shawn
Saving Your Retirement
by Ralph R. Reiland
My 20-year-old students will be just turning 34 when, according to official projections by the Board of Trustees of the Social Security Trust Funds, yearly Social Security payouts will begin to exceed annual payroll contributions. And by 2030, when these students are still nearly two decades short of retirement, the so-called Social Security trust fund, currently over half a trillion dollars on paper, is projected by the government’s own actuaries to go belly-up.
Among these students, there is now a near-complete lack of faith that Social Security will ever pay them a dime. They are not, unfortunately, without professional backing in their cynicism. "Under today’s terms," contends the Princeton Economic Institute, "if you are under 55 you have a greater chance of being abducted by aliens than ever seeing your first Social Security check."
Collapsing Pyramid
What is underlying Social Security’s fundamental flaw is a demographic time bomb. In 1950, the ratio of U.S. workers to retirees was 20 to 1. Today, that ratio has dwindled to 3 to 1. By 2030, it is likely to be 2 to 1. "What you put into the system to provide for your own retirement is not money but kids, but baby boomers have chosen to produce only half as many children as their parents did," says Karl Zinsmeister, editor of The American Enterprise magazine. "As in any pyramid financing scheme, early investors are paid off with cash taken in from later investors," explains Karl Borden, professor of financial economics at the University of Nebraska. "The system collapses when the demands of increasing numbers of expectant recipients confront the limited resources of decreasing numbers of new participants."
Over the long haul, given the demographics, Social Security has simply become an increasingly bad deal with each passing generation. For those retiring in 1942, the average annual rate of return on Social Security taxes, adjusted for inflation, was 36 percent. Even for those retiring in 1980, total forecasted benefits exceed total payroll contributions, including interest, by over 400 percent.
In contrast, American workers born in 1950 can anticipate total retirement benefits that will, at best estimates, represent only a two percent rate of return on their payroll taxes. For teenagers now entering the workforce, Arthur P. Hall of the Tax Foundation projects returns of minus two percent — i.e., less than they put in.
But these forecasts of plunging benefits may be unduly optimistic since they assume the government IOUs in the Social Security trust fund will be fully paid. In fact, the trust fund is nothing more than an accounting artifice — more "trust" than "fund." As it is now set up, the "surplus" in payroll taxes being paid into Social Security each year ("contributions" in excess of benefit payouts — an average of $54 billion per year since 1988, and roughly $100 billion last year) is being immediately spent by the politicians rather than saved and invested for tomorrow’s pensioners.
‘‘There is no Social Security trust fund," explains Investor’s Business Daily. "It’s a myth. Those extra taxes are spent through the general budget the day they are received; the Treasury just puts an IOU in the ‘trust fund.’" In effect, federal politicians have drained the trust fund to meet current operating expenses and replaced the money with nonmarketable government bonds. "The excess money paid into Social Security is just more money for politicians to play around with," says economist Thomas Sowell of the Hoover Institute, "used for everything from congressional junkets and other federal boondoggles to make the national debt look smaller on paper."
Senator Daniel Patrick Moynihan (D-NY), maintaining that trust fund surpluses have simply allowed Congress to spend more than it otherwise would, declared in 1990 that Social Security trust fund accounting is a form of "thievery."
Added Trillions in Debt
This shell game, while providing a crafty way for politicians to buy votes and gather campaign cash through higher government spending, has left the Social Security trust fund with no real assets to meet future obligations. "If the federal government was required to show its current unfunded Social Security and Medicare liability, the national debt would be $17 trillion, rather than $5 trillion," explains Mark Weinberger, former Chief of Staff for the Bipartisan Commission on Entitlement and Tax Reform. These unfunded liabilities — money that should have been saved, but wasn’t — are the equivalent of $120,000 in debt for every household in America.
The coming annual cash shortfalls between Social Security outlays and revenues — the result of fewer births, longer life spans, and the upcoming retirement bulge of America’s baby-boomers — is expected to reach $90 billion a year by 2015, jump to $500 billion annually by 2025, and to $1 trillion a year by 2035. In 2075, the last year for which the Social Security Administration provides estimates, the annual cash shortfall reaches an overwhelming $7.5 trillion. Even adjusting for inflation, the projected yearly Social Security deficits remain immense, reaching $200 billion annually in 2025 in today’s dollars and $400 billion a year by 2056.
