The Death of Social Security

Debating Bush's plan for private retirement accounts.

James K. Glassman & Tyler Cowen from the April 2005 issue

As George W. Bush's second term begins, no item on his agenda is more controversial than Social Security privatization--that is, allowing Americans to divert at least some of their payroll taxes into personal accounts that they can invest in mutual funds or similar instruments. So far, Bush's own plan has been maddeningly vague, but it has opened up a serious debate about transforming a government program that was once so sacrosanct that it was called "the third rail of American politics."

Is privatization necessary? Preferable? Politically viable? In January, with Bush's second inaugural in the offing, Reason invited James K. Glassman, a fellow at the American Enterprise Institute and host of TechCentralStation.com, to discuss and debate the ins and outs of Social Security reform with Tyler Cowen, the Holbert C. Harris professor of economics and director of the Mercatus Center at George Mason University.

Social Security's Fortuitous Crisis

James K. Glassman

This August marks the 70th anniversary of Social Security. If it ever had a reason to exist, it doesn't any more.

Social Security has three big problems, all of which can be solved by allowing Americans to invest--on their own --part of what they are now forced to send to Washington in payroll taxes.

First, Social Security is a blight on liberty. It extracts a big chunk of the pay of working people to benefit the retired. The vast majority of Americans are perfectly able to handle their own retirement savings, just as they buy their own food, clothes, and shelter. Even if we concede that government needs to force all Americans to save today so that taxpayers won't have to chip in to prevent the profligate from starving in their old age, why do we all have to buy the same annuity with the same terms from the same provider--that is, the government itself?

Second, Social Security creates a vast moral hazard. Since its implicit message is "Don't worry--Uncle Sam will protect you in your old age," it's a huge encouragement to spend rather than to save for your own or your family's needs.

Third, Social Security is a terrible retirement system, a Ponzi scheme that was inevitably going to collapse of its own weight. Instead of a conventional retirement account, with real assets accumulated over time, it was constructed as a pay-as-you-go plan: Current workers pay the bills of current retirees. (There's a small amount left over for a so-called trust fund, which predictably has become a piggy bank for the rest of the government.)

The first retirees in the system were big winners. For example, the very first recipient, Ida May Fuller, paid in $44 and collected benefits of $20,934. Times were different then. In the 1930s, 11 workers supported each retiree. The ratio is now 3.3 to 1. Soon it will be 2 to 1 and stay there. In 1929 life expectancy was 57; today it is nearly 80. Americans receive benefits far longer than they did before, and they can start earlier. Meanwhile, work force growth is slowing, and benefits are rising faster than inflation, since they are geared to wages, not prices.

As a result, by 2018, according to current predictions, retiree benefits will exceed workers' taxes paid into the system. Social Security will then present its IOUs to the Treasury for payment. The only way to get the cash will be to raise taxes, cut other government programs (fat chance), or borrow like crazy.

The system has been saved from insolvency in the past mainly by higher taxes. As a result, the actual returns that workers will receive from their contributions are minuscule: an estimated 1.5 percent annually after inflation for a typical person born in the last 30 years. Compare that with the average yearly return since 1926 from an account invested half in a stock index fund and half in Treasury bonds: 5 percent after inflation.

It's not surprising that young people especially have little taste for Social Security and little faith it will survive. The good news is that the impending disaster offers an opportunity to fix Social Security once and for all. The solution should:

� Guarantee the benefits of everyone now getting them, as well as others on the brink (say, those 55 and older).

� Gradually index future benefits to inflation, rather than wages, and increase the retirement age (currently 65 for those born before 1960, 67 for those born afterwards) by another year or two.