If you want the correct answers, you have to ask the correct questions. Unfortunately, when it comes to Social Security, many people have focusing on the wrong question.
Given Social Security's dire financial condition, it is no surprise that much of the public debate has been focused on how to keep the troubled program solvent. After all, by 2013-just 15 years from now-Social Security will begin to run a deficit, spending more on benefits than it takes in through taxes. In theory, the Social Security Trust Fund will keep the program going until about 2032. In reality, the Trust Fund is little more than an accounting fiction, containing only IOUs, not real assets. Social Security's total unfunded liabilities are more than $10 trillion. That certainly should be enough to demand reform.
Yet, focusing too narrowly on the program's financial problems invites cures that are worse than the disease. After all, if solvency is the only concern, it is always possible to "save" Social Security by raising taxes and/or cutting benefits. That's what we have done in the past. Social Security taxes, for example, have been raised 38 times since the program began. Of course, those tax hikes or benefit cuts would be substantial this time. In order to keep Social Security solvent we would have to cut benefits by nearly 25 percent or raise taxes by nearly 50 percent. And, three out of four Americans already pay more in Social Security taxes than in federal income taxes.
That is bad enough, but to focus on Social Security's bankruptcy is to miss an even bigger problem with the program. That is, Social Security has become an increasingly bad deal for young workers.
Social Security taxes are already so high that most young workers will receive back a negative rate of return on their tax dollars. That is, they will actually receive less in Social Security benefits than they pay in taxes-and not just a little less. Some studies show that a 30-year-old-two earner couple with average income will lose as much as $173, 500.
Raising taxes or cutting benefits to keep Social Security solvent will only make this problem worse. Instead we need to create a new Social Security system based on savings and investment.
Our current Social Security system is a pay-as-you-go system. When you pay your Social Security taxes, none of that money is ever saved for your retirement or invested in any real assets. Rather, it is simply used to pay for the benefits of current retirement benefits. When you retire, you must rely on the next generation of workers to pay the taxes for your benefits. Like any pyramid scheme, this only works when you have lots of workers supporting a few retirees. But, because people are living longer and we are having fewer babies, the ratio of workers to retirees has been shrinking. In 1950, there were 16 workers paying taxes to support every retiree. Today, there are 3.3; by 2025, there will be only two.
A new Social Security system would allow you to divert your payroll taxes to individually owned, privately invested accounts, similar to Individual Retirement accounts (IRAs) or 401(k) pension programs. Professional money managers would invest your money in carefully regulated, safe assets, including stocks and bonds. Over the years your assets would accumulate, building on the power of compound interest, providing better retirement, survivors, and disability benefits. How much better? Well, compared to Social Security's projected negative rate of return, the average annual rate of return for bonds since 1900 has been about four percent, for stocks, more than 7.5 percent. That translates into benefits three to five times higher than those offered by Social Security. And, given the long investment horizon-45 years for an average worker-there is little, if any, risk.
Those higher benefits will be especially important to the poor, women, and minorities who are left at a disadvantage by the current system. Perhaps even more important, because the money in your personal account is your property, it becomes part of your estate when you die. That means you can leave that money to your children and grandchildren, an especially important benefits to those segments of society that have not been able to accumulate wealth from generation to generation.
Obviously privatizing Social Security will not come without problems. Very little in life does. We will have to devise a transition that ensures benefits for today's retirees while their children move to a better system. Administrative costs must be minimized and consumers protected from fraud. These are manageable problems and minor issues compared to the great gains from privatization.
When it comes to Social Security, there is only one right question: How can we best ensure retirement security today, tomorrow, and into the future? And, there is only one right answer: privatize.