All Commentary
Thursday, June 1, 1995

$4,000 A Month From Social Security?

The Social Security System Is Fundamentally Unsound

“Social Security will remain nicely in balance for at least the next 20 years . . . If it ain’t broke, don’t tinker.”
—Prof. Robert Kuttner,
Business Week, February 20, 1995


Professor Kuttner, the American Association of Retired Persons (AARP), and other apologists for the current Social Security system don’t get it. The real issue is not whether the national pension program is solvent or not. It is not a question of whether to reduce Social Security payouts, defer retirements, assess a means test or raise FICA taxes again. Congress has attempted all of the above, and the system is still fundamentally unsound.

The real problem is simple: Social Security is a lousy retirement program and, as a result, imposes a huge drag on the U.S. economy and every other nation with a similar plan. FICA taxes cut deep into the pockets of every worker and every business. Payroll taxes have increased 17 times, from 2 percent of wages, up to a maximum of $60, in 1937, to 12.4 percent, up to a maximum $6,438.00 today. To cover future payouts beyond 2015, experts predict taxes will have to rise to 17 percent of gross income. When is this craziness going to stop?

The tragic irony of Social Security is that it is a forced savings plan that doesn’t contribute one dime to real savings. That’s because Social Security is a pay-as-you-go system. Contributions are immediately paid out in benefits. FICA taxes go either to (a) pay current Social Security retirees, who use the money to pay bills, or (b) the Social Security Trust Fund, which invests entirely in T-bills, in other words, government spending. In short, payroll taxes are consumed, not saved. As Professor Joseph Stiglitz states, “the Social Security program is a tax program, not a savings account.”

Social Security vs. Individual Retirement Accounts

Imagine what would happen if Social Security taxes were invested in Individual Retirement Accounts, so that wage earners could invest in stocks and bonds. In other words, what would be the effect if Social Security funds were invested in free-enterprise capitalism, rather than government transfer programs?

Such a study has just been completed by William G. Shipman, principal at State Street Global Advisors in Boston, Massachusetts. He analyzed two workers, one earning half the national average wage (approximately $12,600 in today’s wages), and the other making the maximum covered earnings ($61,200 today). A low-income earner who retires this year will receive $551 a month from Social Security. But if he had been allowed to invest his contributions in conservative U.S. stocks over his working years, he would be receiving an annuity of $1,300 a month for the rest of his life, almost three times his Social Security income.

A high-income earner would do even better. If he retired today, he would receive $1,200 a month from Social Security. Had he invested the money in stocks, he would be receiving an annuity of $4,000 a month. Now that’s what I call retiring with dignity.

In sum, Social Security is a lousy retirement plan and a tragic waste of resources, This year approximately $350 billion will be paid into Social Security. In addition, the Social Security Trust Fund, held for future payouts, is valued at $436 billion and rising. Imagine if all that money had been invested in the capital markets. Imagine if the Social Security Trust Fund could be managed by Peter Lynch, Warren Buffett, or another top money manager and invested in the financial markets. (However, I do not favor government control of American companies. I’m simply demonstrating the profit potential when funds are invested rather than consumed.)

Chile Sets the Example

Wishful thinking is reality in a small nation south of us–Chile. Its Social Security system puts America to shame. In 1981, under the influence of free-market economists, Chile privatized its failing Social Security system and replaced it with private pension fund accounts for new workers. Middle-aged workers were given the option of using the new privatized pensions or remaining in the state system, while the government plans for existing retirees and those within a few years of retirement remained untouched.

The results have been astounding. Today 93 percent of the labor force is enrolled in 20 separate private pension funds. Annual real returns on pension investments averaged 13 percent from 1981 to 1993. Chile’s private pension plan deepened the nation’s capital market and stimulated economic growth. Its domestic savings rate has climbed to 26 percent of gross domestic product, and its economic growth rate averaged 5.4 percent annually from 1984 to 1992.

Retirees still on the state pension system are being paid from general revenues, boosted by tax revenues from privatizations of state companies and the expanding economy.

In short, Chile provides a role model for a successful privatization of the U.S. Social Security system. Converting the pay-as-you-go system into a genuine savings program will dramatically increase capital formation and economic growth in the U.S.

Reform is Coming

Until recently, discussion of privatizing Social Security or highlighting the Chile model has been muted. I recently reviewed the 1995 editions of the top ten textbooks in college economics. Only one mentioned the possibility of privatizing Social Security, and none mentioned Chile’s alternative.

Lately, however, resistance to reform has been crumbling. Time magazine ran a March 20th cover story, “The Case for Killing Social Security,” and virtually endorsed the Chile model. Paul Craig Roberts wrote a favorable column about Chile and Social Security reform in the March 27, 1995, issue of Business Week. And now Senators Robert Kerrey and Alan Simpson are sponsoring a bill to allow workers to pay 2 percent less in payroll taxes if they invest it in their own IRAs. It’s a beginning. House Speaker Newt Gingrich pledged to keep Social Security off limits this year, but for how long? As Lao-tzu says, “To resist change is like holding your breath–if you persist, you will die.” []

1.   William G. Shipman, “Retiring With Dignity: Social Security’s Harmful Role, Capital Markets’ Helpful Solution,” Cato Institute Policy Analysis, forthcoming.

  • Mark Skousen is a Presidential Fellow at Chapman University, editor of Forecasts & Strategies, and author of over 25 books. He is the former president of FEE and now produces FreedomFest, billed as the world's largest gathering of free minds. Based on his work “The Structure of Production” (NYU Press, 1990), the federal government now publishes a broader, more accurate measure of the economy, Gross Output (GO), every quarter along with GDP.