The "present value" of these unfunded liabilities, a measure of how much money would need to be invested today to finance future benefits, reports Daniel J. Mitchell, a Senior Fellow in Political Economy at the Heritage Foundation, is $5.2 trillion. "Collecting that much money today," says Mitchell, "would require imposing tax rates of more than 100 percent on everyone in the country."
When President Franklin Roosevelt set up Social Security during the Depression, he wanted workers’ paychecks to show separate tax deductions for retirement. "With those taxes on there," he said, "no damn politician can ever scrap my Social Security program." Clearly, FDR underestimated the cleverness of today’s politicians. Instead of scrapping the program, they’ve simply stripped it of its sustenance.
Today, after over six decades of rising Social Security taxation, American workers are faced with the fact that there is simply no money in any retirement account for any of them, nothing earning interest or growing with the market until they retire. Instead, they have been handed a pile of IOUs with no guarantee that they’ll ever be replaced with real money. In 1960, the Supreme Court ruled in Fleming v. Nestor that workers have no guarantees or property rights within the Social Security system, no legal claim to either their accrued contributions or their anticipated benefits. Today’s workers, in short, will retire with only a political claim on the income of future generations.
"Perhaps the biggest misrepresentation is that the Social Security trust funds represent actual resources to be used for future benefit payments," stated the Congressional Research Service in its January 1991 report to Congress, "rather than what is in reality a promise by the government to take steps necessary to secure resources from the economy at that time."
Coming Crunch
The crunch will hit when today’s boomers start retiring in droves in 10 to 15 years. In order to obtain the revenues needed to pay escalating benefits and with retirement payouts outstripping payroll taxes, the Social Security trust fund will start turning in its IOU bonds to the federal government. At that point, with the federal government having no money to pay off the bonds, Social Security will be hovering on the brink of a financial abyss and the politicians will have only a limited number of ways to overhaul the system’s insolvency — raise taxes, cut retirement benefits, or slash non-Social Security programs.
Regarding the third option, the Bipartisan Commission on Entitlement and Tax Reform estimates that unreformed federal entitlement spending, primarily Social Security and Medicare, will consume 100 percent of federal revenues within 30 years, leaving no tax revenue for other programs.
In past years, when faced with less massive Social Security shortfalls, the federal government has simply raised taxes. In the past four decades, payroll taxes for Social Security were increased 17 times, producing a real (adjusted for inflation) rise in the maximum payroll tax of nearly 900 percent. In 1995, with federal, state, and local taxes taking a record percentage of family income, the Social Security trustees’ "intermediate cost" and "high cost" projections forecasted increases in payroll taxes of 50 to 80 percent, respectively, over the next 35 years.
"Bringing the Social Security system into balance today would require imposing a 54 percent increase in payroll taxes, reducing benefits by 33 percent, or using a combination of both," estimates Daniel J. Mitchell of the Heritage Foundation. "These drastic measures are the transition cost of maintaining the current system and workers. Younger workers already face real rates of return that are barely above zero; in some cases they face negative returns. Forcing them to pay more and get less hardly represents good public policy."
Former Colorado Governor Richard Lamm concurs, stating: "Despite the fact that our kids are paying so much more into Social Security than we did, they stand to get back less — much less — than we did. What’s worse, our grandchildren stand to pay even more and get back even less than our children will. There’s no end in sight to this cascading pattern of generational inequity. The farther we project into the future, the more inequitable the system looks. The truest measure of our compassion as a society is whether our children will be freer and more prosperous than we are. Today, anyone who says that high taxes haven’t undermined the incomes of our young, or their ability to take care of their own children, is living in a fantasy world."
The current financing structure of Social Security "robs young workers in America of their right to save and invest for their futures," says Stephan Moore, director of Fiscal Policy Studies at the Cato Institute. Put simply, Moore contends that the system is "generationally immoral."
An article in the August/September 1998 issue of Futurist magazine, by professors Richard McKensie of the University of California and Dwight Lee of the University of Georgia, shows how a 22-year-old making a one-time $2,000 investment in the stock market, based on a ten percent compounded rate of return (the market’s appreciation over the past five decades), would see his $2,000 grow to $194,000 by age 70. Investing $2,000 a year, he would see his wealth surge to over $2.l million by retirement age.
