On Monday, May 15, 2000, Governor George W. Bush is expected to outline his plan to reform Social Security. It’s expected that one of his key proposals will be to allow younger workers to divert a portion of their Social Security FICA taxes into a Personal Retirement Account, similar to a 401(k) plan, in which each worker can build real assets for their retirement.
While the details of this plan have not been spelled out, CSE has long supported the idea of workers being able to invest a portion of their Social Security taxes in asset-building accounts – owned and controlled by them – that provide a real nest egg for them in their retirement.
We believe that Personal Retirement Accounts are the key to giving workers a better return on the money they put into the system, a chance to accumulate real wealth, and gain personal control over their retirement security.
Moreover, Personal Retirement Accounts (which have worked successfully in countries such as Chile, Australia, and Great Britain, as well as for the unions and many local government employees here in the U.S.), are also the most sensible way to reduce Social Security’s long-term liabilities because these accounts effectively “pre-fund” the retirement costs of tomorrow’s senior citizens.
More importantly, Personal Retirement Accounts will have the most profound effect on closing the growing “wealth gap” between the rich and poor in this nation. Although more than half of all Americans are now invested in the stock market, the wealth divide has been growing over the past seven years. Personal Retirement Accounts, however, would allow 100 percent of American workers to become stakeholders in the U.S. economy. Imagine the social implications of allowing every worker to own a piece of the American Dream.
Click here to view the results of the Zogby International poll that shows support for Social Security privatization.
Some Have Their Head in the Sand
Despite all the evidence to the contrary, there are some national political leaders who are defending the status quo at all costs and denying that anything is wrong with the current Social Security system. But there are twin crises facing the Social Security system and our national political leaders can not hide from this reality:
1. The first crisis is financial. If nothing is done, the system will begin running cash deficits in just 15 years and will need to be bailed out with $11.3 trillion worth of new income taxes or government borrowing to pay its bills between 2015 and 2037, the year the so-called trust fund runs out of IOUs. Its long-term liabilities are even worse.
2. The second crisis is personal. For younger workers, Social Security is becoming a bad deal. Most younger workers are likely to get less back from the system than the amount of taxes they paid into it. After a lifetime of working, that is not fair.
Denying these problems means cutting the standard of living for millions of future workers by forcing them to pay higher taxes – or bear a huge debt burden – to bail out the program, while they remain stuck in a system that will give them less back than they paid into it.
Social Security’s current surpluses afford us the opportunity to allow younger workers to create these new personal retirement accounts while we guarantee our nation’s seniors and near retirees the Social Security income upon which they depend.
The Solution: Personal Retirement Accounts
The best way to increase the rate of return on workers’ Social Security contributions while we reduce the system’s long-term liabilities is through personal retirement accounts. Given the size of Social Security’s current surpluses, we could allow workers to divert as much as 3 percentage points of their 12.4 percent payroll tax into personal accounts without affecting the amount of money Social Security needs to pay current benefits.
1. Social Security faces a severe cash crisis in just 15 years and has an unfunded liabilities 6 times larger than today’s national debt.
According to the most recent report of the Social Security Trustees, the system will begin running large cash deficits in just 15 years, in 2015. Ten years later, these deficits will reach nearly $500 billion. And, by 2037, when a person born in 1970 retires, the IOUs in the trust fund will be gone and the shortfall will reach $1 trillion.
Unless changes are made, there are only three ways to bail out the system: raise taxes; increase the national debt; or, cut other government programs. In fact, income taxes will have to be hiked by at least a 16 percent to pay the system’s bills by 2030, or the government will have to borrow $11.3 trillion to bail out the system between 2015 and 2037 when the trust fund runs out of IOUs.
Social Security’s unfunded liability is 6 times larger than today’s national debt. If you think today’s $3.5 trillion national debt is bad, the size of Social Security’s unfunded debts are positively frightening. Over the next 75 years, Social Security’s cash deficits add up to a whopping $134 trillion – that’s $22 trillion in today’s dollars.
2. But no amount of bailout can change the fact that Social Security is becoming a bad deal for young American workers.
The second crisis is more personal for American workers – Social Security is becoming a bad deal for young workers.
