Why Social Security Harms the Economy, Workers and the Poor
The Basic Facts About Social Security Retirement
Social Security Taxes and Benefit Payments
The U.S. Social Security retirement system, created by a 1935 law of Congress, collects taxes on the wages of current workers and their employers, at the same rate for both (5.3% each in 2020, excluding the 0.90% each for disability insurance). The wages are taxed only up to a maximum amount ($137,700 in 2020).
Social Security uses this money to provide current older, mostly retired, workers with a monthly payment that can start at age 62 or later, until death. The amount of this monthly payment increases with (1) the age when one starts receiving payments (up to the age of 70) and (2) the total amount that person was taxed while earning wages. Given the age a worker chooses to start receiving social security payments, their monthly amount is roughly proportional to the total paid in social security taxes by the employer an employee during the time that the recipient was earning wages. Since 1975 these payments have been increased each year by the same percent as price inflation, as measured by the Consumer Price Index.
One does not have to retire from work to receive social security payments. However a Social Security payment recipients that also earns wages (and those workers’ employers) continue paying the social security tax on those wages. In addition, the recipient pays income tax on a percent of the social security payments received. That percent grows with the total income earned during the year that the payments are received, up to a maximum of 80% being taxable. If one earns wages before “full retirement age” (66 or 67, depending on date of birth) there are some reductions to one’s social security benefits.
Social security retirement is not a pension plan. In such a plan the money that is contributed is saved and invested in a common participants fund that earns interest or capital gains. Then, at retirement, a monthly payment is made to each retiree from the saved funds (not from current workers contributions), in proportion to what they contributed.
Social Security is: (1) a tax on workers (2) that pays to those that were previous taxed, (3) primarily from younger workers that are paying the tax during the time that the older, mostly retired, workers are receiving the payments. Social Security was not designed to save and invest the taxes received from the workers to pay them when they retire. This system has been called “pay as you go”.
Why Benefit Payments Are Not Sustainable at Current Tax Rates
Given the high birth rates of the “baby boomers” right after the Second World War, starting about 18 years after those births, the ratio of paying workers to recipients started increasing. It increased to the point that substantially more was being collected than paid out by Social Security (and, by law, these excess funds were invested only in interest-paying government bonds). These savings should have made it possible for Social Security to have enough money in its Trust Fund to pay the full scheduled benefits to the baby boomers when they get old enough to receive Social Security.
As the baby boomers started reaching and surpassing age 62, after about 2008, the ratio of paying workers to recipients started dropping. Eventually, this caused Social Security to pay our more than it gets in tax revenues, which is a deficit. Drawing from the savings accumulated during the period of a high ratio of tax payers to benefit recipients has helped maintain the promised benefit payments, despite this deficit. However, years before that deficit started, Congress past laws to increase Social Security payment schedules, without sufficiently raising tax rate, to an extent that made the initial baby boomer surplus smaller than otherwise.
A gradual increase in the age of eligibility for full retirement benefits from age 65 to age 66 in 2009 and age 67 in 2027 was set in 1987. (See Summary of Major Changes in the Cash Benefits Program, 1987 Amendments), but average life expectancy since 1987 has risen from 74.79 years to 78.77 in 2019, adding and average of four years to the payment of Social Security benefits. This alone should have already lead to moving back the full retirement age by about another couple of years.
The baby boomers retirement and the lengthening of life expectancy have contributed to increasing how much Social Security has to pay.
Therefore, as of 2020, the Social Security office has projected that its Trust Fund will run out on 2034. After that year, the only source of money for its benefit payments will be the taxes collected then from wage earners. And this will require that the payments be reduced to 76% of what they were promised, (or the payroll tax be raised). This is a quote from the Social Security website on this subject:
What is Obviously Wrong With Social Security
Broken Promises from Our Representatives
Anyone can see that Social Security cannot keep its promises of paying a certain level of benefits at old age at its current tax rates on wage earners. It is also easy to see why:
Politicians are under pressure to get votes by promising benefits without raising taxes. In fact many other countries have systems similar to the U.S. Social Security and most of them are in the same deficit situation. So this is almost a universal phenomenon. It is so prevalent that it can be called an inherent failure of governments.