Sam Beard, chairman of the National Development Council, lays out an alternative to Social Security for a 20-year-old who is earning $10,000 a year:
You and your employer are paying $l,240 a year in Social Security taxes. That’s 12.4 percent of your hard-earned income for benefits that you will never see. Suppose instead you could invest that same $l,240, as well as an additional $2.50 a week. By the time you are 65, thanks to the magic of compound interest, you would be a millionaire. You would be assured of a comfortable retirement. Assuming a long-range return on your investment of 8 percent a year, $30 a week in savings turns into a portfolio of $29,000 in 19 years, $110,000 in 20 years, $318,000 in 30 years, $822,000 in 40 years, and in 45 years, the normal working lifetime, $1.3 million.* After 50 years, if you work until age 70, the value of your portfolio crescendos to an estimated $2 million.
* Adjusted for a 4 percent annual inflation rate, that $1.3 million would be equal to about $230,000 in today's dollars.
Push for Privatization
"Ironically, Social Security was originally set up because people trusted the government more than financial markets," says Neil Howe of the National Taxpayers Union Foundation. "Today, most Americans under 50 feel just the opposite." In April 1998, for instance, 80 percent of Americans in an Associated Press poll agreed that workers should be allowed to shift some of their payroll taxes into private accounts. Among adults under age 34, support increases to 90 percent. Overall, support for the privatization of retirement funds was expressed by majorities in every sub-group — Democrats, Republicans, young people, and seniors. In contrast, 75 percent of the respondents opposed raising payroll taxes or prolonging the retirement age.
With this widespread support for fundamental reform in Social Security now apparent, politicians and public policy specialists are increasingly advocating individual retirement accounts, funded by existing payroll taxes. Although the plans now being considered would not constitute a total transition to the free market, since workers would be making choices within the framework of the new system, it would still be a huge step in that direction and would be a vast improvement over the present system.
Under a plan proposed by Congressman Mark Sanford (R-SC), for example, current workers would be allowed to invest eight percentage points of the 12.4 percent payroll tax in individual accounts. In the Senate, Budget Committee Chairman Pete Domenici (R-NM) has developed a plan that would permit workers to put three percentage points of their payroll taxes into investment accounts that turn into annuities at retirement.
The bottom line? "Assuming historical rates of return, if individuals born in 1970 were allowed to invest in stocks the amount they currently pay in Social Security taxes, they could receive nearly six times the benefits that they are scheduled to receive under Social Security," says William G. Shipman, principal with State Street Global Advisers in Boston. "Even a low-wage earner would receive nearly three times the return expected from Social Security."
Clearly, raising the rate of return on Social Security taxes has special significance for low-wage earners who expect to have no retirement income except Social Security. For these workers at the bottom end of the pay scale, David R. Henderson, professor of economics at the Naval Postgraduate School in Monterey, California, compared the economic payoff from Social Security with a privatized account earning seven percent a year. Someone retiring last year after working his entire life at minimum wage, Henderson says, would have been better off by $100,000 without Social Security.
Today, the poorest fifth of past wage earners in the U.S. rely on Social Security for 81 percent of their retirement income. In contrast, the richest fifth of past wage earners rely on Social Security for only 20 percent of their retirement income. Given that dissimilarity, it is America’s poorest families who stand to benefit the most in terms of changes in their standard of living during retirement by a privatized system that delivers greater returns to payroll taxes. A recent Cato Institute study projected that a typical low-wage worker born in 1950 would receive a monthly retirement check of $2,490 if his payroll taxes were invested in the stock market, compared to $631 from Social Security, a difference of $22,308 per year. The economic facts, in short, dispute the popular belief that it is low-income workers (those who, on average, start work earlier, have shorter life expectancies, and have fewer years to collect Social Security) who are expressly helped by the current system.
Race Issue
"Black men get the worst deal of all," reports Investor’s Business Daily. "The average life expectancy of a black man is projected to be 64.8 years in 2000, down from 65.4 years in 1995. The current retirement age of 65 means black men on average can expect to see little or none of the money they paid into the system."
Economist William Beach concludes that "a low-income African-American male age 38 or younger is likely to pay more into Social Security than he can ever expect to receive in benefits after taxes and inflation." Beach estimates that for the average black male, "staying in the current system will likely cost him $160,000 in lifetime income."
