Stanford Review - Archive - Volume XXVI - Issue 1 - Opinion
Social Security: Who Invests Your Money?
The United States Social Security system has been tremendously successful in raising retirees' standard of living in the past century, but in its current form it is both financially and structurally unsustainable in the next. The Old-Age, Survivors, and Disability Insurance (OASDI) trustees estimate that the program has a 75-year financial imbalance of 1.89% of payroll. That is, payroll taxes must be immediately raised by about two percent or benefits cut by a corresponding amount for the books to balance in 2074. Even with a direct response now the Social Security system is structured so that another reform will be necessary within a few years to correct deficits projected farther into the future.
The long-term prospects are increasingly unfavorable because the current system's pay-as-you-go form means that retirees are dependent upon wage growth and population growth in future generations to produce returns on their "investments." These factors (not to mention the law's changes to the program) are both historically volatile and outside of the control of retirees, creating an inequitable distribution of retirement payments that is unrelated to payroll contributions, but instead dictated by demographic luck. Since fertility is projected to decline and life expectancies to rise in the future, fewer workers will support the growing elderly population, and one or both groups will have to sacrifice under the current system. Any solution to the immediate Social Security crisis must address both the problems of the financial deficit and the structural instability to be viable and equitable long-term.
While the Social Security Administration projects that the foundations of its pay-as-you-go system, real wages and labor force size, will increase annually at .9% and from .1% to 1.0%, respectively, the Standard & Poor's 500 has historically (1925-1998) performed at 8% above inflation (Ibbotson, 1999). Compounded over a forty-year career, investments in financial markets at 8% have a yield eleven times greater than "investments" in Social Security at 2%. Opening the United States retirement system to individual investment would allow for higher benefits, and it would also expand the supply of capital available to companies for increasing productivity and raising society's standard of living. Moreover, by eliminating dependence on changes in population, wages, and the law, it would make individuals' benefits more equitable in relation to their contributions. The ultimate responsibility for providing for society's retirement should be transferred from Social Security to a universal government-mandated but individually-managed system of Personal Savings Accounts (PSA's). When fully phased in, the 12.4% of payroll that now funds Social Security payments will be instead invested by individuals into the economy, generating larger and more secure returns for themselves, and ultimately, for society.
How do private accounts preserve the current system's provisions for the poor, and how do they account for the cost associated in transitioning from paying for our parents' retirement to paying for our own? To some extent the answer is the same. A certain fraction of the 12.4% in payroll taxes will be allocated to households below the poverty line, assisting them so that they can invest enough to provide for their retirements. During the transition period, a similar fraction will be allocated to honoring the promises of the current system. These promises will not include a 75-year deficit as large as the current 2% of payroll, because benefits accruing after the initialization date will come from robust growth in the private sector rather than create new obligations for the government.
The deficit can be reduced further, and the need to siphon investment capital from the payroll tax revenues can be reduced, by rethinking as a society our accepted retirement age. The magic number 65 (now 67 for those born after 1960) was an arbitrary choice of the original program; it was even higher than the average life expectancy at birth of 63.6 years in 1940. Since life expectancy has risen by thirteen years since the program's inception, and is projected to rise at least an additional five years by 2074, perhaps it is time to accept a longer career as an inevitable result of our increasingly longer lives.
Far from being riskier, a privatized national retirement system offers individuals a stable and equitable alternative to Social Security. Rather than depend upon changing government promises, PSA savings give individuals the choice to invest for retirement in accordance with their own long-run financial goals, and to be rewarded for it commensurately by the free market. The government, as guarantor of societal welfare, should regulate the retirement system and assist the needy, achieving Social Security's original goal of redressing elderly poverty. It does not need to adopt also the false pretense of playing investment banker for the nation.
Scott Rasmussen is a sophomore majoring in Economics and in Mathematical and Computational Science. He expects to be dead when the books don't balance in 2075.
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