January 23, 2005
Social Security: Is it Worth Saving?
First things first: a history. During the early part of the 20th century, America was going through great demographic shifts. Prior to that time, it was highly expected that the family unit included both the young and the old, and that when you reached an elderly age, your family would care for you. With greater urbanization, this was no longer the case. The inability of people at that time to expect a need to save for retirement, coupled with the devastating aspects of the Great Depression, caused an ever-increasing number of elderly to live in poverty. As such, Social Security was begun as an insurance program. The entire cause of Social Security was to ensure that if you lived past 65, you would not live in poverty.
Several aspects of the program were instituted due to social pressures at the time. First, there was a social stigma against “welfare” programs. Thus, the program was designed to be universal. Second, the program was never intended as a retirement program. It was intended to ensure that you would be able to live above the poverty line, but did not offer much more. Last, demographically a much higher percentage of workers reach age 65. Although life expectancy of those who reach age 65 hasn’t increased dramatically, the percentage of workers who will reach 65 has grown considerably.
Fast-forward to current times, and we see the results of the design of the program, and of the add-ons that politicians have tossed on top over the last 60 years. As a result, taxes used to support the system have grown from 3.0% (in 1950) of income, to 12.4% today. Note that I combine the employee and employer contribution for two reasons. First, the employer contribution is part of the cost of having employees, and thus could be contributed as salary. Second, self-employed persons need to provide both halves, showing the true percentage to be 12.4%. For that 12.4% of your income, the average benefit paid is slightly below $1000/month, and the maximum is slightly below $2000/month. Given the current cost of living in most of the country, these amounts are very low.
Considering that Social Security is an insurance program, and not a retirement program, perhaps these benefits are not too low. But considering the premiums for that insurance (12.4% of your income over 40 years), I consider it to be a pretty poor deal.
So we are forced with a question: Is the system, as currently configured, worth saving? It is widely understood that current benefits cannot be supported by current tax rates, assuming the demographical assumptions currently made held true.
The supporters of Social Security say that with a few tweaks, the system can remain indefinitely. Perhaps that may include such things as raising the retirement age to 70, further benefit cuts for those who retire earlier than 70, etc. However, there is no answer for the question of whether an army of workers contributing 12.4% of their income for such low benefits is worth it.
My answer, as is expected, is that the system is wholly not worth it. For everyone, the system is far too costly to continue exist in anything approaching its present form. Furthermore, it is a raw deal, considering what obvious advantages there are to other systems. So our question, rather, should be whether we make serious changes to the current structure, or switch to privatization.
Simple solution: The easy solution is a serious restructuring of our current system. The initial program was structured to avoid thinking of the system as a “welfare” system. Thus, if you turn 65, you get paid. The first possible solution is means-testing. As a group, the elderly are becoming more and more wealthy over time. One is forced to wonder, with the high costs of this system, why we are paying these benefits to people who do not need them? There are a lot of advantages to means-testing, however, the main advantage would be lowering the payroll tax rate, allowing those funds to be invested by their earners into true retirement vehicles.
However, means-testing has a few perils. First, one of the cornerstones of public support for Social Security it’s universality. This could hurt the future public support of the program. I beleive this peril is overstated, however, because as we see these greater financial difficulties the system is going to face, public support for the system as it stands is bound to wane. Second, is the potential for reduced saving and fraud. If this is means-tested, it could entice workers to abstain from saving, since saving will reduce their future benefits. This could be especially true for poor workers, who don’t see the advantages of saving over the amount of benefits they would receive. Likewise, fraud could be encouraged, as hiding income or assets will result in higher benefit payments. These perils could hurt the future of the system, but with the current cost/benefit structure, I think would result in some needed reforms.
Hard Solution: The harder solution, of course, is privatization. I had made a quick calculation using a 401k calculator online over on B After The Fact, showing that even for someone making minimum wage their entire life, 12.4% of their income into an average retirement fund would result in 50% higher benefits than Social Security pays. Granted, the numbers I use are fuzzy, but I tried to keep my assumptions as conservative as possible. Likewise, I chose a worst-case scenario (minimum wage during an entire working history), as this would artificially make the numbers worse than reality. Against those odds, investments still made Social Security look pathetic.
The benefits of such a system are amazing. For the poor and minorities, it is a door to true ownership and long-term wealth. At the time of death (frequently sooner than rich white folks), leftover funds can be turned over to descendents and kin. In addition, the return on investment for the poor, who typically do not have income available to invest, absolutely dwarfs the return from Social Security. In my above example, that person who made minimum wage his entire life (about $20k/year) would retire with an annual income of $30k/year from his retirement fund, assuming a 5% fixed-income annuity. It sounds like a better deal to me. Second, the system actually encourages saving and investment. And since capital investment is the true engine of economic growth in this country, it would result in faster economic growth for all. They say a rising tide lifts all boats, and this would definitely bring in the tide.
