Start Saving Now, Because Social Security Is Screwed

If Congress doesn't address its insolvency issues, payouts will need to be slashed by a quarter starting in fewer than 20 years.

The single largest government program in the United States will soon have an annual budget of $1 trillion a year. Yet even that amount isn't sufficient to fulfill the promises it has made. If Congress doesn't address its insolvency issues, payouts will need to be slashed by a quarter starting in fewer than 20 years.

The program is Social Security, and our national pastime seems to be turning a blind eye to its dysfunctions.

The problems with this entitlement aren't unique. Obamacare is also a mess, while cumulative government spending on Medicare and Medicaid is growing at a faster rate than Social Security is, and eventually will consume a larger share of the economy.

But that's no reason to ignore the serious fiscal issues with America's main retirement program. Since 2010, it has been running a cash-flow deficit—meaning that the Social Security payroll taxes the government collects aren't enough to cover the benefits it's obliged to pay out. That should have been a signal that the time had come to look at reform.

Instead, we've spent the last seven years ignoring the problem. To get by, the program started tapping into the assets set aside beginning in the 1980s for rainy days. Prior to 2010, the program collected more in payroll taxes than was needed to pay the benefits due at the time. The leftovers were "invested" into Treasury bonds through the so-called Old Age Trust Fund, which is now being drawn down.

In fact, the Treasury bonds are nothing but IOUs. When it's time to disburse benefits they can't afford, Social Security administrators turn in those paper promises in exchange for hard cash from the Treasury Department.

But Treasury also doesn't have the money: It has already spent it on wars, roads, education, domestic spying, and much more. So when Social Security shows up with its IOUs, Treasury has to borrow to pay the bonds back. That adds to the debt that future generations will be on the hook for via higher taxes.

Did you catch that? Past generations of workers paid extra payroll taxes to bulk up the Social Security system. But the government spent that additional revenue on non-retirement activities, so now your children and grandchildren will also have to pay more in taxes to reimburse the program.

You may be tempted to wave away this problem. After all, there's more than $2.3 trillion left in the trust fund.

Don't. The Social Security trustees have calculated that the cash-flow deficit over the next 80 years will amount to a staggering $44.2 trillion, and that's after adjusting for inflation. Under current projections, the make-believe assets in the fund will only be enough to pay full benefits until 2034. At that point, the system will have to revert to paying out only the amount taken in through annual taxes. And that means benefit cuts across the board of 25 percent.

This will screw up everybody's plans, but it will be especially hard on lower-income Americans, who are more likely to depend entirely on the program during their later years.

Options for reform at that point will be limited. With the national debt projected to be 105 percent of GDP, or $39.1 trillion, in 2034—and with Medicare and Medicaid facing even bigger long-term problems—Congress will be too broke to restore full benefits for all. The most likely scenario is that higher-income earners will see their benefits disproportionately reduced, their taxes disproportionately hiked, or both. To them I have but one piece of advice: Start saving now.

Given this predicament, Congress should make it easier for all Americans to save. One way to do that is through the creation of Universal Savings Accounts, or vehicles that allow people to invest money without all the complicated rules that now apply to IRAs and 401(k)s. In addition, Congress should boost the maximum contributions people can make to Health Savings Accounts, so that more Americans can afford the medical expenses most of us inevitably incur in our old age.

More broadly, Congress should shift away from Social Security into a "funded" system based on real savings, much as Australia and others have done. The libertarian economist Daniel J. Mitchell notes that, starting in the '80s and '90s, that country has required workers to put 9.5 percent of their income into a personal retirement account. As a safety net—but not as a default—Australians with limited savings are guaranteed a basic pension.

That program has generated big increases in wealth. Meanwhile, Social Security has generated big deficits and discouraged private saving. Who would you have emulate the other?