No Easy Way Out

Fixing Social Security can't be painless.

John Attarian from the July 1996 issue

(Page 2 of 3)

It doesn't add up. The same dollar cannot go into both Tier 1 and Tier 2. Paying current retirees all present-law benefits (Tier 1) would, we saw, require 90 percent of payroll taxes. But creating "100 million millionaires" (Tier 2) would require all payroll taxes, at least on incomes up to $12,580. Beard's plan would allow someone at the maximum taxable income to put $1,560 of payroll taxes into Tier 2, or 20.6 percent--more than twice what a 90/10 split permits. The conclusion is inescapable. We can use payroll taxes to pursue one goal or the other, but not both.

Something's got to give.

Sure enough, in Restoring Hope in America,Beard escapes into something called Liberty Bonds "to finance the two-tier system." Liberty Bonds are "a new financial instrument" that would offer Americans "the opportunity to trade promised Social Security benefits which come due from 1996 through 2025--a thirty-year period--for a future benefit." Retirees with "more adequate" income from private means can voluntarily defer receiving benefits and instead pass them on tax free after 30 years (2026-2055) to their heirs or others.

Stripped of promotional humbug, Liberty Bonds are Beard's tacit admission that his plan doesn't work, that it overpromises, that it is unsound and must be "financed"--bailed out by asking current retirees who can afford it to lend Social Security money in exchange for not getting their benefits on time. Beard draws a specious analogy with a bankrupt firm asking creditors to accept deferred payment: "The business will bring in a large infusion of capital, and pay off the creditors once profits return. Similarly, Liberty Bonds will infuse cash into Social Security." It takes monumental effrontery, the kind found in banana republics negotiating with Western banks, for a deadbeat not only to stiff his creditors but to ask them to lend him more money. Worse, this particular deadbeat's only "profits" for repaying his creditors are taxes on those selfsame creditors or their children.

Coercion is statism's last resort when it runs out of tricks, and so it is here: "If a voluntary plan does not work, I recommend implementing the Liberty Bond system on a mandated basis...a scaled formula could be created whereby Liberty Bonds...would become mandatory." This is a singularly obnoxious stiffing of retirees with private savings, penalizing them for being provident and thrifty. Mandatory "Liberty" Bonds also amount to taxing retirees--who thus get taxed twice, once in their working years and again in retirement--by forcing them to buy 30-year IOUs on their benefits. And whether voluntary or mandatory, 30-year benefit deferral is tantamount to benefit termination. So much for keeping all promises to current retirees.

The other possible escape is to raise payroll taxes on selected victims. As described by Rick Henderson in the March issue of REASON, Beard's plan implicitly does this: "Workers who pay more than $3,000 a year in Social Security taxes couldn't invest all of their payroll taxes privately; benefits for current retirees would come from the payroll taxes these higher-wage workers pay." Translation: Taxpayers with taxable incomes between $24,194 a year (which corresponds to a $3,000 payroll tax) and $61,200 (the maximum) would carry the whole burden of supporting current retirees. Exempting taxable incomes up to $24,200 (rounding again for simplicity's sake) substantially narrows Social Security's tax base. Common sense says that if we narrow the tax base, we must raise tax rates to obtain the same revenue. Workers with $24,200 to $61,200 in taxable income would have to pay much higher payroll taxes.

This would be an economic and moral disaster. The Social Security Bulletin's 1994 annual statistical supplement includes tables giving the number of workers with taxable incomes below the 1991 maximum of $53,400 (since then increased, but these figures suffice for illustrative purposes). It turns out that workers with incomes below $24,200 paid 38 percent ($121 billion) of 1991's total payroll tax revenue ($317 billion); workers with incomes from $24,200 to $53,400 paid 62 percent ($196 billion). So if workers with incomes below $24,200 had been allowed to put all their payroll taxes into Tier 2, and all of them did so (which would be their rational choice), in 1991 Social Security would have lost 38 percent of its revenue.

Now, if people with taxable incomes from $24,200 to $53,400 were to support the retirees, they would have had to pay not $196 billion but all $317 billion, or 62 percent more. In other words, had Beard's plan been operating in 1991, these "higher-wage workers" would have had to pay a 62 percent higher payroll tax rate--i.e., 20 percent--all of it going into Tier 1, none into IRAs. So much for creating 100 million millionaires via payroll taxes. With today's maximum taxable income of $61,200, this tax hike would be smaller but still substantial. To use the payroll tax as an instrument of forced saving for these workers, so they too could have Tier 2 accounts, their taxes would have to go higher still.

Thus, this version of Beard's two-tier plan necessarily means a two-tier tax rate, with an abrupt, sharp jump when one's income hits a mere $24,200 or so. The effect on work incentives would be disastrous. It is not the plutocrats who would suffer--Social Security does not tax income above $61,200--but the middle class and small-scale entrepreneurs, who would despair at hitting so high a tax rate so quickly.

At work here is not only Beard's flight from a fiscal bind of his own making but his egalitarian agenda of democratizing capital ownership. Lower-income taxpayers would be allowed to escape payroll taxes and become "minimum-wage millionaires"--thanks to bleeding even modestly higher incomes. Far from ushering in a utopia of saved Social Security, 100 million millionaires, and an ocean of capital to finance fabulous growth, Beard's plan is a grim recipe for economic cannibalism.

In sum, Beard's two-tier plan cannot do what it promises to do without doing precisely what it promises not to do: raise taxes or cut benefits. It cannot work without making somebody suffer.

Even if none of these problems existed, fiscal realities would kill the plan in the cradle. The Social Security Board of Trustees' actuarial analysis using "high-cost" assumptions-- the most realistic--projects that in 1999, payroll taxes will stop generating a surplus. In just three years, there will be no payroll taxes to spare for Tier 2.

This exposure of the Beard plan's calamitous weaknesses is a cautionary tale for two- tier plans in general and for the whole Social Security reform debate. There simply isn't enough wiggle room to allow current taxpayers to both pay full current retiree benefits and build nest eggs from payroll taxes.

As for Chilean-style privatization, its private pension option for taxpayers is analogous to Beard's Tier 2 and would likewise create a revenue shortfall requiring coverage, perhaps from general revenue, to pay current retirees full benefits. Again, making it work would require either beneficiary or taxpayer sacrifices.

The brutal truth is that Social Security's prospects are so bleak, and we have evaded reality for so long, that a cheap, painless solution is not possible. Beneficiary or taxpayer suffering is inevitable and necessary. Our first task here is to look reality in the face. That means admitting that you can't get something for nothing. It also means publicly demolishing the pernicious myths of Social Security, which still grip the minds of millions, including Beard. One doesn't get what one paid in; benefits are not an "earned right"; Social Security isn't retirement insurance. We have to face the immorality of Social Security, too. It is wrong to force people to support others. It is wrong, an odious abuse of trust and breach of faith, to lie to young and old about what is going on. And a system grounded in coercion, deceit, and dishonor does not deserve to survive. We must abandon the delusional entitlement mentality itself. There is no entitlement to comfortable retirement. Asserting that one exists doesn't make it true. The only guarantee in life is death.