Shore Up or Ship Out?

The 1982 elections raised the level of demagoguery to new heights on the issue of Social Security. The same pious windbags who set up a pay-as-you-go system but fraudulently called it "insurance," who expanded it pell-mell in the 1950s and '60s, who threw caution to the winds in the '70s by legislating benefit increases that could never be paid—these same "public servants" denounced as uncaring monsters anyone courageous enough to point out that the system cannot survive as it is.

In none of the political debates has the full truth been uttered: Social Security is a pyramid club, and like any pyramid club or Ponzi scheme, it must sooner or later come to a halt when it runs out of suckers. Today's short-term funding crunch is but a preview of the system's longer-term crisis. Soon after the turn of the century there will be just two workers for every person retired (instead of the three at work today). Total Social Security taxes would have to be as much as 40 percent to ensure the kind of benefit levels people think they've been promised. Clearly, there is no way workers in the year 2020 will put up with such crippling rates of taxation.

Thus, any fundamental solution to the Social Security mess must come to grips with one basic fact: the politicians lied. They lied when they called it insurance, they lied when they told people their contributions "entitled" them to specific future benefits, and they're lying today when they promise that with a little tinkering everything will continue as before. It won't because it can't. The money is simply not there.

A political reaction to the heretofore invincible clout of "senior power" is starting to appear. Horace W. Brock of Strategic Economic Decisions, Inc., speaks for 131 million Americans under 35 by pointing out the way Social Security discriminates between generations. The average married worker retiring today at 65 gets back his entire Social Security contributions plus accrued interest in just 2.2 years. Yet the payback period for today's 30-year-old who retires in 2015 would be 10.1 years (using realistic assumptions about the economy's performance).

So today's retiree is getting a 400 percent better deal than the baby-boom generation can expect. And by 2030, retirees will get back less than their contributions, according to the Institute for Socioeconomic Studies. Today's Social Security system, concludes Brock, "amounts to institutionalized pickpocketing of tomorrow's elderly by and for the benefit of today's elderly."

Moreover, as Harvard economist Martin Feldstein has demonstrated, basing our retirement system on a pay-as-you-go plan reduces people's incentive to save for their old age. Total US savings are cut in half by the existence of Social Security, Feldstein estimates. The result is a lack of capital investment. Money that would be put into mutual funds and other investments that permit industry to modernize goes instead directly from today's workers to today's retirees. Feldstein has estimated that our Gross National Product is 11 to 12 percent less than it otherwise would be because of this lack of capital investment.

Tragically, the president's Commission on Social Security Reform has dodged the real issues. All it has come up with is a hodge-podge of tax increases and benefit adjustments to allow the system to scrape past its short-term crisis while ignoring the fundamental long-term problem. That is hardly surprising, given that the average age of the commission members is 58. The entire under-45 population has been left out, both in the make-up of the commission and in its recommendations.

Surely chairman Alan Greenspan, who learned many of his social and economic ideas at Ayn Rand's knee, knows better. A whole generation of economic thinkers—Michael Boskin, Milton Friedman, Thomas Sowell, Norman Ture, Walter Williams—have identified Social Security's fundamental flaw and urged real reform. Apparently Greenspan the establishment politician has overruled Greenspan the knowledgeable economist.

What do these economists all recommend? All agree that Social Security's welfare function and insurance function are in conflict, that the two should be separated, that the welfare aspects should be handled along with other welfare programs, and that the insurance function could be operated on normal insurance-annuity principles.

The most comprehensive ideas on how to do this have come from Peter Ferrara, now on the White House staff. His transition proposal would phase out payroll taxes, spin off the welfare functions, and rely on an expanding program of Individual Retirement Accounts (IRA)s to take over the insurance functions. People already retired or nearing retirement would continue to receive present benefits during the several-decade transition period.

But where Ferrara's plan would drain up to $40 billion a year from "general revenues" to continue present benefit levels during the transition, we'd suggest a less-costly approach. As the Adam Smith Institute has suggested (p. 12), let's take people at their word that they've paid for their benefits. Give everyone a certificate equal to the value of his or her accumulated "contributions" plus interest. When deposited with an IRA firm, the certificate would be exchanged for a government bond, redeemable when the person retires.

This approach is a compromise between the wishful thinking that people are "entitled" to benefits irresponsibly promised them and the reality that the money has already been spent and is not there. Simply giving people the value of what they have paid in would still cost many billions but could probably be financed by selling off federal assets.

Sooner or later, reality must be acknowledged. Social Security is an issue that affects every generation, not just those at or near retirement age. Everyone wants a secure retirement. And we all want a healthy, prosperous economy. Today's Social Security system threatens both. It must be rethought and restructured. For openers, we can throw out the report of the president's commission and start fresh. But we need not start from scratch. The blueprints for real reform already exist. All we need is the courage to work with them.