Saturday, February 05, 2005

The truth about Social Security

What strikes me most about the arguments over Social Security is how many people just don’t get it.
They might understand, in a general way, that the system is in trouble. They might even know that it’s supposed to run out of money someday. What they don’t get is how seriously out of whack our national retirement system has become or how painful the solutions will have to be. Should someone suggest a fix that might remotely affect them, they howl bloody murder -- as if any of us working folk will be able to emerge from this financial debacle unscarred.
There’s a $45-trillion gap, in present value terms, between the future money the government is expected to take in and what it’s promised to pay out, with Social Security and Medicare accounting for virtually all of the shortfall. That’s according to economists Kent Smetters and Jagadeesh Gokhale, who studied the issue for the U.S. Treasury Department. (You can read testimony Smetters gave to Congress on the topic here.)

To put this mind-numbing figure in perspective, the Federal Reserve estimates the total net worth of every person in the U.S. to be around $40 trillion. Our massive U.S. national debt is about $7 trillion.

Net tax rates would have to double to pay for all the benefits promised, Kotlikoff and Burns say. If you think you pay too much now, think about handing over twice as much.

Just dealing with the Social Security deficit would require a 4.5 percentage point increase in payroll taxes, the authors say. Such an increase would take the combined Social Security tax to nearly 17%. (Currently Social Security takes 6.2% of workers’ checks while employers contribute another 6.2%, for a total of 12.4%.)

All these calculations were made before Congress passed the prescription drug benefit for Medicare. That’s expected to add another $6 trillion to the gap.

Waiting to fix the system just makes matters worse. The gap could grow to more than $76 trillion if lawmakers delay reforms another 15 years.

Our kids’ world: higher taxes, inflation, instability
In other words, each year that we stall, we put a bigger burden on the back of today’s children. The world they’ll face, as painted in grisly detail by the authors, features much higher tax rates, stunning deficits, massive inflation and political instability, among other ills. The current transfer of wealth from the young to the old -- and, in some cases, from the poor to the prosperous, as I wrote about in “How Social Security cheats you to pay the rich” -- could reach astounding proportions.

The core of the problem is demographics. Fifty years ago, there were 16 workers to support every person receiving a Social Security check. By 2030, there will only be two.

There aren’t any easy fixes; Kotlikoff and Burns argue persuasively that most of the ones routinely offered -- delayed retirement, increases in productivity due to technology or more immigration -- won’t come anywhere close to realistically solving the problem. (Relying on immigrants to maintain the ratio of workers to beneficiaries, for example, would require an influx of 4 million to 6.5 million immigrants a year, the authors say. That compares with the 825,000 legal immigrants and 400,000 or so illegal ones we get annually now.)

The authors’ solution is to back away from Social Security’s founding premise as a safety net for the elderly. Instead, they want to convert the system into a kind of restricted 401(k), with:

Individual accounts. Workers would get their own accounts, but their mandatory contributions would be invested in a massive global index fund of stocks, bonds and real estate. There would be none of the day trading that some proponents of privatized accounts dream about. The transaction costs of allowing people unfettered access to their money, plus the risk of failure, would be too high, the authors say.

Few guarantees. Your rate of return would depend on market forces and wouldn’t be guaranteed. Your principal would be, however. The least you’d get back is everything you paid in, and your balance could be bequeathed to heirs if you died prematurely.

Annuitized payouts. If you made it to retirement age, you wouldn’t be able to get your benefits in a lump sum. Your account would be converted into an annuity that would pay you a stream of income for the rest of your life. Rather than replacing a certain portion of your working salary, the size of your monthly checks would depend on how much you and your employer contributed, plus how well your investments performed.

Given the world we’re setting up for them, twentysomething workers should be marching on Washington right now with pitchforks and torches. The reason they aren’t is probably because, like most everybody else, they just don’t get it.