This column by ACRU General Counsel Peter Ferrara was published March 17, 2011 on Forbes.com.
Next year the baby boomers begin to retire on Medicare in earnest, and the year after that on Social Security. For decades now, the federal government’s own official reports have been showing that Social Security would not be able to pay all promised benefits to the baby boomers without dramatic, unsustainable tax increases.
Last year, for the first time since President Reagan saved the program in 1983, Social Security began running a cash deficit. Under what the government’s actuaries call intermediate assumptions, those deficits will continue until the Social Security trust funds run out of money to pay promised benefits by 2037. After that, paying all promised Social Security and Medicare benefits will require eventually almost doubling the current total payroll tax of 15.3% to nearly 30%.
Under what the government’s actuaries call pessimistic assumptions, the Social Security trust funds will run out of money to pay promised benefits by 2029. After that, paying all promised benefits to today’s young workers would eventually require raising the total payroll tax rate to 44%, three times current levels, and ultimately more.
Social Security operates as a pure tax and redistribution system, with no real savings and investment anywhere. Even when it was running annual surpluses, close to 90% of the money coming in was paid out within the year to pay current benefits.
Even the remaining annual surpluses were not saved and invested. They were lent to the federal government and spent on other government programs, from foreign aid to bridges to nowhere, with the Social Security trust funds receiving only internal federal IOUs promising to pay the money back when it is needed to pay benefits. Those federal IOUs are rightly accounted for in federal finances not as assets but as part of the Gross Federal Debt, subject to the national debt limit. That is because they do not represent savings and investment but actually additional liabilities of federal taxpayers.
Such a pay-as-you-go tax and redistribution system does not earn the investment returns that a fully funded savings and investment system would. Consequently, over the long run the system can only pay low, inadequate, below-market returns and benefits.
That is why studies show that for most young workers today, even if Social Security does somehow pay all its promised benefits, those benefits would represent a real rate of return of around 1% to 1.5% or less. For many, the real effective return would be zero or even negative. A negative rate of return is like putting your money in the bank, but instead of earning interest on it, you have to pay the bank for keeping your deposit there. That is effectively what Social Security is for many people today.
Moreover, on our present course, that is what Social Security will be for everyone in the future. Whether the long-term deficit is closed ultimately by raising taxes or cutting benefits, that will mean the effective rate of return from the program will be lower, ultimately falling into the negative range for everyone.
There is a better way that is proven to work in the real world. Workers could be allowed to save and invest what they and their employers would otherwise pay into Social Security in personal savings, investment and insurance accounts. Studies show that at standard, long term, market investment returns, for an average income, two earner couple, over a career the accounts would accumulate to close to a million dollars or more. Even lower income workers could regularly accumulate half a million over their careers.
Those accumulated funds would pay all workers at all income levels much higher benefits than Social Security even promises, let alone what it could pay, two to three times as much, and possibly even more. Retirees would each be free to choose to leave any portion of those funds to their children at death.
Another virtue of these personal accounts is that with workers financing their own benefits through their own savings and investment, they can be free to each individually choose their own retirement age. Moreover, they would have market incentives to choose on their own to delay their own retirement ages as long as possible, because the longer they wait the more they would accumulate in their accounts, and the higher benefits those accounts could pay.
As a result, millions of workers with less physically taxing jobs would choose on their own to delay their retirement well into their 70s, a result that could never be imposed politically. But other workers whose jobs required heavy physical labor or who for other physical reasons could not work past their early 60s could retire early. With planning, they or their employers could make additional contributions to the accounts over the years to finance more benefits in that earlier retirement. This is a far superior solution to the question of the retirement age than the political system imposing one, uniform, unworkable retirement age on all.
Indeed, in 2005, Congressman Paul Ryan (R-WI) and then Senator John Sununu (R-NH) introduced comprehensive legislation providing for just such a personal accounts plan, officially scored by the Chief Actuary of Social Security. Workers under the proposed plan were empowered to choose to save and invest in the accounts just half the Social Security payroll tax. Despite reduced deposits into their individual retirement accounts, the Chief Actuary concluded that the accounts offered a much better return such that all workers would choose to opt in to the personal account plan.
Over the long term in the pro-forma scenario, the accounts result in breathtaking reductions in government spending, because the payment of Social Security benefits is shifted out of the federal budget altogether, financed instead through the accounts in the private sector. This would result in the largest, most dramatic reduction in government spending in world history.
Because of this, the personal accounts alone under Ryan-Sununu eventually closed the long term Social Security financing gap entirely, without any benefit cuts or tax increases. Indeed, since the employer half of the payroll tax continued to be paid, while the payment of the benefits was shifted to the personal accounts, the Ryan-Sununu plan eventually resulted in very large Social Security surpluses, which allowed for major cuts in the remaining payroll tax. For these reasons, the Chief Actuary of Social Security scored the plan as achieving full solvency for Social Security.
Imagine then how workers accumulating hundreds of thousands or even millions in their own personal accounts by retirement would transform society. The Chief Actuary calculated that under Ryan-Sununu, after just 15 years with the personal accounts, working people all across America would have accumulated $7.8 trillion in their accounts, in real terms after adjusting for inflation. That would climb to $16 trillion after 25 years.
Moreover, all those funds would pour into our economy as a mighty river of increased capital investment, rapidly expanding economic growth. Those funds would finance the practical implementation of our rapidly advancing science, leapfrogging our economy further generations ahead.
In 1981, the South American nation of Chile, then with a Social Security system just like ours, with the same problems, adopted a personal account option similar to Ryan-Sununu, with astounding success. Virtually all workers chose the accounts within 18 months, and for 30 years now they have paid less into the accounts and gotten higher benefits, while their economy boomed with all the increased savings and investment. They included a safety net guarantee of former Social Security benefits, which has never suffered a loss or cost due to failure of the personal account to beat the old system.
In America itself, such a system was tried in 1981 as well, for local government workers in Galveston, Texas, who still enjoyed an option under the law then to choose an alternative to the current system. Just as in Chile, for 30 years now they have paid much less into their personal account savings and investment system than required by Social Security, but receive much more in benefits. The mostly parallel Thrift Savings Plan retirement system for federal employees has similarly worked spectacularly well now for nearly 30 years.
But didn’t the financial crisis prove that this idea would be a disaster, as President Obama insists? The fallacies of that thinking will be demonstrated in next week’s column.