Reforming Social Security

John R. La Plante

A New Deal for Social Security, Peter J. Ferrara and Michael Tanner, Cato Institute, 1998. 265 pages, $10.95 paperback;

The current bull market swells the coffers of IRAs and other retirement accounts. At the same time, Social Security is heading for bankruptcy. Peter Ferrara, an economist for Americans for Tax Reform, and Michael Tanner, a policy analyst at the Cato Institute, explain why Social Security is going broke, why a system of private retirement accounts should replace it, and how to get from here to there.

Visible and Invisible Costs

Social Security's Board of Trustees projects that the program will start to run a deficit by 2013, though it could start even sooner. The problem, in simple demographic terms, is this: more retirees, living longer, will require more support from a relatively unchanging number of workers.

According to the "medium case" official scenario, paying all the promised benefits for a young person entering the workforce today would require increasing the Social Security payroll tax rate from 12.4 percent to approximately 18 percent. Under the pessimistic (and more realistic) projection, the payroll tax rate would rise to 26 percent. Without a tax rate increase, benefits would have to be cut anywhere from 25 to 33 percent.

Social Security--a foundation of FDR's New Deal--is actually a very poor deal. Even under the most favorable conditions, Social Security gives a 2 percent "return" on taxes paid. By contrast, private capital markets have averaged, on an annual basis, a 9 percent return after inflation. A worker contributing an equivalent amount to a true investment account would receive at retirement at least twice the income provided by Social Security.

Ferrara and Tanner provide many detailed scenarios to illustrate that minimum-wage workers, blacks, women who work outside the home, stay-at-home moms, and others would fare better under a system of private investments.

Social Security's tax is much greater than what shows up on the pay stub. Over a lifetime, Social Security robs the average family of over $1 million--about three times the benefits of Social Security. It's not surprising then, that the current arrangement decreases GDP anywhere from 5 to 10 percent. The formula is brief: higher taxes, lower savings, less investment, slower economic growth.

But the case against Social Security cannot be measured in monetary terms alone. Social Security, a system born in political manipulation (described in graphic detail in chapter 2), breeds cynicism with its language of a (bogus) trust fund and forced "contributions." It fosters an attitude of dependency among workers. By crowding out private savings, it robs many people of the chance to become "capitalists" through ownership investments--and leads to needless and unproductive confrontations between labor and management.

Lessons from Overseas

Having explained why Social Security is a bad (and unsustainable) deal, Ferrara and Tanner describe how Chile, Great Britain, and other countries (including China!) are, to varying degrees, turning to a fully funded system of private accounts.

In Chile, employers withhold a portion of worker's pay, and send that to investment companies that have met standards of good management. The government pays, out of general revenues, a modest stipend to those individuals whose accounts fail to provide adequate income. In its 17 years of operation, the Chilean program has provided the typical retiree twice the income of his U.S. counterpart on Social Security--and at a lower cost.

Ferrara and Tanner also outline their preferred method of getting to a new system. They propose letting worker and employer each pay 5 percentage points of the current Social Security tax into a private account, with the balance continuing, for 10 years, to pay for the transition costs.

This is a thorough, and thoughtful, book. The authors do not simply present their facts and arguments, but they consider, and refute, the objections: that Social Security is a good deal, that a system of private accounts is undesirable, and that the current system can be fixed with only a minor tax increase. It is not light reading, but neither is it off-limits to the average reader.

For those who will be affected by Social Security--and that includes almost everyone who has ever earned income--this book is worth reading, if only to find out how yet another noble-sounding government program undermines the goals it publicly supports.

Published in the March /Aprl 1999 edition of Intellectual Ammunition.

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