For American males who reach age 65 (fewer black men, proportionately, than white men), the U.S. Department of Health and Human Services reports that blacks live an average of two years less — 24 Social Security payments — than whites. Similarly, the National Center for Health Statistics reports that black women born in 1990 have a life expectancy four years shorter than white women. A study by the RAND Corporation, Socioeconomic Differentials in the Returns on Social Security, found that the lifetime inter-racial income transfer through Social Security from blacks to whites was as much as $10,000 per black worker.
Social Security, says Deroy Murdock, Adjunct Fellow at the Atlas Economic Research Foundation, "essentially transfers money from working black men and women, who die earlier, to older white women, who live the longest." Murdock recommends replacing Social Security with individual pension accounts invested in private capital markets. "Money accumulated in these accounts could be handed down to one’s heirs," he says, "something today’s system forbids." Additionally, on top of allowing black parents to bequeath larger estates to their own children, individually-owned, privately-controlled retirement accounts would supply a huge asset base that could be directly invested in the black community, replacing dependency on government with higher levels of commerce, economic independence, and self-reliance.
Ironically, those who have led the most aggressive campaigns against privatization of Social Security are the key Democratic special interest groups — unions, senior citizen groups, feminist organizations, and black groups, the very organizations that claim to represent the financial interests of America’s least privileged constituencies. Congressman Pete Stark (D-CA), two weeks before the House vote on impeachment, declared, "If Clinton votes to privatize Social Security, I’ll vote to impeach him." On December 3rd, Jesse Jackson, Patricia Ireland of the National Organization of Women, and AFL-CIO head John Sweeney announced their staunch opposition to any kind of Social Security privatization.
Under current government promises, a typical 35-year-old union worker earning $33,000 a year will receive about $1,500 a month from Social Security at age 67. In contrast, a Cato Institute study projects that the same union worker would have accumulated "enough money to purchase annuities paying $2,671 a month at retirement" by investing Social Security taxes in "bonds, a virtually risk-free investment." With a "balanced portfolio," divided equally between stocks and bonds and assuming a four percent rate of return on bonds and seven percent on stocks, that same union worker "could purchase annuities of $5,002 a month." With Social Security taxes invested all in stocks, the $33,000 a year union worker "would be able to purchase annuities paying an astounding $9,575 a month." That is $114,900 per year, compared to current Social Security promises of $18,000 per year. It is a pretty safe bet that AFL-CIO chief Sweeney, rejecting privatized accounts for his own union members, has the bulk of his retirement assets firmly invested in today’s bullish market.
Scare Tactics
At the close of last year, following a sharp drop in the stock market, Solidarity, the magazine of the United Auto Workers, trumpeted a bold "At Risk" across its cover. "The summer decline," declared the UAW, "has been a bracing slap of cold water in the face of the new wave of politicians that see individual stock market investments as the best route to secure, happy retirement for Americans." The National Committee to Preserve Social Security and Medicare weighed in with full-page newspaper ads: "On Monday, the stock market dropped by over 500 points. On Tuesday, millions of Americans received their Social Security checks. Aren’t you glad Social Security hasn’t been privatized?" In fact, by year’s end, the Standard & Poor’s 500 was up by 26.7 percent for 1998, the DOW gained 16.l percent, and the NASDAQ composite soared a startling 39.6 percent — a pretty straight route to a "secure, happy retirement."
Observing these scare tactics each time the market takes a dip, one can only speculate about why these leaders who speak on behalf of millions of Americans are so opposed to giving individuals the freedom to run their own lives, invest their own money, and plan for their own retirements. In fact, the privatization of Social Security taxes into individual retirement accounts would ensure a more even distribution of U.S. wealth, an enduring goal of America’s liberal politicians. Currently, the poorest half of American families own only two percent of the nation’s financial wealth. Harvard economist Martin Feldstein estimates that with Social Security privatization, allowing for the creation of new wealth in workers’ private accounts, the concentration of wealth in America would be reduced by 50 percent.
As a fallback position, seeing the increased prospect for the privatization of retirement funds, President Clinton, Senator Ted Kennedy (D-MA), Congressman Earl Pomeroy (D-ND), and other Democratic politicians have recommended a collective solution, proposing government-directed investment of payroll taxes. Centralized government control, contends Pomeroy, would be less risky than individualized investing and more shielded against political influence. In contrast, months prior to President Clinton’s State of the Union proposal for government-directed investing of a portion of the Social Security surplus in the market, Federal Reserve Chairman Alan Greenspan flashed a caution light to the idea of the government controlling billions of dollars in private investment. That kind of collective investing in the private sector, warned Greenspan, "has far reaching potential dangers for a free American economy and a free American society."