If fact, this is one of the many failures of government that have been categorized under the name: “the principal-agency problem”. This principle recognizes that, when we choose representative agents to run a government (or a business or a social group like the Rotary Club), their interests are not entirely aligned with those who chose them. The problem gets worse for organizations as: (1) the number of people doing the choosing gets larger (2) the means of removing the selected agent gets more difficult and (3) the difficulty of getting out of the organization increases. How many recall elections do you recall? (2) which institutions have the largest number of electors in most cases, corporations or governments? and (3) which is is the most difficult institution to leave from for something else like it, a social club, a corporation or your country?
And, though democracy is the best form of government, precisely because we do get to choose the leaders of government, a government that is not limited will be inevitably used for abuses because the interests of the government agents are not well-aligned with those of the voters (among other reasons). I will show that Social Security is one of the many failures of government that occur because we have given it permission to use force to tax, spend and regulate that is far too broad.
Only the Use of Force Keeps this Ponzi Scheme From Blowing Up
A Ponzi Scheme is a fraud where a manager of other people’s money promises, and actually pays, higher interest rates than one can get anywhere else, to attract more depositors (just like Social Security promises higher benefit payments for which it has to tax others to get it). But most of the interest is paid from the new funds being attracted not from earned from investments (just like the Social Security benefits are paid from worker members, except these members are forced in, not fooled, to participate).
All non-governmental Ponzi Schemes eventually fail as they run out of money to pay the interest, even if the manager does not steal any of it (which is rare). And such a scheme will be out of money sooner if its depositors find out that it is going to be out of money in the future, causing a run to make withdraws.
Everyone knows that Social Security will be running out of money to pay the full amount of benefits to its recipients (unless more force is used to raise its taxes, or benefits are reduced, both of which our representatives are afraid to even consider). If it were not for the fact that its revenue comes from taxes that are forced on people, the young would stop paying these taxes knowing that they will not be getting part of them back. This would result in further losses of funds to pay the current and soon to be recipients, leading even older workers to refuse to pay, since, they too, would not get much of it back.
So, Social Security is just a forced Ponzi Scheme. One where workers are forced to lend the government money to be paid back decades later with no interest added.
It is incredible that there are people in this country that deny that Social Security is a Ponz1 Scheme. Here is a quote from one of them:
Why Social Security is not a Ponzi Scheme.
A “contract between generations”? Contracts are voluntary agreements between or among individuals or organizations. They are not something forced upon people.
Where Social Security Does the Most Damage
Suppression of Savings
Social Security does its greatest damage by forcing and fooling people into refraining from saving their money for old age and retirement. This reduces the total amount of savings available to private business and individuals to invest in the building of productive physical capital goods like equipment and factory buildings, and for research and education. And these are the drivers of sustained economic development, therefore of rising standards of living. Basically, we are all poorer because of Social Security.
Social Security fools workers into not having to save as much for retirement because it promises them a future retirement income in return for the current tax payments. However, the Social Security benefit payments do no come from the taxes previously paid by the workers that are older and currently retiring. The government spent that money to pay the workers that were previously older and mostly retired. The Social Security tax is not saved (except when the ratio of workers to retirees becomes abnormally high, but even then, not enough of it is saved for when the bulge of those workers retire). The taxes of each working generation are used to make the benefit payments of the current older and retired generation.
And, of course, forcing workers to pay the Social Security tax also leaves them with less money to save.
Destruction of Income From Savings
But Social Security is not just bad for economic development in general, it also lowers the retirement income of every worker. This is because, if workers did not have to pay social security taxes or receive its benefits, they could save that money and earn interest on it, adding to the size of the fund they would have available for retirement. This would result in a much higher monthly withdrawals or purchased annuity during retirement.
This is demonstrated in two model versions described below that are integrated into one spreadsheet. The data used in this model is documented on the spreadsheet with links to its sources. And the formulas in the cells are locked but visible.
