Mr. Wilson is a freelance writer in Fairfax, Virginia.
As a 22-year-old still paying off college debts, I may seem a bit premature in worrying about my retirement. Then again, how could I not? Every payday, more than 15 percent of my check is siphoned away, ostensibly to ensure that I have an income when I retire at age 65. Or will it be 70—or 75? and will there really be any funds to collect when I retire? Most importantly, why can’t I decide how best to provide for my own future?
The Making and Breaking of Trust
A glance at the history of Social Security shows why it has been dubbed the third rail of American politics. In their debate on the Social Security Act of 1935, the two major parties appeared to switch traditional roles. The Republicans advocated a program targeted solely at the poor (not the party’s usual constituency) to be a funded on a pay-as-you-go basis out of general tax revenues. The Democrats, on the other hand, backed a program to include everyone (not just their poorer supporters), and to be paid for with earmarked tax dollars held in a trust fund.
This apparent shift in the parties’ usual preferences was no mere quirk. According to political scientist William Keech, the Democrats seem to have known that if people believed that ‘insurance contributions’ were being held in a ‘trust fund,’ they would feel entitled to those benefits and would retain higher self-esteem than if they were receiving tax revenues doled out to the needy, [making it] more difficult to limit or scale down the Democratic program in times of budgetary stringency. In short, no one would want to cut Social Security because doing so would reduce benefits to themselves. By 1936, Republican opposition to Social Security had disappeared.
Unfortunately, Republican fears about the program were soon confirmed. Until 1972, when a presidential candidates’ bidding war burned off the excess in the Social Security coffers, Social Security increases corresponded suspiciously to even-numbered (i.e., election) years. Most beneficiaries were paid many times what they and their employers contributed. (In 1982 the Federal Reserve Bank of New York reported that the average 65-year-old retiree with a nonworking spouse recovered his lifetime contributions within nine months of retirement.)
Moreover, the alleged trust fund, which in truth is nothing more than a pile of IOUs from the U.S. Treasury Department, camouflaged the system’s pay-as-you-go operation. Some Social Security critics understandably call it the trust fund with no trust and no fund.
Can We Trust Uncle Sam?
The issue of trust becomes even clearer when considering how to respond to the looming Social Security crisis. The basic problem is demographics. When the Social Security Act was passed, 65-year-old male retirees could expect to live for another 12 years, females another 13. By 2030, male retirees can expect to live another 17 years, females another 21. Moreover, the population is aging, as the baby-boom bulge nears retirement. Thus, while the number of workers supporting each Social Security recipient stood at 16 in 1950, there will be less than two by 2030.
There are three basic policy options to preserve Social Security: do nothing, raise taxes, or cut benefits. The first ensures disaster. Even the Social Security Administration admits that by 2013 outgo will exceed income.
The second option is to increase the 15.3 percent payroll tax (employers theoretically pay half of that, but it comes out of the worker’s check). Unfortunately, the levels of taxation required to maintain the current system would impoverish workers and cripple the economy. According to A. Haeworth Robertson, former chief actuary of the Social Security Administration and president of the Retirement Policy Institute, a payroll tax of between 26 and 44 percent would be necessary to cover currently promised benefits. Even if the economy still functioned under such a burden, observes Robertson, people would retain such a small proportion of what they produced, and there would be such a massive redistribution of income, that the nation would have moved a long way—if not all the way—toward a socialist economy.
The third option is to cut benefits. However, the reductions would have to range between 25 percent and 50 percent, forcing individuals to retire much later and with a lower standard of living than they had planned. Government would find its own credibility brought into question.
In essence, then, with Social Security sliding toward fiscal disaster, Washington has only two options, neither of which is attractive: break its promise to taxpayers and wreck the economy, or break its promise to Social Security recipients and destroy its image.
But the problem gets even worse. Even if the government could preserve the current system without further raising taxes or cutting payments, beneficiaries would still lose. Most taxpayers below the age of 37 face a negative rate of return, if they collect at all. This compares to the 5 to 10 percent, or more, compounded annual return possible with private investments, a much greater long-term opportunity cost imposed by the system. Ironically, in the name of retirement security, Social Security forces rich and poor worker alike to retire with a lower standard of living than if the program did not exist.