Following the State of the Union speech, Greenspan attacked President Clinton’s Social Security proposal, saying he feared that government investments in the market would fall victim to political manipulation. "I do not believe," he said, despite Administration promises that money would be invested apolitically, "that it is politically feasible to insulate such huge funds from government direction." Additionally, Greenspan warned that the Clinton investment plan would lower the efficiency of capital allocation, reduce productivity growth, and hurt living standards. Citing studies showing that returns on state and local pension funds have been usually two to three percentage points lower on average than comparable private pension funds, Greenspan said he was "fearful that we would use those assets in a way that would create a lower rate of return for Social Security recipients."
Politics as Usual
One need only look to the recent proposal by the Clinton Administration to require private pension funds to invest a portion of their assets in "socially responsible" projects to spot the inherent dangers in putting Washington in charge of investing retirement funds. As the Clinton plan explicitly illustrates, it is foolish to assume that politicians can be consistently relied upon to invest assets with the objective of wealth maximization for fund participants, or consistently be relied upon to resist the temptation to dictate which hoops American companies should jump through in order to qualify for "public" support, in order to be on the receiving end of billions of investment dollars.
"State and local public funds have been used to preserve local jobs or to make moral statements by dumping stock in tobacco companies and, in one case, shares of Walt Disney," notes Wall Street Journal reporter Greg Ip. "Looking at the experience around the world," states World Bank economist Robert Palacios, "we haven’t found any examples of a well-insulated pension-fund investment-management system."
In the long run, the practice of the government massively investing in private securities would allow a gradual government takeover of American businesses as the escalating trust funds assumed an ever-larger ownership share in the private sector. It is a statist’s dream, a clear formula for the merging of state and business leadership. Based on the Clinton Administration’s projection of an investment of $650 billion of Social Security funds in stocks over the next 15 years, the federal government would wind up owning four percent of the stock market by 2014. By comparison, the stock holdings of the nation’s largest single fund manager, Fidelity Investments, represent about three percent of U.S. market value.
The American public seems to recognize the dangers of government-directed investment. White House pollster Mark Penn found that 67 percent of registered voters and 52 percent of Democrats favor personal investment accounts over government-managed investment. Across the world, the victory of the free market paradigm is the top economic story of our age. Applied to retirement, both Chile and Britain provide remarkable illustrations of the superiority of free market performance and privatization. In Britain, a two-tiered system now permits workers to invest a portion of their payroll taxes in private retirement plans. The first tier is state-run, paying a safety-net pension. The second tier allows workers to opt out of the state-run retirement plan and invest their payroll taxes in either personal retirement plans or company-based private pension plans. In personal pension plans, workers may deposit up to 17.5 percent of tax-free earnings. Similarly, in the company-based plans, employees and employers may contribute up to a combined 17.5 percent of tax-free earnings. Company-based pension plans must be voluntary, approved by the government, portable to the plans of other companies or personal plans, and provide guaranteed minimum pensions at least as good as the government plan. In both plans, investment returns, until cashed in, are free of both income taxes and capital gains taxes.
Today, given the choice, more than three-quarters of British workers have chosen to be enrolled in private pension plans, earning an average of 13.3 percent per year on their payroll taxes since 1986. Younger workers in private plans can now expect pensions that are twice that provided by the state-run plan. Further, in a nation faced with the demographic problem of a declining ratio of workers to retirees, British pension reforms have curtailed pressures for benefit cuts and tax hikes by significantly reducing the long-term liabilities of the state pension system.
Miracle in Chile
In Chile, the retirement system was privatized in 1981. At that time, retirees were grandfathered under the old government system and paid out of general revenues instead of payroll taxes, while current workers in the government retirement system were given the option of switching to a new privatized system. Under the private plan, workers are required to contribute ten percent of their annual salaries to private pension accounts. Management of pension funds is left to privately-run investment firms, and the government provides a safety net for those whose pensions at retirement are inadequate. Additionally, another three percent mandatory payroll deduction buys life and disability insurance with private firms, plus workers have the right to contribute an additional ten percent of after-tax wages to their accounts, compounded tax-free.