Single Worker to Life Expectancy
Our spreadsheet retirement model shows an example of a single worker that pays a 10.60% Social Security tax rate (including the employer portion, excluding disability insurance taxes), earns $40,000 a year from age 18 to 66 and gets back, between ages 66 and 83 and 8 months (the average life expectancy in the U.S. at age 66), all that was paid to Social Security . In this case, Social Security collects $203,520 by the time this worker is 66 years old. If we we divide the $203,520 by the number of months between the worker’s retirement at 66 and the current age of life expectancy at 66, this worker would receive monthly benefit payments of $960.
For an emailed copy of this model, please email your request to ricardomejias@hotmail.com.
Our example assumes that the elimination of the employer portion of the Social Security tax is passed to the workers in the form of higher wages. The reasons why this assumption is justified are explained under the subtitle “Why The Employer Portion of Social Security is Paid by the Employee” below.
If Social Security actually pays more than that amount in this case, it is because it is currently paying from its Trust Fund more than it is collecting in taxes to current workers. This fund is projected to be exhausted on 2034. After that year Social Security benefits will have to be 76% of current levels.
Suppose that workers did not have to pay any of the Social Security taxes, saved that money and earned on it a real annual interest rate of 1.20% on US Treasury 20-year bonds whose principal goes up with inflation. In this case the worker’s ending principal balance (after paying income taxes on the interest) would be $266,550. The monthly withdrawals of principal and interest during retirement to age 83 and 8 months would have averaged $1,383, 1.44 times that of Social Security benefits.
Or this worker, with the $275,662 saved by age 66, could have purchased an immediate annuity from an insurance company paying $1,332 per month, 1.30 times the $980 that is offered with the $203,520 in total Social Security taxes. However, the private annuity option is not actually available to Social Security participants since the money they were taxed was already spent on currently retired workers receiving benefits.
The annuity pays less than a withdrawal of savings because: (1) it pays for the rest of the worker’s life, not to a specific age, so its total amount to be paid is not entirely predictable, which is riskier to the insurance company and (2) it has to cover the company’s operating expenses and profit. But an immediate annuity is more comparable to what Social Security is paying since they are both for life.
A real annual interest rate of 1.20% is the average yield on 20-year Treasury Inflation Protected bond fund. This has been the bonds monthly average yield during the range of dates since the bond was created: July of 2004 through April 30, 2020, net of 0.10% of fund expenses.
Also consider that: (1) twenty years is much less time than what it takes the average worker to get back what was paid in Social Security taxes and (2) withdrawals from the fund (to be re-deposited later) can always be made, though there would usually be some gains or losses due to bond price fluctuations. Therefore, this approach gives the worker much greater asset liquidity than does the government’s Social Security benefits promise.
Workers Up to Last Surviving Age
A second part of this model follows a group of 100,000 workers through a survival table (created and used by the Social Security Administration). The table tells us how many workers live up to each age. For our model’s Social Security approach: the taxes it collected until full retirement age include those paid by workers who died before full retirement age. But for the savings approach: only the savings achieved by those reaching retirement age can be included. The savings of those who died before then would, of course, go to their heirs. The table below summarizes the comparisons of the results between the two approaches.
Investing In Inflation Adjusted Treasury Bonds
This model using the distribution of 100,000 workers’ up to survival ages shows $266,850 saved per worker and $229,860 taxed per worker by Social Security. The withdrawals of the savings are $1,422 and the Social Security benefits are $1,078 monthly. This is a smaller advantage to the savings approach over Soc. Sec. benefits, of 1.32 times, not the 1.44 times of the model of single worker to life expectancy. But the savings approach retains an advantage despite the fact that the Social Security workers that died before full retirement had their tax money transferred to the surviving retiring workers, while the saver workers who died left their saving to their heirs. Of course, this advantage is due to the ability of savers to earn interest.
This worker’s survival age distribution models is the appropriate one to analyze the economic and social impact of Social Security. The single worker model was only created to make it easier to start to understand our comparison of Social Security vs. Savings with a simpler model version. Comparing the single worker model to the survival ages model also helps us to understand how much social security affects those it covers depending on their longevity, compared to the savings approach.
