What, Exactly, is Social Security Reform?

Testimony of
Max Pappas
Policy Analyst
Citizens for a Sound Economy

before the

NH State Senate Executive Departments & Administration Committee

February 4, 2004

Mr. Chairman and members of the Committee, thank you for inviting me to offer testimony regarding the resolution before the New Hampshire Senate which urges the Congress of the United State to enact legislation that would allow New Hampshire’s citizens to voluntarily opt-out of the federal Social Security system and invest their Social Security taxes in personal retirement accounts that they themselves would own and control. I commend you for taking this bold and honorable step.

My name is Max Pappas, and I am a Policy Analyst at Citizens for a Sound Economy. I am representing our 300,000-plus members nation wide, and the thousands of members of New Hampshire Citizens for a Sound Economy.
There is no economic issue facing the United States today that is more important than converting the Social Security pension system from a pay-as-you-go government-run program into one based on personally owned retirement accounts.
I will begin by outlining what is wrong with Social Security as we currently know it. I will then discuss possible solutions to this problem, concluding that Personal Retirement Accounts are the only viable answer. I will then finish by talking about how these accounts would work and what they would mean for different people.

What is wrong with Social Security?

Social Security—the largest government program in the world—is going bankrupt. Social Security is a pay-as-you-go system. Taxes are collected from current workers to pay benefits to retirees—an intergenerational wealth transfer. Like a pyramid scheme, it works as long as the base is considerably larger than the peak—the base in this case being workers and the peak being retirees. In the 1950s the system worked well because there were 16 workers paying taxes for every one retiree. For one retiree to receive $1,000 a month, each worker had to pay $62 a month in FICA, or Social Security taxes. But today there are just over 3 workers paying for each retiree and by 2025 that number will shrink to 2 to 1. Then, for one retiree to receive a $1,000 monthly Social Security check, two workers will have to each pay $500 per month in Social Security taxes.
But at current rates, by 2018, the system will begin to owe more to retirees than it is taking in. To solve this deficit the government can raise taxes and/or cut benefits. But these option do nothing to guarantee a prosperous retirement for tomorrow’s seniors, it just slightly delays the inevitable collapse of the system.
The Social Security Administration reports that payroll taxes will need to be raised to 18 percent by 2032 to meet current promised benefits. These taxes have already been increased more than 30 many times, form 2 percent of the first $300 earned at the program’s inception to 12.4 percent of the first $87,900 earned today.

Cutting benefits to seniors would also prolong the programs solvency. The Social Security Administration estimates that benefits would have to be reduced by between 33 and 25 percent. Gradually reducing the benefits paid to seniors may prolong solvency, but it is the opposite of what the program is meant to do, and that is guarantee a secure retirement. In today’s system, one in ten elderly people already live in poverty. Such benefit cuts would be devastating to many seniors who simply cannot afford live on less. Our seniors deserve something better than these tired old accounting tricks.

What about the Social Security Trust Fund?
The trust fund will not save Social Security because it does not have any money in it—and it never has. Tax money comes in, retirees are paid, and any surplus is turned over to the Treasury in exchange for government bonds. These bonds are what fill the trust fund. But government bonds are just I.O.U.s from the government. So the government is writing I.O.U.s to itself. This is the same as a person writing himself an I.O.U.—all you have is a piece of paper. You have to get the money from somewhere, and in the government’s case, they get it from taxes. The trust fund makes no difference. When the bonds are redeemed to pay for Social Security, the government will have to get the money from taxes. If they did not exist, the government would still have pay for Social Security with money from taxes. They are nothing but a promise to tax future generations.

What are we proposing?

