Freeman

ARTICLE

That Taxing Time of Year Again

Social Security Is Flawed in Its Conception

APRIL 01, 1996 by DOUG BANDOW

Mr. Bandow is a Senior Fellow at the Cato Institute and the author of The Politics of Envy: Statism as Theology (Transaction).

Despite their extended budget wrangling, the two major parties agree on one thing: Social Security is sacrosanct. Taxpayers are suffering as a result.

Today government takes more in payroll than income taxes from many people. The 15.3 percent levy effectively doubles the marginal tax rate for those with modest incomes. Moreover, the payroll tax is highly regressive, since top wage earners pay nothing on most of their salaries and those relying on investment income are exempt. The Social Security tax also acts as a direct penalty on job creation.

Alas, it’s not just the tax that is flawed. The program itself is a public Ponzi scheme built on a financial foundation of unfunded liabilities. Early next century Social Security is likely to hit fiscal reality and collapse.

The Washington, D.C.-based Tax Foundation recently detailed the bad news for recipients. According to economist Arthur Hall, “most members of the baby-boom generation—those born between 1946 and 1964—can expect to lose money on Social Security when it is viewed as an investment for retirement.” That’s bad enough. But if Congress does what comes naturally, adopt short-term palliatives rather than address fundamental problems, the news will get uglier. Explains Hall: the negative returns “will almost certainly become worse if law-makers enact traditional reforms to keep the Social Security system from going broke in the year 2029.” That is, in a desperate attempt to preserve the system Congress is likely to hike the taxes on and cut benefits for baby-boomers. Hall figures that a typical 36-year-old would then suffer a nearly two percent negative rate of return. And that’s just the average. The same age high-earner would enjoy a negative three percent return. It adds new meaning to the line, “I’m from the government and I’m here to help you.”

Even these numbers understate the magnitude of Social Security’s bad deal. A better measure is to compare the annual after-tax Social Security benefit with the private, after-tax annuity that could be purchased with the same employee/employer “contribution.” A 36-year-old, low-wage worker would receive $52,132 (for a couple, after taxes), compared to an annuity of $58,664. The difference is not just an extra 12.5 percent year- in and year-out, however. When a worker dies, Social Security benefits cease, while the annuity’s principal remains. For a low-wage worker that would be a savings of a half million dollars or more. The gap for a high-wage worker is even greater: annual after-tax earnings of $101,014 versus $137,530, respectively, or 36 percent more for private retirement. Plus principal worth between one and two million dollars. Looked at another way, William Shipman of State Street Global Advisors in Boston figures that even a low-income worker entering the market today would earn up to three times as much investing in the stock market.

Social Security taxes would have to be cut up to 30 percent, depending upon the recipient’s income and age, to accurately reflect the annuity value of the expected benefits. As Hall says with admirable understatement: “most boomers will pay too much for their Social Security.” Indeed.

However, this entire discussion assumes that Social Security survives. Round about the year 2013 (if current estimates hold, and they have always been too optimistic in the past) outgo will begin to exceed income. By 2030, admits the Social Security Administration, the system will be running in the red. But the news gets worse. The $3 trillion surplus supposedly accumulating in the Social Security trust fund to pay benefits between 2013 and 2030 doesn’t exist. Social Security merely possesses federal bonds representing cash spent. To redeem those bonds—in order to pay retirees, as promised—will require some combination of massive borrowing, tax hikes, and benefit cuts. That’s only the start of the fun, however. By 2070 the annual flood of red ink will be $7 trillion. In fact, between 2010 and 2070 the system is committed to paying out $140 trillion more than it is projected to take in. Oh, well . . . .

A Flawed Program

The basic problem with Social Security, which no one in Washington wants to admit, is that the program is flawed in its conception. It should never have been created. Government has no right to redistribute income, even if the beneficiaries are elderly. Nor is there any cause for Uncle Sam to guarantee everyone’s retirement. People have a responsibility to make themselves financially secure; families have an obligation to care for their older generations. The burden does not belong on taxpayers.

What of those who are incapable of caring for themselves through no fault of their own? Associations, businesses, churches, individuals, and neighborhoods should all help look after those in need. If there is a proper role for government, it comes next, as a last, rather than a first, resort. It is not Social Security, which recipients view as a matter of right and treat as their primary retirement income.

Of course, when Franklin Roosevelt established Social Security in 1935, benefits were far more modest. But an election-minded Congress raised payments by 25 percent in 1972 alone. Demographics has also transformed the program. In 1935 life expectancy was only 62—three years less than the eligibility age for full benefits. It has since risen to 76. In short, Roosevelt kept Social Security cheap by ensuring that many Americans—almost half of men and 40 percent of women—died before receiving their first check!

Then there’s the bulge of 76 million baby-boomers who start retiring around the year 2010. As late as 1945, 42 workers supported every retiree, which allowed taxes to be fairly low. The ratio today is 3.3, and early next century it will be less than two. In sum, Social Security has more people collecting more benefits for more years. It’s no wonder, then, that the system is hurtling towards financial disaster.

As people tote up their tax bills, they should contemplate the future. Without change, the combined Social Security tax rate will have to be raised to upwards of 40 percent—that’s in addition to income tax levies to pay for the rest of government. Conventional remedies are a mixture of more modest tax hikes combined with benefit reductions, such as raising the retirement age, capping cost-of-living-adjustments, and modifying spousal benefits. These would help put off fiscal Armageddon. However, as Hall points out, they would also worsen the deal for baby- boomers.

Opting Out

The only way to simultaneously avoid generational war and treat baby-boomers fairly is to allow workers to opt out of Social Security. Radical though this may sound, in 1981 Chile created just such a system. More than 90 percent of citizens now invest in private pension plans rather than participate in the government program. Hall proposes a similar approach: baby-boomers would receive a government bond worth their employee/employer contribution (adjusted for inflation), which could be used at retirement to purchase a private annuity. It would be even easier to design an escape mechanism, such as tax credits for IRA contributions, for younger workers. The specific details matter less than returning to people control over their retirement futures.

April 15th will continue to be a taxing time of year as long as Americans expect Uncle Sam to play a combination of fiscal Santa, national nanny, and global cop. Unfortunately, the burden will grow far worse unless officials begin planning to replace rather than save Social Security.

ASSOCIATED ISSUE

April 1996

ABOUT

DOUG BANDOW

Doug Bandow is a senior fellow at the Cato Institute and the author of a number of books on economics and politics. He writes regularly on military non-interventionism.

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