Investing In a Diversified Stock Fund
The assumed interest rate for the savings approach of 1.20% is based on the most secure form of investment: Inflation Adjusted Treasury Bonds. But, if you are just a little more adventurous you can invest in a well-diversified stock fund, such as one with the 500 stocks in the S&P500 index. Although stock prices are quite volatile, that volatility is considerable smoothed by the passage of time. And time left to retirement is something young people have plenty of. On the model spreadsheet, the sheet Returns On S&P500 shows the total annual real rates of return on this index fund for money invested at the start of each period. These are overlapping periods of the last 12, 24, 36 and 48 years, summarized below.
Notice that the longer the period, the smaller the difference between maximum and minimum rates of real annual total returns, reflecting the lower volatility and risk of returns over longer periods. Between 1926 and 2019 the lowest real (adjusted for inflation) rate of return (of price appreciation plus dividends) of 47 overlapping 48 year periods between 1969 and 2008 was 5.03%.
So the stock market does not have to be “the Wall Street Casino”, to use socialist Bernie Sander’s favorite description of it. Certainly not for a young worker saving and investing for retirement into a highly diversified stock portfolio. And the best thing about this is that the young worker does not have know anything about the stock market to get these higher returns beyond this: deduct 10.60% of each paycheck to invest on this 500 stock fund and don’t worry about its day-to-day ups and downs. This is the 10.60% of wages that worker would have if not for Social Security taxes.
On a separate page of the spreadsheet (Monthly Investment In S&P500) is a monthly simulation model that calculates the amount that a worker earning $40,000 per year would accumulate between ages 18 and 66 if investing the monthly social security tax payments in an S&P500 mutual fund between 1969 and 2008. These are the 48 years with the lowest real total rates of return (5.03%) between 1927 and 2019. It includes the effect of the actual real (inflation adjusted) price fluctuations, dividend yields and the fund’s expense rate.
Using the worker’s survival ages model, the amount accumulated by age 66 is $344,579 by saving 10.60% of income. This compares with $203,520 for the total collected in Social Security taxes during the same number of years at a 10.60% tax rate. When the $344,579 is used in the model on the page SocSecVsSavings it converts to an annuity of $1,717 per month, 1.59 times the Social Security benefit payment of $1,078 per month on the model version of workers by survival age.
In addition, for saver workers that die before retirement, their heirs get the balance of the savings, something not available to Social Security participants.
Younger workers who understands these things would have to be extraordinarily risk-averse to avoid a diversified stock fund investment, at least, for part of their retirement plan.
Why The Employer Portion of Social Security is Paid by the Employees
This conclusion depends on a well-established application of economic analysis to “the incidence of taxation”, meaning “who really ends up paying for the tax”. It concludes that the employer portion of social security taxes is past on to employees from businesses in the form of lower wages. Therefore, employees actually pay for both their own and the employer’s social security tax This is the reasoning for why that happens:
People have a choice between opening their own business or working for wages for a business. One critical difference between these two choices is that opening one’s own business requires saving enough money to invest in the business before it starts earning an income. Another difference is that a business investment puts one’s money at much greater risk of loss then depositing it in a back account or buying Treasury or corporate bonds.
Therefore, people who choose to make a business investment (whether active in management or just as an owner of corporate shares) do it because they expect the annual rate of return on that investment will be high enough to be worth the risk of loss. For example, a five-year certificate of deposit at a bank might pay 3.00% interest. But those deciding to start a restaurant business will not do it unless they expect that its net income will be at least 10% per year of what was invested, due to its high risk of loss.
The employer portion of the Social Security tax is 5.30% of workers’ wages. If this federal law did not exist and were suddenly created, it would make a large dent on the profits and rates of return of all business in this country, making their expected return on investment to seriously drop. This would discourage new investments in businesses and lead to cut backs in employment and production and the shutdown of the least profitable businesses. And some existing and potential business owners will choose to search for a job instead.