Certain safeguards, of course, would need to be instituted in the system. And of course, those would be included. I am not going to speak to the merits of each, but they include aspects such as sharing between working and non-working spouses, limits on the risk allowed in a portfolio, strong oversight of the investment plans offered, etc. And while, as a libertarian, I abhor the government forcing anyone into a savings plan, I am also a pragmatist, so workers would be forced into either a private account or the current system, they could not pull out those funds for their own investment outside the plan. Likewise, transition costs are going to come up as an issue. Perhaps a combination of means-testing and privatization would help to solve that, but it needs to be addressed.
But the question, when we get to privatization, is no longer about saving the system. The system, whether it is saved or not, is a raw deal. Privatization is both saving and improving the system. Privatization will give us a system where instead of trying to avoid poverty, we are going to ensure wealth. Liberals complain that Bush is trying to destroy the system. They’re half right, in that he is trying to replace the system with a much better one.
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An interesting proposal to pay for the transition costs of the new system:
http://www.townhall.com/columnists/jackkemp/jk20050124.shtml
Thanks for the shout out, Brad!
As I said when we discussed this on my site, the hidden cost that you do not refer to is the cost of private administration of the system, which is much higher than the cost of public administration. After all, no matter how overpaid you think government workers are, they still make less than private investment managers.
The other myth that I keep hearing is that the Social Security system is going to run out of money in 40 years. 40 years is the same number that the people opposed to Social Security have been using for a long time. It was certainly the same 40 years that Edwin Meese used — almost 20 years ago. Does the Pentagon have enough money to go for 40 years? Does anyone except the Donald?
The last myth I keep hearing is that in 40 years Social Security will not be able to honor its “full commitments.” However, it seems that even on present scenarios, Social Security after it “runs out” will still be able to pay out 70%. So small tweaks, like raising the retirement age, would allow the system to keep paying.
No, this is about taking a huge pot of public money, that has been used efficiently, and turning it over to the private sector, where, as in the S&L crisis, it will suddenly disappear into the pockets of supposedly incorruptible business interests.
No, this is about the moral issue. Millions of people (whether or not you are one of them is besides the point now) are opposed to both “Social” and “security”. They say that it is not God’s way. What they really mean is that they are not happy unless other people are miserable.
B,
The cost of administration is inconsequential. The return on investment will far outstrip administrative costs. This is especially true if the vast majority of investments is done in index funds, for which the expense ratios are miniscule. Even if you allow true actively-managed mutual funds, the expense ratio is much lower than the rate of return.
Regarding running out of money, the problem is simply. Right now SS is running a surplus. That tax money is being used to finance current government spending. The “trust fund” is just bonds sold to the government’s general revenues. As demographics change, that money will need to be paid back to the “trust fund”. All that money being sucked up by the general spending won’t be there. Therefore, to keep our current spending on SS, as well as our current general spending, will require drastic increases in general government receipts. If there was a *true* trust fund, where this money was being kept, it wouldn’t be such a problem. But the “trust fund” is full of IOU from the government, which means when that income stops coming in, the government will need to raise taxes to make up for it.
But I think you’ve missed my point. With small tweaks, we can keep the system paying. But the costs that we go through to do so are *WAY* too high for what it pays. I don’t doubt that if we raise the retirement age, maybe put a small tax increase in now, and change the way benefits increases are indexed to inflation (the tweaks I heard of), we can continue to pay. But people can do better. 12.4% of your income over 40 years should be a large nest egg, not a near-poverty government stipend. Financially, it’s just a bad deal, and we can do better.
Last, when it comes to safeguards, I recommend you take a look at Chile’s system. They’ve done quite a bit to make sure that individual accounts and fees are separated, and that if a company fails or goes under, the funds are protected. I’m sure we can find a way to ensure the same thing. And, of course, if you don’t want your money privatized, we can certainly let you stay in the current system. That was done in Chile too.
There may be evil, wretched right-wingers who are against “social” and “security”. And no, I don’t think I’m one of them. But even if people don’t like “social security” because it’s not “God’s way”, doesn’t make it financially any better of a deal. Personally, I can afford to save for my own retirement, outside of Social Security. It’s the very fact that I see the poorest among us, who can’t afford to contribute any money to a 401k, getting 12.4% of their income sucked up into a system that will pay them a meager pittance when they retire (if they manage to live that long). Wouldn’t those people be the ones most served by private accounts? Wouldn’t those people be the people most served by building actual wealth?