In fact, the younger you are, the longer you work, and the more payroll taxes you pay into the system – the more likely it is that you will get far less back in Social Security benefits than you paid into the system.
This is especially true for young minority workers and blue-collar workers who often have lower life expectancies than their middle-class neighbors.
Example: The Heritage Foundation has calculated that a single, 25 year old woman working in factory will pay more than $167,000 in Social Security taxes over her career, but collect only $215,000 in benefits. After adjusting for inflation, this represents a paltry 0.9 percent return on her lifetime contributions.
Example: An average income, two-earner Hispanic family will pay about $215,000 in Social Security taxes during their working lives, but collect only $420,000 in benefits. After adjusting for inflation, that’s a return of just 2.17 percent on every dollar they paid into the system.
Had these workers been able to put those taxes into a conservative investment account, they could have built a nest egg worth significantly more.
And to make matters worse, when you die Uncle Sam – not your heirs – gets to keep your unused Social Security contributions.
Solution: Personal Retirement Accounts
The best way to increase the rate of return on workers’ Social Security contributions while we reduce the system’s long-term liabilities is through personal retirement accounts. Given the size of Social Security’s current surpluses, we could allow workers to divert as much as 3 percentage points of their 12.4 percent payroll tax into personal accounts without affecting the amount of money needed to pay current benefits.
Q: How would a system of personal retirement accounts work?
A: Workers would be free to redirect a portion of their payroll taxes into retirement investment accounts managed by a wide range of government-approved and regulated companies. Firms such as major banks, insurance companies, brokerage houses, mutual funds, labor unions, and AARP would apply to an independent government board for certification.
Investment returns earned by the accounts would be tax free. The tax treatment of distributions from the accounts would be the same as for Social Security. No withdrawals would be allowed from the accounts until age 59 ½, as with IRAs.
In retirement, workers could use their funds to buy an annuity, paying a promised monthly sum for the rest of their lives, or they could live on the continuing investment returns on their fund and leave all of the principle to their children or favorite charity.
Q: Al Gore says there are considerable risks involved in a Personal Retirement Account system. What’s the truth?
A: First, we already know Social Security is becoming a raw deal for young, working Americans. This is especially true for minority and blue-collar workers. They will likely get less back in benefits than they paid into the system. Personal Retirement Accounts represent a huge upside to these workers. (And, don’t forget, Social Security faces a $22 trillion unfunded cash shortfall.)
None-the-less, a new system of Personal Retirement Accounts would include a guaranteed minimum benefit for all workers at least equal to the benefits they would have received from Social Security. And, workers would be free to stay in the Social Security system if they preferred not to subject themselves to the risks, and rewards, of the investment market.
However, as is now well known, the average real return on stock market investments over the past century is about 7 percent. Studies have also shown that the worst 30 year performance of the stock market in U.S. history provided a real return of 5.2 percent. Indeed, the worst 63 year performance (reflecting an adult lifetime) provided a real return of 6.3 percent.
Q: Won’t there be huge transition costs as we shift from the current system into a system built on Personal Retirement Accounts? In other words, won’t workers be forced to pay for two systems at the same time, their own retirement and the retirement of their parents?
A: First, let’s remember that Social Security’s current unfunded cash shortfall is $22 trillion in today’s dollars. Since those are the costs of doing nothing, its safe to assume that the costs of changing to a pre-funded system, even while paying the benefits of today’s retirees, will be considerably less.
In fact, moving to a pre-funded system through Personal Retirement Accounts will substantially reduce the program’s massive unfunded liabilities which, in turn, substantially reduces the tax or debt burden on the next generation of workers.
There are many possible sources of financing for this transition, including:
Tap the $3.5 trillion in projected Social Security surpluses over the next 15 years;
Tap some of the roughly $1.5 trillion in non-Social Security surpluses projected over the next 15 years;
Sell “transition” bonds which would be retired after the transition is completed.
Q. Have Personal Retirement Accounts been used anywhere else?
A. Yes, in many countries such as Chile, Australia, and Great Britain. In fact, nearly twenty years ago, Chile began allowing workers to opt into personal retirement accounts after its social insurance system collapsed. Since then, the personal retirement accounts of Chilean workers have gotten an average rate of return of 9 percent per year.