All of this will result in more unemployed people seeking a job, leading to a willingness by more workers to accept lower wages to get or keep one. The great majority of workers would have no other choice, including starting a new business (since returns on business investments have also fallen). Once reduction in wages equals the increase in taxes: (1) the expected rate of return on investment back to one that is acceptable to investors and (2) businesses expand, more people are hired and employment levels are restored.
If Social Security taxes end, this process operates in reverse. Having increased profits from the elimination of the 5.30% tax on wages, employers will expand hiring to take advantage of the higher rates if return from it. This makes wages rise by the amount of the employer portion of the (former) social security tax, which returns the expected returns on business investments to their original values.
In technical economist speak this is described as having a very high price elasticity of supply of business investment and a very low price elasticity of supply of labor (only if for the whole economy, this is not entirely applicable to particular industry or firm).
A high price elasticity of supply of business investors means that a relatively small change in their expected rates of returns on investment leads to a relatively large change in the amount they invest in the opposite direction. For example, money for business capital investment can be moved to a country without a tax-induced decline in profits with the click of a mouse.
A low price elasticity of supply of labor means that a relatively large decline or increase in labor wages leads to a very low change (most likely no change) in the amount of labor supplied. In other, words, the overwhelming majority of workers have no choice but to work in the country where they live, so they have to accept whatever wages are available.
Workers find it very difficult to move to a job in another country due to immigration restrictions, language differences, family ties at home and many other obstacles. And labor force supply does not change due to higher or lower wages, it is ultimately driven by birth rates that occurred about two decades earlier. Therefore increases in demand for labor will only increase wages, since the amount of labor supplied in one country can barely go up due to rising wages.
And, when all investor-employers have had their returns on investment cut by a tax increase their demand for labor falls and wages fall. A tax reduction does the opposite and makes wages rise.
The wage adjustment process described happens gradually over a period of up to two years. But Social Security taxes have been around since 1937. And, the original tax rate for the Social Security Retirement plan was only 1% for employees and 1% of employers. It has grown gradually to 5.30% for each the employer and employee by 2020. This gradual increase provided plenty of time for the declines in wage rates from the employer social security tax to have taken place. Analogously, an elimination of Social Security could only minimize adverse effects to potential and current benefit recipients if done gradually over many years. So wages have time to adjust to its impact.
Suppression of the Savings of the Poor for the Benefit of the Rich
The study below shows just how much life expectancy declines as income declines. For men: (1) the top fourth of income earners in 2014, with an average income of $256k per year, had life expectancy of 87 years and (2) the bottom fourth, at an average income of $17k per year had a life expectancy of 77 years. For women at the same income quartiles these life expectancies are (1) 89 and (2) 83.5.
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Changes in Race- and Ethnicity-Adjusted Life Expectancy by Income Group, 2001–2014
Scatter points in the A panels show the race- and ethnicity-adjusted life expectancy estimates by year and household income quartile. Solid lines represent best fit lines estimated using ordinary least-squares regression.
Source: The Association Between Income and Life Expectancy in the United States, 2001–2014. JAMA. Author manuscript; available in PMC 2016 May 13. Published in final edited form as: JAMA. 2016 Apr 26; 315(16): 1750–1766. doi: 10.1001/jama.2016.4226.
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Because of their shorter lifespan, a higher proportion of the poor than the rich die before reaching full retirement age, or they receive Social Security benefits for a shorter time after that age. And what Social Security does not have to pay to the poor that do not live as long, goes to the rich who live longer.
For the same reason, the use of Social Security, instead of savings, is suppressing the ability to accumulate savings that heirs can inherit, more for the poor than for the rich. Those savings would have gone to the worker’s heirs at death, not to the richer who live longer, as happens with Social Security.
Therefore, this government program is a major contributor to the increasing inequality of wealth due to lessening the upward mobility in wealth over the generations.
Yet the typical politicians, many of which have asked for more government intervention to “correct the problem of wealth inequality”, never mention the role of Social Security as one of its causes. This is another example of what economist Frederick Hayek mentioned in his book The Road to Serfdom: Every government intervention creates problems that many want to “solve” by another government intervention, rather than by repealing the law that caused it.
