A Primer on Social Security Reform

For those not fixated on Osama bin Laden, international global tests or other such nonce issues, I recommend an excellent new article from the Heritage Foundation, “The Top Ten Myths About Social Security Reform”. The author, David C. John, lucidly summarizes the reasons why the present system is unsustainable in the long run and explains why a gradual shift to full or partial privatization will reduce the risk of a future collapse.

Within 15 years, Social Security retirement benefits will exceed the taxes collected to pay them. At that point, the system will begin drawing down its hypothetical trust fund, which holds nothing but I.O.U.’s on the U.S. Treasury. To meet those obligations, the government will have to raise taxes, cut spending or borrow money, just as it would if the trust fund did not exist. By about 2042 the I.O.U.’s will be gone, an event of no economic but some legal significance. Current law, with limited exceptions, forbids using general revenues to pay Social Security benefits, except to the extent that the trust fund cashes in its “assets”. Unless the law is changed, either Social Security taxes will rise sharply in the 2040’s, as people born in the late 1970’s and early 1980’s are reaching retirement age, or benefits will be cut back. Today’s twenty-somethings can look forward to one of history’s great inter-generational donnybrooks, pitting their elderly selves against younger workers who don’t want to bear a steadily escalating tax burden. (Amending the law to permit the use of general revenues will not, of course, ameliorate the burden; income taxes would simply go up instead of Social Security levies.)

If the present system remains unchanged, without benefit reductions, the government will have to collect additional revenues of $27 trillion (adjusted for inflation but not present-valued) over the next 75 years. The amount needed each year will rise steadily, e. g., from $280 billion in 2050 to $640 billion in 2075 (2004 dollars in each case). Those gaps won’t be as daunting then as they would be now, because the economy will presumably grow in the meantime, but they will never be small change.

The concept behind privatization is to substitute capital accumulation for a large portion of Social Security’s unfunded liability, thus making retirement benefits individual property that will not be at the mercy of younger taxpayers. That strategy does have to get over a short-term rough patch: Since reducing benefits already accrued is, quite rightly, politically impossible, there will be a phase-in period during which workers will have to continue paying the taxes needed to support grandfathered benefits and put funds into their own individual accounts. In effect, part of the system’s unfunded liability will be accelerated, but whatever hardship that entails will be more than offset by the long-run decrease in unfunded commitments and the creation of private wealth to replace public promises.

Mr. John’s analysis covers these and other issues in greater detail. At some point during the third Presidential debate (the one on domestic policy), Senator Kerry is bound to drag out privatization as a bogeyman. By reading a few pages now, you can be ready to skewer his arguments when he does.

Comments

[Gil Colgate]

Just plotted the U.S. average wage versus the dow jones.
The numbers track very closely until the 1990s, whereupon the stock market takes off into the stratosphere.
This makes me think that the high prices of the 1990s are an abberation, and that the stock market will drop down to meet wages eventually.

Here is a link: http://home.comcast.net/~gcolgate6/wsb/index.html

[Gil Colgate]

Yes, my numbers are in error: the Stock Market increased in value over the past 60 years faster than the average wage in the USA.

This leads us to two possible scenarios:
1) Wages are becoming less and less important as an input into economic growth, and eventurally noone will have to work for a wage as everything will be capitalized (I don't believe this one) or

2) The global average wage (including poor countries) has risen along with or faster than the stock market, but American workers have not seen their wages rise as much. The stock market growth has been greater than the growth in American wages because it reflects growth in the foreign as well as the domestic economy. This explanation makes more sense to me, and it would seem that privatizing social security might be a way to take advantage of growth outside the U.S. (We can't make foreigners contribute to the Social Security system directly).

P.S. My email address in the previous post is wrong, it is missing a '3'.

[Gil Colgate]

In 1940, total social security receipts were 1,785 million dollars. In 2000, social security receipts were 652,852. This is an increase of over 36000%.

In the same time, the dow jones average in 1940 (December) was 131.13 and in 2000 it was 10,787.99, or 8200%, only 1/4 as good as the growth in wages.

This is because capital growth only tracks PART of the growth in the economy; while growth in wages is a more accurate measure of the growth in the economy.

Should social security go bankrupt due to wages not keeping up with the number of retirees, we cannot expect good stock market performance either

(source: http://www.taxpolicycenter.org/TaxFacts/TFDB/TFTemplate.cfm?Docid=46&Topic2id=50)
and
http://table.finance.yahoo.com/ for dow jones

Me: In 1940 the combined employer-employee FICA tax rate was two percent of wages up to $3,000. In 2000 it was 12.4 percent of wages up to $76,200. (Source: Social Security Online) If the tax rate and taxable wage base had remained at the 1940 level, Social Security tax collections in 2000 would have been (back-of-the-pixel calculation) roughly $8½ billion, less than a fivefold increase from 1940 and only 1/17th the growth of the Dow. (You have also made the error of omitting dividends in computing the change in stock value.) Your method of comparison scarcely strikes me as a compelling argument against relying on private saving rather than unfunded government promises for retirement income.