Commentary

A Penny Saved Is a Penny Earned

By Carrie Lips
March 11, 1999

Saving is a virtue. That’s what we’re taught as children: we learn Franklin’s memorable phrase, “A penny saved is a penny earned,” and absorb images of dutiful squirrels packing nuts away for the winter.

In talking about the need to “save” Social Security, President Clinton has paid lip service to the virtue of saving. Unfortunately, his actual reform proposal leaves in place a tax-and-spend system and fails to give individuals a real opportunity to save.

In fact, the centerpiece of the president’s proposal has nothing to do with Social Security at all. Instead, he suggests creating a new “savings entitlement” with the clever moniker “USA Accounts.” So far, we don’t know much except that it will leave the current Social Security program unaltered while it uses up 12 percent of the projected budget surplus. At best, individuals might get a small amount of money back from the government for an account.

But this gesture toward savings is dwarfed by the federal government’s gigantic anti-savings retirement program, Social Security. Each year Social Security swallows up 12.4 percent of each worker’s paycheck with one hand and then sends out checks worth $400 billion to be consumed by retirees with the other hand. This means a worker who earns $20,000 a year loses more than $2,000 to Social Security. This is money that is not saved and is not earning interest for that individual. The lost opportunity for this worker is considerable: $2,000 per year in an account that provides an annual return of just 5 percent would grow to be more than $150,000 after 35 years.

Instead, Social Security takes this revenue and promises workers a defined benefit. At best, the payments will represent a 1 percent rate of return for young workers; but many young workers can expect a negative return on the dollars they send to Social Security. According to Lawrence Kotlikoff, professor of economics at Boston University, the average 20-year-old male can expect to pay $182,000 more in Social Security taxes than he will receive in benefits. That’s hardly a savings program, by anyone’s definition.

Another indication of the president’s disingenuous approach to encouraging savings is his reference to the Social Security “trust fund” as a “savings account.” The president proposes increasing the value of that trust fund by an amount equal to 62 percent of the budget surplus and claims that such a move would help pay benefits when payroll tax revenues start to lag behind obligations. But the trust fund is not a savings account. The trust fund consists of nothing but government bonds, which are simply claims on future taxpayer dollars.

To understand the distinction, the president needs only to read the fine print of his own budget. Page 337 of the president’s budget states plainly: “These [trust fund] balances are available to finance future benefit payments and other trust fund expenditures — but only in a bookkeeping sense… . They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, have any impact on the Government’s ability to pay benefits.”

In fact, the trust fund is better understood as a liability than an asset. The amount in the trust fund represents what we are forcing future generations to pay — in addition to their payroll taxes — to provide the Social Security benefits we have promised ourselves. Try to explain the value of this “savings account” to taxpayers in the year 2030, when they have to cough up hundreds of billions of dollars to pay off the IOUs in the Social Security trust fund.

If the administration really wants to encourage savings, there is one straightforward, simple solution: let individuals use the money they already spend on Social Security to fund a personal retirement account. This would allow all workers — including those who don’t have the money to participate in other savings programs — to take advantage of the power of compound interest and accumulate substantial personal savings. Such a plan would reduce the multi-trillion-dollar debt that will otherwise be passed to the next generation. Moreover, by giving all workers first-hand knowledge of the power of compound interest, it will serve as a much-needed reminder that a penny saved is truly a penny earned.

Carrie Lips is a Social Security analyst at the Cato Institute.