And all Democrat and Republican politicians would rather hide in a cave, or take a long walk on the Appalachian Trail, than face any of the problems of Social Security and suggest how to solve them. This is because these problems have no easy solutions.
Answers to Objections to Life Without Social Security
The Poor Cannot Afford to Save for Retirement
Social Security pays monthly retirement benefits to each person roughly in proportion to how much they paid in taxes during their working years (but on the average, for a longer time to the rich than to the poor due to the shorter lifespan of the poor). It is not a system to redistribute income or wealth from the rich to the poor. It does the opposite.
As shown above, poor worker that save the same amount of money as they are being taxed will end up with enough savings at retirement to buy an annuity paying monthly benefits for life significantly greater than what social security can pay from its tax revenues.
In fact, even with the most conservative investments of those savings that pay the lowest interest rates (such as US Treasury bonds) anyone will end up receiving a larger monthly annuity payment than what can be had with Social Security, since that program is “pay as you go”, meaning that it saves almost none of the money it collects in taxes, therefore earns almost no interest.
Some People Are Not Financially Responsible Enough to Save for Retirement
One of the corollaries of the Libertarian Rights Principle is that protecting individuals from themselves should not be the responsibility of government. And the benefits of this corollary applies to this Social Security because it prevents this list of damages:
Political mismanagement, demagoguery and deception associated with a “pay as you go” retirement system where workers are given a retirement benefits Ponzi scheme that cannot be sustained with current tax rates.
A lower level of savings in the economy, therefore lower economic development, real incomes and standard of living.
Lower retirement income for workers because Social Security takes the money that makes their savings possible by taxation, and removes the incentive to save and earn interest by promising a future retirement income.
Increasing inequality of wealth and income and a decline in upward mobility over the generations because the poor die younger, thus a greater proportion of them receive no benefits and their heirs no inheritance from it, or the benefits are over a shorter period.
Should everyone suffer these adversities for the sake of protecting a minority from its financial irresponsibility in the form of not saving for retirement?
Having the government protect people from themselves is never a good idea. This piece shows just why this is the case with Social Security. It is because representation is too imperfect to delegate so much power to a government, specially to the federal government, where the electors are most dispersed. Which is why these government schemes can only do harm, as shown here.
In addition, in a society where the government protects people from themselves, they will not learn to protect themselves from themselves. And this is what we get from all socialistic practices like Social Security.
We learn from our mistakes and those of others. So when a child asks “why is that old man still working instead of retired”? and the answer is “because he did not save money for retirement”, that child is learning something useful.
Transitioning Out of Social Security
The Plan
It has bee suggested that the Social Security retirement system should be made voluntary. But this, by itself, would precipitate a disorderly exit by those now paying the payroll tax that would leave the current benefit recipients “holding the bag”, an empty bag, after having paid all their Social Security taxes. There is a much better way to accomplish the transition out of Social Security:
Pay off everyone who is currently paying into social security all that was taxed from them, adjusted for inflation. The payment will be in the form of a marketable Treasury bond maturing on the date of a specified retirement age of the recipient. But it can be traded for other forms of investment at any time. Thereafter the worker can add monthly savings to that or other investment funds, then live after retirement from withdrawals from this fund, by buying a private annuity, or any desired combination of these.
For those currently receiving social security, the plan deducts from the amount paid off payment the amount already received. If this amount is enough to buy a private annuity at least equaling the social security payment, nothing more needs to be done. If it is not, the retirees would continue receiving social security payments to cover the difference between social security and the annuity. This will continue to be funded by a much reduced and declining payroll tax rate that will end when the last of them dies.
Fiscal, Financial and Economic Considerations
Facts
As of December 31, 2019 the consolidated federal debt (held outside the government, i.e. excluding the ownership of Treasury bonds by Social Security, the Federal Reserve and other government agencies) was $16.8 trillion, or 79% of GDP.
