To recap last month's article, we took a look back at Social Security's creation and how it has evolved into an overly burdensome and fully inefficient program. The taxable wage base has skyrocketed from $3,000 to $106,800 and the Old Age and Survivor's tax rate has more than tripled, but still the "Trust Fund" is scheduled to be depleted in 2037. This supposed Trust Fund has been used as a mechanism to fund all sorts of government expenditures through purchasing federal bonds that will someday need to be redeemed. Where the cash will come from at the point benefits owed exceeds tax revenue (2016) is a mystery to us all!
So how long will we keep pouring money into a program that cannot survive in its current state? Social Security reform has been heavily debated with all political parties agreeing that something must be done, but the agreement stops there. Of all the proposals out there, only one really seems to make sense and that is privatization. I am going to take a look at the meaning of privatization, the main concerns and objections as well as the alternatives.
Privatizing Social Security would mean allowing each individual to invest and manage their own account, rather than allowing the federal government to do so in a collective pool for everyone. Based on the annual salary limits and tax rate, young to middle-aged workers are faced with the prospect of receiving retirement benefits that represent between 0-1.5% return on their lifetime contributions. I am positive the private market could easily beat that level of return and we wouldn't have to worry about the government's mismanagement! To add a little clarity to the privatization debate, I'd like to address some of the main concerns that have been put forth thus far.
Private accounts are too risky. Let's be clear about one thing; accounts are not risky. It's the investments in the accounts that are risky. To that end, beating the current 1% you're getting from Social Security doesn't require taking on any risk. This myth is spawned from the belief that Social Security is currently investing in Treasury Bonds that are yielding bond market based returns. Accepting this at face value, which in and of itself is hard to do, then why are we only offered retirement payments that equate to an average annual return of 1%? Those supposed long-term bonds should be yielding around 6%. Does this imply that the government is charging a 5% management fee on their bond fund or are they investing in some sort of special 1% Treasury bond that is sold only to the Social Security Administration? If every bit of Social Security tax you and your employer paid went into a private account and was invested in Treasury bonds (the very same bonds the "trust fund" claims to own), you would retire with 3-times the amount of income currently offered. Although we don't think they should be excluded, the argument that private accounts are too risky is easily defused by removing equity securities as an option for private account investment.
Privatization is too expensive. If the Feds were to get out of the retirement planning business, the cost would be enormous. The process would require weaning the government off the Social Security tax revenue over many years. This is precisely why most reform proposals only involve redirecting a small portion of the tax dollars into private accounts - they have to start small. Be assured that the long-term goal of the reform movement is to eventually have all withholdings directed into private accounts. To help fund this transition younger Americans would have to be willing to forego any benefits that they have accrued so far. This is why the superior long-term prospects of stock-based returns are being discussed so much. It is hoped that the chances of higher returns will be enough to entice young Americans to opt-out of the current system. This is where the real success in transitioning will occur. It is the future liabilities of these young people that add the highest costs.
Another point to keep in mind about some of the cost figures being tossed around is that none of this is going to occur overnight. The alarmists will loosely throw around trillion dollar figures without providing the framework by which that will come about. These costs that the government will have to expend will take generations to be fully realized. Keep in mind that the cost of Social Security on its current path will be far greater than the costs of transitioning to privatization. The really frightening figures become evident when you look at waiting to fix the system when it is near collapse. If people are truly afraid of the costs of reform, they should be pushing for a faster overhaul of the system rather than none at all.
Social Security is the only income for many seniors. Under no circumstances is anyone even remotely contemplating changing anything about the system that would affect current retirees. To imply otherwise is nothing less than dishonest. Paying for the current retiree obligations are the least expensive liabilities that the program faces. It is the youngest participants (individuals in their 20's and 30's) that pose the greatest risk to solvency. One point of irony here is that a system designed as a safety net for seniors has become so burdensome that it will most certainly be the major cause of poverty among retirees in the future due to its mismanagement.
This will only enrich the financial services industry. This argument appeals to the conspiracy theorist. Although it might seem a little self-serving because our firm falls into this category, this argument is just plain silly. It's a little like saying we shouldn't have electricity because the power company may make money on it. While it is true that privatization would be a huge boost to the financial services industry, that doesn't mean that anyone would be forced to use their services. As we've discussed earlier, simply buying Treasury bonds (a totally free transaction available at www.savingsbonds.gov) would provide you with higher returns than you're currently getting from your Social Security contributions.
People can't be trusted to make wise investment decisions. This comes from the big government camp. These are the people who think that every problem, real or imaginary, can be fixed with a government program. This is mostly a philosophical argument. We would respond by saying that this government program has had 70 years to get it right, and has yet to do so. Let's try something different.
All kidding aside, it is true that there are a great many poor decision makers out there. By definition, that's why we need some form of forced savings program. The objections to the current system arise from the mismanagement of those funds and not by its existence. Any program that would involve private accounts would be tightly controlled and would have limited investment choices for those funds.
Now that we have taken a deeper look into privatization, let's consider the alternatives. While there are many proposals that keep an entirely government run system, they all fall into two categories: they either raise taxes or cut benefits.
Three common proposals for increasing tax revenue include raising the Social Security taxable wage base which is currently set at $106,800, increasing the payroll tax rate and raising taxes on Social Security benefits. I think I made how I feel about raising Social Security taxes clear in last month's article so I won't harp on it again here!
There are a variety of ways to cut Social Security benefits. One way would be to increase the retirement age. Supporters suggest that as life expectancy increases, workers will be able to work longer. While this may be true for some workers, we all know that the older we get, the greater the chances for disability and other health issues. Another proposed way to reduce costs would be to reduce the Cost of Living Adjustment. The COLA is the percentage by which benefits increase year to year. Without the COLA, retirees would continuously lose purchasing power. Supporters of the current system have also proposed indexing benefits to prices rather than wages since prices increase more slowly than wages. While all these proposals would help with the Social Security shortfall, they are all at our expense and offer us nothing but a lower standard of living in retirement.
I hope that I've been able to hit the high points in this debate and that you have found this informative. This issue obviously hits close to home for us and we think it is far too important to have this decision based on which special interest group or political party can spin it the best.
Our belief is that if a financial account is truly yours, at a minimum, it should:
Be in an account with only your name on it.
Regularly provide a statement that values the account in today's dollars.
Contain investments that can be sold close to the price quoted on the statement.
Here is one last thought on private accounts; under the current system, we are all subject to a stealth estate tax, regardless of wealth. It is currently impossible for your Social Security contributions to be passed on to your heirs because there is no value associated with your benefits. With private accounts, you would have this ability because there would be an identifiable account with your name on it. This would particularly help the least wealthy in our society. And most notably, the government would not be allowed to confiscate what is rightfully yours upon your death.
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