No, It Would Aid Workers of the Future

If you want the correct answer, you have to ask the correct question. Unfortunately, when it comes to Social Security, many people have focused on the wrong question.

Given Social Security’s dire financial condition, it is no surprise that much of the public debate has been about how to keep the troubled program solvent. After all, by 2013--just 15 years from now--Social Security will begin to run a deficit, spending more on benefits than it takes in through taxes. In theory, the Social Security Trust Fund will keep the program going until about 2032. In reality, the trust fund is little more than an accounting fiction, containing only aIOUs, not real assets. Social Security’s total unfunded liabilities are more than $10 trillion. That certainly should be enough to provide the impetus for reform.

Yet focusing too narrowly on the program’s financial problems invites cures that are worse than the disease. After all, if solvency is the only concern, it is always possible to “save” Social Security by raising taxes or cutting benefits or both. That’s what we have done in the past. Social Security taxes, for example, have been raised 38 times since the program began. Of course, any tax hikes or benefit cuts would be substantial this time. To keep Social Security solvent, we would have to cut benefits by nearly 25% or raise the Social Security tax by nearly 50%. And three of four Americans already pay more in Social Security taxes than in federal income taxes.

That is bad enough, but to focus on Social Security’s bankruptcy is to miss an even bigger problem with the program: Social Security has become an increasingly bad deal for younger workers.

Social Security taxes are already so high that most young workers will get a negative rate of return on their tax dollars. That is, they will actually receive less in Social Security benefits than they pay in Social Security taxes--and not just a little less. Some studies show that a married couple of 30-year-olds with an average income will lose as much as $173,500.

Raising taxes or cutting benefits to keep Social Security solvent will only make the problem worse. Instead, we need to create a new Social Security system based on savings and investment.

Our current Social Security system is a pay-as-you-go system. None of the money in Social Security taxes is ever saved for your retirement or invested in any real assets. Rather, it is simply used to pay for the benefits of current retirees. When you retire, you must rely on the next generation of workers to pay for your benefits. Like any pyramid scheme, that only works when you have lots of workers supporting a few retirees. But because people are living longer and having fewer children, the ratio of workers to retirees has been shrinking. In 1950, there were 16 workers paying taxes to support every retiree. Today, there are 3.3; by 2025, there will be only two.

A new investment-based Social Security system would allow you to divert your payroll taxes to individually owned, privately invested accounts, similar to individual retirement accounts or 401(k) pension programs. Professional money managers would invest your money in carefully regulated, safe assets, including stocks and bonds. Over the years, your assets would accumulate, building on the power of compound interest, to provide better retirement, survivor and disability benefits.

How much better? Well, compared to Social Security’s projected negative rate of return for individual workers, the average annual rate of return on bonds since 1900 has been about 4% and on stocks more than 7.5%. That translates into benefits three to five times greater than those offered by Social Security. And given the long investment horizon--45 years for an average worker--there is little if any risk.

Those higher benefits will be especially important to the poor, women and minorities who are left at a disadvantage by the current system. Perhaps even more important, because the money in your personal account is your property, it becomes part of your estate when you die. That means you can leave that money to your heirs, an especially important benefit for those segments of society that have not been able to accumulate wealth from generation to generation.

Obviously, privatizing Social Security will not come without problems. Very little in life does. We will have to devise a transition that ensures benefits for today’s retirees while their children move to a better system. Administrative costs must be minimized and consumers protected from fraud. Those are manageable problems and minor issues compared with the great gains to be reaped from privatization.

When it comes to Social Security, there is only one correct question: How can we best ensure retirement security today, tomorrow and into the future? And there is only one correct answer: privatize.