Today, over 90 percent of Chilean workers have switched out of the government- run system, choosing among 21 competing private mutual funds that invest in stocks and bonds. Since 1981, the real, adjusted-for-inflation, annual rate of return on these private retirement accounts has averaged 13 percent. In the late 1970s, there were virtually no savings in Chile. Today, the cumulative assets in retirement accounts total over 40 percent of the nation’s gross domestic product.
At retirement, Chilean workers may withdraw their accumulations on a phased basis linked to their life expectancy, or use their retirement nest egg to purchase an annuity from a private company that will pay them monthly for the rest of their lives. Prior to retirement age, workers may withdraw from their accounts at any time if they have accumulated more than what is required to fund an annuity paying 70 percent of their final wage. At death, any balances left in a worker’s account can be bequeathed to heirs. Today, the typical retired worker in Chile is receiving a yearly retirement income equal to nearly 80 percent of his average annual wage over the last ten years of his working life. In terms of equity, with rates of return in the new privatized systems much greater than in the old state-run system, it is the poorest in Chile — those who lack capital assets and are most likely to depend exclusively on a basic pension — who have been helped the most by privatization.
"Workers now carry passbooks in their pockets because they are capitalists," says Jose Pinera, Chile’s former Labor Minister and a key architect of Chile’s new privatized system. "We have made a nation of owners." Further, with workers now having a greater stake in what happens in the overall economy, Pinera maintains that tax hikes and ill-conceived regulatory proposals aren’t as likely to succeed because workers simply won’t stand for the drag on their investments. "When workers feel that they own a part of the country, not through party bosses or a Politburo," he says, "they are much more attached to the free market and a free society."
Closer to home, municipal employees in three Texas counties voted in 1981 to opt out of Social Security (before it became illegal in 1983) and invest in a private pension system. In Galveston, by a 78 percent to 22 percent vote, employees elected to join the Alternate Plan. In Brazoria and Matagorda Counties, municipal employees soon followed.
In the Alternate Plan, an employee contributes 6.13 percent of his income and the employer contributes 7.65 percent, with 9.737 percent of that 13.78 percent going into the employee’s individual retirement account, earning 6.5 percent interest, guaranteed by an investment company (the remaining contribution pays for life and disability insurance). Today, with virtually the same payroll costs as Social Security, an employee earning an average of $50,000 per year for 40 years can choose among several annuities at retirement or a lump sum payment of $956,303. With an average salary of $20,000 or $30,000, an employee will receive, respectively, a lump sum of $383,032 or $573,782, or an annuity that pays guaranteed monthly benefits. Under one annuity option, for example, a $20,000 per year worker will receive a monthly retirement check of $2,740, compared to $775 from Social Security. With a $50,000 salary, the annuity’s retirement check jumps to $6,843 per month, compared to $1,300 from Social Security.
"More than l million state and local government employees in the United States have been exempted from Social Security," says Daniel J. Mitchell, McKenna Senior Fellow in Political Economy at the Heritage Foundation, "and are now enjoying higher levels of retirement income through private pension plans." In December 1998, federal lawmakers suggested making the Social Security program mandatory for some five million teachers, state and local government employees, and law enforcement officials around the country who are now exempt. The response? In a letter to President Clinton in December, Robert Scully, executive director of the National Association of Police Organizations, said that "a proposal of mandatory Social Security taxes for public safety officers is one of the greatest and most detrimental attacks on public safety organizations and their respective members." The 40,000-member United Teachers of Los Angeles called the plan "a bailout of the Social Security trust fund on the backs of school teachers and other state and local workers who didn’t create the problem." In Ohio, the heads of five government retirement associations warned of "the anger among millions of working adults and retirees and subsequent political backlash that will likely follow if mandatory coverage is imposed."
"Opportunity Costs"
As for the rest of us, Eugene Steuerle of the Urban Institute has calculated the price of Social Security in terms of "opportunity costs," i.e., the cost of doing A compared to alternative B. Based on receiving a seven percent return on payroll taxes invested outside the Social Security system, today’s 40-year-old married sole provider earning $60,000 a year has a net loss of $750,000 from Social Security, comparing projected Social Security benefits to the estimated returns in individually invested retirement accounts. For a married sole provider earning $25,000 a year, the loss is $268,000. With both spouses working, one earning $60,000 and the other earning $25,000 a year, the loss is $1.2 million.