On the same date, the estimated unfunded liability of the social security system based on the next 75 years is $13.3 trillion. Unfunded liability is the present value of the monthly payments to retirees to be made in the future. Present value discounts to the present from each future month by an interest rate, that is compounded by the number of months to each future payment. This is not net of the payroll tax, it is based on the gross payments to the social security recipients. It is the US governments debt to current and future social security recipients. And it is the proper number to use for our purposes because this plan includes eliminating the payroll tax.
Consequently the additional debt incurred in our plan by the bond issues to Social Security participants is offset by the reduction in the unfunded Social Security liability. But the unfunded liability debt declines by much more than the bond debt. This is because unfunded liability includes projections of people who have not yet entered the social security system that will never enter under this plan.
For example, a 7 year old child on December 31 of 2019 will start receiving social security payments at age 67, 60 years from now. The unfunded liability calculation counts that child as receiving social security starting 60 years from now and for the next 15 years (assuming a life expectancy of 82 years). But, under this plan that will never happen, since this person will never enter the Social Security system.
I don’t have the data to calculate how much the bond payments to the current Social Security participants will be, but they would have to be some percentage lower than $13.3 trillion. The bonds will be paid only to those people in the social security system today, not also people who are projected to enter it or have not even been born yet (as in the unfunded liability calculation). But the current system’s unfunded debt to people in the system is a very real debt.
Analysis
From the point of view of the government and the economy there is a qualitative difference between a bond debt and an equal amount of unfunded social security liability.
An increase in the Treasury bond debt in relation to the government’s ability to pay (such as a higher ratio of debt to GDP) will makes the bonds riskier for its investors, causing them to require higher interest rates on them to buy them when when they are due to refinancing them after they mature. If the increase in bond debt and their interest rates are high enough, the increase in taxes required to pay the interest would have to be so high as to be impossible to collect and very damaging to the economy. During the last three decades this happened to Argentina and Greece with disastrous economic consequences.
The continuing increase in the amount of unfunded Social Security liability can legally be curtailed by Congress by reducing Social Security benefits and/or raising their payroll taxes. And unlike the rise in interest rates on bonds, the social security recipients and tax payers cannot do anything in response that will damage the government’s finances by increasing its costs. Tax payments and benefit can be anything the Congress decides under our system of government, but lenders (particularly foreign lenders, of which there are many) can only be induce to lend by paying them the interest rate they require).
However, the history of Social Security shows that reducing the benefits or increasing the taxes is extremely unlikely to happen. The Social Security deficit has been going on for decades and nothing has been done about its deficit. In 2020 we are facing the fact that the Social Security Trust Fund will be exhausted by that deficit in 2034, after which current taxes can only provide 76% of what the recipients were promised. And, if Congress decides to just borrow the money to pay the 34% deficit, we will have an increase in bond debt anyway, and one that will only be indefinitely getting larger.
And no one is even discussing how to solve this Social Security deficit. Social Security is commonly referred to as “the third rail” because this is the rail of electric trains that transmits electricity and is deadly if touched. Social Security is the third rail because the older retired people show up to vote in larger percentages than the younger working people, in part, because they have more time available for that. The politicians know that and consider it political suicide to even discuss any possibility of curtailing Social Security benefits. And the mood in this country is very much against increasing payroll taxes in particular, in fact the talk is about reducing them.
Therefore, from the standpoint of what happen to government debts and the economy, this privatization plan is preferable to continuing with Social Security because it represents a one-time increase in bond debt that stops a growing increase in unfunded liability debt.
Of course, for the workers and the economy, it has many other benefits mentioned above, such as higher worker wages from the repeal of the payroll tax, higher retirement income, and higher savings rates that will accelerate economic growth and a better standard of living.
Difference from Similar Retirement Privatizations Plans
This is the most important difference between (a) this Libertarian transition plan from a government-run pay-as-go retirement funding plan to one that is entirely controlled by individuals and (b) other similar proposed and actual plans of this type:
The other plans include “forced savings”. In other words, though the savings are placed into the individual workers’ accounts with a broad range of choices regarding where to invest them, they are based on a legally-required monthly savings percent into the accounts. This is like a payroll tax, but one that goes into the worker’s account, not to the government. In addition, they do not allow withdrawals from the accounts until the worker reaches a specified age.
