During his acceptance speech at the Republican National Convention, President Bush reinforced his commitment to modernize Social Security.
Such legislation would be the most fundamental, and needed, reform since President Roosevelt introduced Social Security in 1935 as part of his New Deal. This reform means moving from a tax‐based system to one of saving and investing in the strength of our economy.
The nest egg the president referred to would be one’s personal property, a marked improvement over the existing system, wherein one has no personal property rights. This would allow retirees to bequeath their accumulated assets to their loved ones should they choose.
And for the first time, low‐income workers would have the opportunity to accumulate wealth — not magically become multimillionaires, mind you — but build a nest egg they would own.
The problem with all of this, many argue, is that it would be too expensive. Their point is that under present law, projected payroll taxes will not be enough to pay all promised benefits. Redirecting some of that tax to personal accounts would, therefore, incur a further burden.
This argument does not consider the costs of the existing system should it not be reformed. According to Social Security’s trustees, this would lead to payroll taxes being insufficient to pay all benefits by about 2018. Let’s further assume that the government at that time borrows the difference so that all benefits are honored.
Such borrowing would continue through 2078 and then well beyond because the demographic trends that cause the imbalance are well established and not subject to meaningful change. The trustees estimate that total borrowing only to 2078 would be about $4.5 trillion in present value terms.
Another way of presenting this is each American family would have to give the government about $43,000 today, plus pay payroll taxes stipulated in present law in order to afford promised benefits.
Now let’s assume we reform the system as broadly outlined by Bush. First of all, not everybody is going to jump on the president’s idea, and for good reason. A 64‐year‐old wouldn’t want to budge from the current program because he wouldn’t have sufficient working time left to save and invest enough to replace what he would otherwise receive from the government program.
Conversely, a 21‐year‐old would opt for the personal account because he does have time to accumulate enough wealth on which to retire with benefits that most likely would be far greater than those from Social Security.
Let’s assume all workers older than 35 would stay with Social Security, pay the full payroll tax and receive the stated benefit. All workers younger than 35 would choose the market‐based alternative, save and invest part of their payroll tax for their retirement and continue to pay the remainder of the payroll tax to the government to help provide for those who stay with Social Security. The government is largely off the hook for them and fully off the hook for all new, younger workers who enter the labor force.
The government’s liability, therefore, is now capped at the benefits payable to those over 35 and the much lower accrued benefits of those under 35. Starting almost immediately, the total number of workers and retirees in the older group shrinks because of death and the fact that no one enters the group.
When the last person dies, the government’s benefit payments drop to zero. The government’s ongoing liability for the younger group phases out as well because more and more people of this expanding group provide for themselves exclusively through their personal accounts.
It is true that achieving President Bush’s vision for modernizing Social Security will require a transition period, bridge financing and an earlier date when we experience negative cash flows.
But under all reasonable assumptions, a market‐based Social Security system will, over the long run, always be less costly than remaining with the present tax‐funded structure.