Commentary

The Savings Mystique

The federal dog and pony show convening this week in Washington to deal with our national “savings” crisis is a classic example of missing the forest for the trees. There is no need for experts, committee reports, or econometric models. Savings in America will increase as soon as governments at all levels reduce our tax burden sufficiently to let us, well, save some money.

According to the non-partisan Tax Foundation, the average two-earner family pays more than 37 percent of their income in taxes (to say nothing of the higher prices they pay as a result of corporate income taxes). After typical living expenses, says the Tax Foundation, that leaves such a family with less than 4 percent of their income to save. Even if they were disciplined enough to save it all, accumulating wealth at that rate for retirement would be a problematic undertaking.

While there are IRAs, 401(k)s, and 403(b)s to provide opportunities to accumulate savings, for the most part only those with significantly above average earnings are able to take advantage of these plans. For most Americans there simply is not enough disposable income available to invest after taxes. As a result, fully one-third of Americans have no savings at all, while the next third have less than $3000 in savings.

Those Americans are forced to depend on Social Security for the majority of their retirement income. And that’s a very risky proposition — much riskier, as it turns out, than depending on the stock market. Since its inception, Social Security has increased taxes on 38 separate occasions, in each instance lowering the return on one’s “investment” in the system. Imagine a private investment firm offering an annuity that would periodically demand that additional capital be paid in order to keep benefits at the agreed upon level.

But that’s one of the dirty little secrets about Social Security. There is no contract, no guaranteed return. According to the most on-point Supreme Court decision on the subject, the 1960 case of Nestor v. Fleming, Social Security is not an investment plan, but a social policy totally in the hands of Congress, which may reduce benefits at will, regardless of what has been paid in.

Given the importance of Social Security to the savings plans of the vast majority of Americans, it is more than a little absurd that the so-called National Summit on Retirement Savings is charged with looking at savings without considering Social Security. That’s a little like looking at the history of basketball without considering Michael Jordan.


It is ironic that so many people in public life who wring their hands over the growing wealth disparity in America would oppose total Social Security privatization.


The payroll tax takes 12.4 percent of workers’ income to “invest” in Social Security. But the money is never invested in any meaningful sense. Most of the tax is paid out to current retirees. What’s left over is expropriated by the federal government for other programs. The government does leave nice little IOUs in the form of Special Treasury Notes, but those are merely scraps of paper promising to tax further the American public from which it has just “borrowed” the money.

Now, we know from Economics 101 that savings must equal investment, which brings up a revealing point. A real investment is one in which wealth is generated in sufficient amount to pay a real return. But a government bond generates no wealth. It is merely a vehicle for coercively transferring income from some to others. Thus, there is no saving going on at all under the present Social Security system.

A privatized retirement system, on the other hand, generates real wealth. An investment in General Motors bonds or Federal Express stock leads to economic growth, which is to say wealth creation. Harvard University professor Martin Feldstein estimates in a Cato Institute study that the net present value of the wealth created by investing the future cash flow from the payroll tax in a fully funded system to be $15 trillion, or about 5 percent of GDP for every year in the future.

To illustrate how quickly lower income workers would become serious savers under a private system, consider a worker born in 1970 who began working at 18 and earned 20,000 a year, adjusted for inflation, his entire working life. That worker would retire with a stock portfolio (assuming a nominal 10 percent annual return) of $657,000, yielding an annuity income of $5,500 a month in current dollars, or more than five times the Social Security system’s promised $935 a month. Even a conservative bond portfolio (at six percent) would accumulate $228,000, yielding a monthly annuity of $1480.

It is ironic that so many people in public life who wring their hands over the growing wealth disparity in America would oppose total Social Security privatization. Rather than redistributing wealth from the rich to the poor, they should focus on allowing the poor to accumulate their own wealth. The Social Security payroll tax makes it virtually impossible for low income workers to do so. According to the Bureau of Labor Statistics Consumer Expenditure Survey, in 1995 people earning between $20,000 and $30,000 actually had dissaving at a rate 11.8 percent — almost precisely what the combined payroll tax extracts from them.

The single most important step we can take to increase savings in America, and in so doing create the dignity of not having to depend on politicians for our retirement income, is to privatize Social Security.

Edward H. Crane is president of the Cato Institute.