Meaningful reform to the system must embrace the following four principles:

• Guarantees promised benefits for the currently retired and nearly retired
• Does not increase taxes
• Allows workers to invest a portion of their Social Security taxes in Personal Retirement Accounts
• Ensures that workers would own their own accounts—not the government

Workers should be allowed to put their Social Security tax dollars into Personal Retirement Accounts. These accounts would be funded by the FICA tax already taken out of our pay. But, instead of being used to fund current retirees, it would stay in an account owned by the person who earned it, like an IRA or 401(k). Workers would own this money.
Surprisingly, workers have had no legal right to their Social Security contributions since the 1950s when the Supreme Court ruled, “To engraft upon the Social Security system a concept of ‘accrued property rights’ would deprive it of the flexibility…which it demands.” In other words, if we owned it, politicians would not be able to take it away by cutting our benefits, which is what has repeatedly happened over the years. Personal retirement accounts would shift control of our retirement security from the promises of politicians to the safety of our savings accounts.

These accounts would grow tax free over the course of the individuals working years, creating a tangible asset that, unlike Social Security, could be passed on to future generations. This offers low and middle wage earners the opportunity to build the wealth currently available only to the rich, and enable them to own a stake in the US economy.

If the workers keep their payroll taxes, from where does the money for current and near retirees come?

This is what is referred to as the transition cost. But it is inaccurate to refer to this as a cost. This money is already owed to retirees—it is the unfunded liability, currently estimated at $10.5 trillion. Shifting to personal accounts would only make this implicit debt explicit. Moving to personally funded Personal Retirement Accounts would be the largest reduction of government debt in history—not a new cost.

Financing for this debt reduction—again, debt which already exists—would come from the sort term Social Security surpluses projected until 2018, from the savings from modestly slowing the rate of growth of federal spending, from revenue feedback and through the sale of new and already existing Social Security trust fund bonds, which would spread the burden over several generations. Cutting the $100 billion-plus spent on corporate welfare each year offers an additional source of financing.

What are the benefits of Personal Retirement Accounts?

First, there is the human happiness benefit. The current system is a one-size fits all approach that disregards individual preferences about old age. Some want to work forever while others would rather quit their job as soon as possible and go fishing. Currently, the government dictates when you can retire. With Personal Retirement Accounts each worker would be able to calculate how long he needed to work to save the amount of money he wants for retirement. Pensions and retirement ages could be made to order like a tailor-made suit.

Individuals would have control over their retirement security, and would see the connection between their hard work and their increasing wealth.

Such accounts would also offer individuals a greater return on their money. Even the most conservative investors would amass substantial wealth during their working years with Personal Retirement Accounts—far more than Social Security promises in retirement income, as I will detail later.
The economy would also benefit from this substantial increase in the national savings rate. Harvard economist Martin Feldstein calculated the present value of this change to the US economy to be between $10 and $20 trillion dollars. It would permanently increase our GDP by 5 percent, resulting in at least one million new jobs and an increase in annual income of $5,000 for a family of four.
Chile, the first of many countries to adopt a system of Personal Retirement Accounts, saw the growth rate of their economy leap from a historical 3 percent a year to an average of 7 percent per year after implementation.

Isn’t the stock market too risky?

While individual stocks are volatile in the short run, the market as a whole proves to be very stable over the long run—and saving for retirement is a long run investment. Since 1926, the average rate of return on the stock market, after adjusting for inflation, has been 7.56 percent. Even the worst 20-year-period, from 1929 to 1948, a period including the stock market crash, the Great Depression, and World War II, had a positive real rate of return of 3.36 percent. Social Security historically offers a 1 to 2 percent return, but it is getting worse. An average-earning single male born after 1966 can expect to receive a rate of return after inflation of less than one-half of 1 percent on the Social Security retirement taxes that he pays.

Also, no one would be required to put all their money into stocks. Remember, this is a system based on the freedom to choose. Conservative investors could put their money in safe government bonds, for example, which typically yield a 3 to 4 percent return.

Most of the plans currently being proposed would require Personal Retirement Accounts to be widely diversified, shielding investors from the volatility of individual stocks. A limited number of professionally diversified portfolios, similar to what mutual fund companies offer today, would be what was available to choose from. No one would need to be an expert investor to benefit from personal accounts—they could rely on financial advisors for their retirement accounts like they rely on doctors for medicine.

What if I do not end up with enough money to provide for my retirement?