A Seventeenth-Century Solution to a Twenty-First-Century Problem
Although the Social Security debacle is primarily seen as a fiscal emergency, the economic problem is really an extension of a larger moral crisis: government’s assumption of control over individuals’ lives and livelihoods. While such concerns may seem abstract, they represent fundamental flaws in the program, which we must recognize, lest we risk replacing one failed policy with another.
Yet the lack of such an understanding is evidenced by the reform proposals put forth by Washington’s usual suspects. For example, several members of President Clinton’s Social Security Advisory Council have suggested investing a portion of the existing Social Security Trust Fund in stocks to help stave off bankruptcy. While taking advantage of higher returns in the private marketplace might seem to make sense, government investment would suffer from two crippling flaws. First, individuals would still not be allowed to prepare for their retirement as they wished. Second, allowing the federal government to purchase stock on such an enormous scale would give it dangerous control over private industry. We would end up in the same collectivist mire as with the high-tax solution.
Thus, the only morally and economically sound reform is privatization: allowing individual investors to choose where to put their money and retain a property right to that money. Moving to such a system would not be costless: Workers would obviously have to assume the risks normally associated with investing. Moreover, protecting those near retirement who have already paid large sums into Social Security would generate transition costs of as much as $7 trillion over the next 75 years, according to the Cato Institute.
However, these costs are not insurmountable, nor are they unique to privatization. The system as it now exists gives those retiring in future decades no choice but to invest in a fund that is not only risky but guaranteed to cost them money. And it is a deal that can only get worse, as taxes are raised, benefits are cut, or some combination of the two. In short, no system can avoid paying high costs. However, the privatization solution forthrightly replaces today’s decrepit system with a better alternative, rather than attempting to patch it for another few decades. Without doubt, the benefits of privatization make it the best alternative available.
Wall Street and the Paradox of Trust
With their economic arguments exhausted, critics of privatization fall back on vague appeals to the spirit of Social Security. Robert Dreyfus, writing in the November/December 1996 issue of Mother Jones, says, privatization would destroy the communal vision that is the strength of the Social Security system. Dreyfus worries that a privatized system would evolve from a universal retirement system to a welfare program for poor and low-income workers which would rapidly lose support from those with higher incomes, undoing the political Gordian (some would say Machiavellian) knot constructed by the Democrats back in 1935, and giving the Republicans their victory at last, albeit over half a century late. However, Social Security’s communal vision is political, not moral—a delicately coordinated set of self-interested constituencies, as Dreyfus’s own Realpolitik concerns reveal. Moreover, a private system would allow poor and low-income workers to secure a higher standard of living for their retirement by investing their own money, rather than devolving into a welfare program.
Some critics of privatization still balk at the prospect of relying on Wall Street to ensure Americans’ retirement. However, the beauty of a private system rooted in individual investors’ property rights is that they don’t have to trust either Pennsylvania Avenue or Wall Street. Every investor could choose to take his money elsewhere, giving private fund managers an interest in actively attracting and retaining customers. If one fund is losing money or even earning a smaller profit than the market as a whole, individuals can simply change companies. Investment firms must earn profits for their clients, irrespective of their communal vision, or lack thereof.
Thus, it is private property and economic competition, not political campaigns, that breed true trust. With would-be retirees treated as individual customers, not as constituencies to be bought off at the expense of all, and with investors reaping the benefits of an expanding stock market and compound interest, trust would naturally develop. Paradoxically, then, real trust evolves out of a property rights-based system that does not need it, while trust is destroyed by an outdated Social Security system that demands it.
Ultimately, for both economic and moral reasons, people should be allowed to invest their money as they please, especially when it has such a dramatic impact on their future quality of life. So serious are the flaws of the existing system that most young workers would be better off stuffing their savings under their mattresses rather than letting the federal government invest it. We must replace, not fix, Social Security.