Libertarians are opposed to forcing people to do what is good for them or to not do what is bad for them. We believe that individuals should make their own decisions about themselves that do not adversely affect anyone else. Not because we think everyone is perfect. Rather because we believe that people are capable of learning from their mistakes and if they are not allowed to make mistakes, they will not learn and become increasingly dependent on the state to make decisions for them. And the state cannot possible make the right individual decision for millions of people that it does not know, even with the best of intentions.
In addition, the experience of countries that have adopted the compulsory contributions to the retirement plans is one of over-regulation resulting in low competition among financial services providers and high administrative costs.
This is why this transition from Social Security ends in a complete clean break from government control and management of workers’ retirement. The transition process is needed because money was taxed and commitments were made that cannot be fulfilled. Without this orderly transition process there would be many injustices and a chaotic situation. Plus the transition process enhances the chances of legislation being passed because it assures that such injustices and chaos will not occur.
Of course, this conversion to freedom to choose how one provides for retirement does not affect the current choice people have to voluntarily participate in private pension plans, such as those offered by many employers and other private organizations.
Personal Retirement Accounts in Other Countries
The following countries have implemented some type of personal account to save and invest for retirements, by itself, or in combination with a totally socialized retirement system like the one in the United States. However, their contributions are compulsory and other aspects of them are highly regulated.
Singapore never had a totally socialized retirement system. In 1955, it started with a compulsory savings plan with individual accounts that allowed a variety of investment options dedicated to retirement, where withdrawals can start at a given age. This plan has since been expanded to other uses, such as housing and health care and by increasing the compulsory savings rate.
There is a similar compulsory savings plan in neighboring Malaysia.
Chile replaced its socialized pay-as-you-go retirement plan with privately managed individual accounts in 1981 for all workers, except those retiring within five years. The accounts are held with competing private pension fund management companies with a variety of investment programs who charge fees for their services. The compulsory contribution rate is 10% up to a maximum set amount and voluntary contributions beyond that are welcome. Employers do not contribute and self-employed individuals can voluntary choose to participate. Starting with the retirement date (60 for women and 65 for men) there are various ways to choose withdrawal plans, conversion to private annuities or both.
Various versions of the Chilean plan have been adopted by Argentina (1994), Bolivia (1997), Colombia (1993), Costa Rica (1995), Dominican Republic (2003), El Salvador (1998), Mexico (1997), Panama (2008), Peru (1993), and Uruguay (1996).
In addition, many countries provide tax advantages to special retirement accounts like the US IRA accounts. Like the IRA’s these accounts are highly regulated regarding limits to contribution, schedules of retirement withdrawals and many other aspects.
There is no way to get out of the Social Security hole without many people making serious initial sacrifices before they get the benefits of it. Lets face it, Social Security has trillions of dollars to pay in future years that can only be paid by taxing current workers “as you go”, since it has too little money saved to pay from. And its Trust Fund (accumulated during the years of high ratios of workers to retirees) will be exhausted by 2034, requiring a reduction of benefits to 76% of current levels, or increasing taxes.
But even without the looming 2034 problem, Social Security taxes cannot be reduced and eventually eliminated without either: (1) moving the start of benefits into older ages or (2) reducing the benefits of current and/or future benefit recipients.
Of course, Social Security taxes could be replaced with increases in excise, income or other taxes. But that is just another way of distributing the same burden of taxation, most of which will still directly or indirectly fall on workers and retirees.
Or Social Security could end its taxation and run a deficit, financing it by borrowing with Treasury bonds. But this would not only pass the buck to future generations, but increase the US government debt by so much that it could cause a financial crisis as the bonds credit quality are downgraded.
Gradually moving the start of benefits to older ages, while subsequently gradually lower the tax rates could result in an eventual end to Social Security. But to accomplish it without seriously disadvantaging those within a few years of receiving social security would take several decades to complete.