In the unlikely event that this happens, most plans include a safety net, financed out of general revenues, which would top-off any accounts that fell below a certain standard. The main variable that would lead to insufficient retirement accounts is the portion of Social Security tax dollars workers are allowed to save in their accounts. The more of our own money we are allowed to control, the less like we are to retire without enough to live on. A system allowing us to own a large portion of our Social Security tax money is the surest way to free ourselves from depending on the government in retirement.

Could the government invest the money instead?

Federal Reserve Chairman Alan Greenspan believes this “has very far reaching potential dangers for a free American economy and a free American society.” The federal government could become the largest shareholder in American corporations, using political motives to decide which companies would receive investments. Government control over businesses has a long history of failure. The Soviet Union for example.

If we switch to personal accounts, what happens to the Social Security taxes I’ve already paid?

It is the moral, if not the legal responsibility of the government to honor the promises it has made to workers who have paid Social Security taxes. Any acceptable plan would give those workers opting for personal accounts “recognition bonds” based on their level of contributions to that point. These bonds would be redeemable upon retirement and become part of their Personal Retirement Account portfolio.

What about the disability and survivors benefits Social Security provides?

Disability and survivors benefits are nothing more than forms of insurance that are already widely available in the private market. They would be purchased with a small part of the funds in the Personal Retirement Accounts. Workers without children would be free to forego the life insurance portion and devote those funds to their retirement benefits—another example of the freedom such accounts offer. To protect the infirm, all investors in a given retirement fund would be treated as a common pool for underwriting purposes. This would make the insurance a group policy rather than an individual policy.

How would these accounts affect the middle class?

The Heritage Foundation has found that a 30-year-old, two-earner couple who make average incomes together will pay a total of about $320,000 in Social Security taxes, including both the employer and employee shares. They can expect to receive about $450,000 in total retirement benefits—or a 1.2 percent return. If this same couple had been allowed to invest these same tax dollars in a conservative portfolio of 50 percent U.S. Treasury bonds and 50 percent stock index funds, they could expect to have $975,000 at the time they retired—$525,000 more than they would get from Social Security. $525,000 more.

And low-wage and minority workers?

Low-wage workers stand to benefit substantially. Few have enough money left over to save after paying taxes and providing for necessities. Personal Retirement Accounts would allow them to create the sort of nest egg only wealthier workers can under the current system. In a system of Personal Retirement Accounts, low-wage workers would receive substantially higher benefits, which would have a real impact on their quality of life at retirement. For example a 28-year-old earning $13,500 a year would get just $815 per month from Social Security but would receive $2,292 per month if he invested in a mixed fund that earned a 5.75 percent return, which is below the historical average.

African-Americans would similarly benefit. Payment totals from the current system depend on how long you live—the longer you live, the more monthly checks you receive. A 65 year old white man can expect to live 15.7 more years, while a black man can expect to live for only 13.6 more years. This equals 24 fewer checks for the African-American man, and anyone who dies before retirement forfeits their Social Security tax contributions to the government. With Personal Retirement Accounts, workers can leave money to family members, instead.

How would individual accounts affect women?

Researchers at Harvard University found that virtually every woman would probably be better off financially under a system of personal retirement accounts. The researchers studied 1,992 women who retired in 1981, and compared their Social Security benefits to what they would have received from a personal account that returned 6.2 percent. Not one woman was worse off under a system of Personal Retirement Accounts which, on average, would have provided the single women with 58 percent more than Social Security and wives with 208 percent more.

Conclusion

As I hope I have made clear, something must be done to our Social Security system if today’s workers are to enjoy a prosperous retirement tomorrow. Social Security’s pending bankruptcy, due to irresistible demographic pressures, can be solved by raising taxes, lower benefits or introducing Personal Retirement Accounts. The morally and economically superior choice is the introduction of Personal Retirement Accounts. They will improve the retirement prospects of all members of our society both monetarily, by offering higher returns, and emotionally by offering everyone the freedom to choose the sort of retirement they most prefer.
And, most importantly, they will offer the average citizen the dignity of not having to rely on the benevolence of the government in his old age.

Thank you for the opportunity to testify, and I look forward to seeing the federal government follow your courageous lead.