Tuesday, January 4, 2011

Fixing Social Security

Based on analysis in the annual report of the Trustees of the Social Security program,  the Social Security Trust Fund will experience negative cash flows as early as 2016.  That means cash outflows of benefits paid to recipients will exceed taxes paid in by citizens to finance the benefits paid out.  Unless Congress makes changes to the system, the fund will be entirely depleted by 2037. 

Dollars withheld from our pay checks as OASDI taxes are not placed in the Social Security Trust Fund (SSTF).  In fact, all that’s really in the SSTF is an electronic record of U.S. Treasury debt.  Since Congress runs an annual budget deficit in the hundreds of billions of dollars, all that’s in the Social Security Trust Fund (SSTF) is U.S. Treasury bonds.  That means the U.S Treasury is promising to reimburse the SSTF, plus interest, as the bonds mature in the future. 

But it wouldn’t matter if the SSTF actually had Federal Reserve Notes (i.e., real paper dollars with pictures of dead presidents on them) in Al Gore’s infamous “lock box.”  People can no more eat, be sheltered by, nor be housed by paper dollars than by paper Treasury bonds, let alone zeros and ones recorded on a hard drive in Washington. 

Our Social Security system is deeply and fatally flawed.  It is a poorly designed pension program cobbled to a poorly designed welfare program cobbled to a poorly designed disability program, all of which began during FDR’s New Deal push toward socialism.  Considered alone, none of the elements of what we now call Social Security would likely have been passed into law. 

Cobbled together during the Great Depression and subsequently amended to become the largest income transfer program in U.S history, Social Security must now be reformed.  Congress no longer has a choice.  One wonders if “the third rail” of politics will electrify some of the 545 who rule the land

Congress will likely be forced to reform the program within the next two or three years.  Since the current system is a pay-as-you-go system, once current OASDI payroll tax collections fall short of current benefit pay outs, continued payment of benefits will only increase the federal deficit faster.  Whatever fix Congress pursues, there will be blood.

Three principles guide my skeleton proposal for fixing Social Security.  First, the fix must not impede or slow economic growth, because without economic growth, fewer workers cannot possibly produce enough real goods and services to meet their own consumption demand plus the consumption demand of millions of Baby Boomer retirees.  The real issue is about real economic growth and increasing productivity of labor. 

The issue most certainly is not how much money is in a lockbox, and it is not how many workers per retiree we will have in future decades.  The number of workers per retiree has fallen for decades as technology improved productivity.  That’s a good thing, not a bad thing.

Think how great it would be if we could sustain all our consumption demand using the output produced by just 100 workers.  If 100 workers could be that productive, the rest of us could all enjoy using our time for whatever we like, 24 hours per day.  Productivity that high is not just around the corner, but that’s the direction technology takes us. 

Technology has always moved us toward greater productivity throughout history, and I am optimistic that it will continue to do so in the future at an ever-accelerating rate. Some might say I am delusional, but I choose to remain a technology hawk.

Second, the fix must not raise taxes to levels that discourage work effort, technological innovation, and investment in capital goods.  We cannot tax ourselves into economic prosperity that can sustain both a reduced work force and an enlarged retiree pool.  But we can certainly tax ourselves into reduced work effort, reduced private saving, and diminished investment in technology and capital investment. 

Without investment in technology and capital goods that voluntary exchange markets foster, the increases in worker productivity we’ll need ahead just won’t happen.  Government is not innovative; government does not create new technology; government does not put plant and equipment in place; government does not and cannot produce the goods and services future retirees expect to enjoy.  Private businesses operating in voluntary exchange markets do all those things.

Third, and perhaps most important, the fix must not expand the intervention of government in voluntary exchange markets, further deepening the dependency of the masses on a Robin Hood government, and further entrenching the power of the 545 over  the people.  I argue against government intrusion on two grounds: (1) it’s morally wrong to compel other people, which is a normative proposition, and (2) government intrusion doesn’t solve the economic problem with maximum economic efficiency, which is a positive proposition.

Logic and the record throughout all history show that maximum economic efficiency requires voluntary exchange.  The Social Security program we have today is the result of misplaced faith in government intervention–intervention that transfers income from people who earn it to people who did not. 

Some who favor such income transfers say the transfer is from the wealthy to poor, from the haves to the have nots, from people who have more than they need to people who have less than they need.  But even if that were the case, transferring income on the scale required by our Social Security system cannot be sustained.  Transferring income simply is not and has never been a viable solution to the economic problem. 

I propose that Social Security benefits be phased out over a period of 25 years.  During the phase out, the percentage of OASDI taxes going to finance benefits of current recipients would reduce from today’s 15.3% to zero percent.  The percentage of OASDI taxes going to finance Personal Retirement Accounts, which would be recorded in the names of and owned by individual workers, would rise from zero percent today to 15.3% in 25 years. 

The percentage of OASDI taxes going to mandatory Personal Retirement Accounts would be invested in two index mutual funds, one that tracks the Wilshire 6000 stock index and one that tracks a market-weighted bond index with a long-term dollar-weighted average maturity, a fund such as Vanguard’s Long-Term Bond Index Fund (VBLTX). 

At the end of the 25-year phase out period for Social Security, all government-mandated retirement pensions would be financed entirely by each individual’s wholly owned Personal Retirement Account.  Social Security as we know it today would be gone forever. 

The increased private saving mandated by Personal Retirement Accounts would quicken economic growth. The elimination of Robin Hood transfer payments would promote work effort and foster reliance in individual accomplishment and responsibility. The reduction of government intervention in voluntary exchange markets would increase economic efficiency, allowing the economic pie to grow as large as possible so that each American could enjoy a larger slice of a larger economic pie.

Of course, given the Social Security errors of our past, there will still be blood. Remember, there ain’t no such thing as free lunch (TANSTAAFL, hat tip to Robert Heinlein).  But recognizing that reforming Social Security imposes costs of transition cannot rise to the level of an decisive argument not to move to Private Retirement Accounts. 

Sadly, I doubt, though, that Congress will pursue the proposal I’ve outlined in this essay.  That would take courage and statesmanship, and both are in very short supply in Congress.

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