That comparison, of course, rests on two assumptions: 1) a seven percent privatized return; and 2) the assumption that today’s workers won’t be subjected to hikes in Social Security payroll taxes or cuts in benefits. As it now exists, the Social Security system is simply a tax-and-transfer program in which participants earn no contractual claim to any future benefits. "The open-ended appropriation that Congress has granted Social Security expresses its long-term support for the program, but it does not say anything meaningful about how the long-term cost will be funded — or, indeed, whether the cost is affordable at all," explain Neil Howe and Richard Jackson, economists and senior advisers at the Concord Coalition. "Actuarial solvency thus rests on nothing more than Congress’ promise to spend money that it has yet to raise."
Michael Tanner, director of the Cato Institute’s Social Security Privatization Project, underlines the risk: "A young worker entering the Social Security system is gambling on what a Congress and president 45 years from now will decide to do. Given the system’s $9.5 trillion unfunded liability, and the inevitable tax hikes and benefit cuts to come, the political risk of staying in Social Security far exceeds the market risk of private investment."
As is the case with risks, there are transition costs both to staying in the current Social Security system and in moving to an individualized retirement system. With the latter, for instance, given the moral obligation to continue benefits to today’s recipients and to those nearing retirement and the fact that payroll taxes diverted to private accounts will no longer be available to pay those benefits, the transition costs with privatization are significant. In effect, today’s workers will have the burden of simultaneously paying for two retirements — their own pre-funded plans and that of current beneficiaries who continue to collect under the current state-run pay-as-you-go system.
"Yes, privatization entails a sizable transition cost," states Daniel Mitchell of the Heritage Foundation, "but keeping the current system in place and putting it on a sound footing would involve a large transition cost as well." The key issue, Mitchell contends, "is whether the price tag for moving to a private system is larger or smaller than the amount of money lawmakers would have to find to fulfill the promises of the current system." As it turns out, "privatization is less expensive." A valid economic analysis, in short, must look at the cost of privatization in light of Social Security’s current unfunded liabilities. In that sense, says Tanner, "privatizing Social Security will actually reduce the total debt we owe."
"While any financing mechanism will be political — involving some combination of debt, transfers from general revenues, asset sales, and the like — the expected budget surplus offers a good place to start," says Tanner. The notion of a budget "surplus" separate from Social Security is deceptive, in fact, since it is the result of robbing the supposedly off-budget Social Security trust fund of money collected for the Social Security program. Senate Finance Committee Chairman William Roth (R-DE) has offered a plan that basically leaves the current system untouched while using the surplus to create individual retirement accounts for all working Americans. In July, the Congressional Budget Office reestimated that the Social Security surplus will be $1.6 trillion over the next ten years.
In another plan, proposed by Senator Rod Grams (R-MN), workers would be allowed to shift ten percent of their payroll taxes to individually held personal retirement accounts. The transition cost, says Grams, would be financed by cutting federal spending by five percent across the board — federal spending that is now budgeted to be some $300 billion higher next year than when the GOP took over the reins of Congress in January 1995.
Given the superior long-range rates of return in the private sector, additional tax hikes to keep the current Social Security model afloat is basically throwing good money after bad. On top of a total federal, state, and local tax burden that now consumes nearly 40 percent of a typical family’s income, the projected string of benefit cuts and tax increases which are unavoidable in the current system is certain to further weaken the nation’s anemic savings rate, restrict new capital investment, hamper productivity expansion, impede wage growth, and restrain improvements in the general standard of living.
On the other hand, the private investment of Social Security taxes in personal retirement accounts, is most likely to have exactly the opposite effects — an increase in national savings, greater investment, higher productivity, more growth, enhanced American competitiveness, and more jobs at higher wages. Harvard economist Martin Feldstein estimates that the disincentives and distortions of the current Social Security system have reduced private savings in the United States by 60 percent and lowered gross domestic product levels by five to six percent.
Put simply, we have arrived at a crossroads. With privatization, we go in the direction of more individual responsibility and the creation of a larger and richer economy, exactly what is required to meet the nation’s obligations to its future retirees. On the other path, we go in the direction of more dependency on the government, fewer choices, and increased generational inequity as each new birth of Social Security participants receives a worse deal than the last.
Most of all, by taking back our own income, we take back independence and offer ourselves, our children, and future generations of Americans a dramatically different vision of the role of government.
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Mr. Reiland is Associate Professor of Economics at Robert Morris College in Pittsburgh.
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