A Giant Step to Improving “Social Security”

by | Dec 18, 2003

Last April, I had the opportunity to sit across a table from President Bush and discuss his plans for the economy. I asked him what his most important policy priorities were, and he gave me a refreshingly simple and direct answer: “In the first term we’re going to cut taxes. And in the second term […]

Last April, I had the opportunity to sit across a table from President Bush and discuss his plans for the economy. I asked him what his most important policy priorities were, and he gave me a refreshingly simple and direct answer: “In the first term we’re going to cut taxes. And in the second term we’re going to save Social Security.”

Well, so far he’s been a man of his word — he cut taxes. But now for the hard part: to come to grips with the government’s single largest and most politically sacred program, and one that also just happens to be a massive economic time bomb. Make no mistake about it, Social Security as we know it simply isn’t sustainable without either significant benefit cuts or substantial tax increases.

Bush hasn’t even gotten re-elected yet, of course, but his administration is already hard at work laying the groundwork for saving Social Security in what it hopes will be a second term. The latest step in the master plan was the floating of an important trial balloon in the form of a proposed roadmap for Social Security reform by Peter Ferrara, director of the International Center for Law and Economics and adviser to the Club for Growth, an influential conservative political-activism organization.

Ferrara’s proposal is a bold one. About half the taxes currently paid by workers into the Social Security system would be directed to individual accounts that would operate much like a 401(k) plan. Taxpayers would have a choice: to either opt out of the old system in favor of the new individual-account system, or to stay just as they are today.

Those who choose the new system — and play by prudent asset-allocation rules that would be specified — would be guaranteed that their results at retirement would be no worse that under the current system. You’d have the option to take more investment risk in an individual account, but if you do that then you’d lose the government guarantee.

When you take money out at retirement, it would be entirely tax-free.

Obviously, anybody with half a brain would opt out of the old system and into the new one. Think about it: You can’t do worse because of the guarantee, and you might do better. In fact, you might do a lot better. Right now the effective return-on-investment for new Social Security system participants is less than 1% a year.

Hold on. At this point you must be saying, this is too good to be true. How could America possibly afford such a fantastic system when we can’t even afford the one we have now?

That’s probably why Ferrara’s proposal didn’t get a lot of traction when he first issued in six months ago. But now the game has changed. Last week Steve Goss, the chief actuary of the Social Security Administration, issued a lengthy memorandum evaluating Ferrara’s plan. He found that not only can the system afford it, but that Ferrara’s proposal powerfully strengthens the system’s long-term solvency.

How can this be? Like most magic tricks, the secret is actually very simple once you know it.

For starters, every Social Security participant who opts in to the new system is, at the same time, opting out of the old one. That makes the old system far, far smaller.

Then the new system puts tax dollars to work in America’s capital markets. Individual accounts would be invested in stocks, bonds, mutual funds, variable annuities and so on — all of which can be expected to earn a far higher return over time than the Treasury bills that currently make up the Social Security Trust Fund.

Sure, there are lots of messy details about how we’d have to manage the transition. I won’t go into them here, but Ferrara and Goss have them all figured out — and they will work. The bottom line is that the combination of shrinking the claim on the US Treasury and putting tax money to work in markets can save the system from what is otherwise certain disaster.

There are other benefits. They’re intangible, but they’re important, too.

First, the opportunity for Social Security participants to earn more than the current system’s paltry 1% or less will make a real difference in the lives of every American who is counting on Social Security income in retirement. For many Americans who earn modest incomes, Social Security taxes soak up the only investment dollars they’ll ever have. Earning 5%, 6%, 10% — who knows? — over a lifetime makes an enormous difference in retirement wealth.

Second, as every American worker with a 401(k) plan has learned, the challenge of making personal-investment decisions — and seeing your balance go up and down every quarter — makes you a “stakeholder” in American enterprise. Yes, it can be a source of anxiety. But it’s also a source of great satisfaction and pride.

Third, today’s Social Security participants are, in essence, at the mercy of the state. Your Social Security account is not your property (you can’t, for example, leave it to your heirs). Benefits aren’t contractually promised; they’re at the whim of some future Congress. Under an individual-account system, your account is your personal property while you’re alive, and part of your estate when you die. And the benefits are whatever your investments have earned, no matter what the politicians may say.

Twice now, in 2000 and 2002, George Bush has campaigned successfully on a promise to reform Social Security. He has proven that this issue isn’t the third rail of American politics. The public really is hungry for reform. Now, we’re almost a year from the presidential elections, but he’s starting to campaign on this issue again already.

I’m not going to suggest whom you should vote for. Sure, I believe that Social Security reform is just about one of the most important issues in America’s future, and I’m delighted to see Bush taking a courageous position on it. But this can be anybody’s issue. So here’s my challenge to the field of Democratic candidates: Take a hard look at Social Security reform, and see if you can beat Bush at his own game.

Originally published on SmartMoney.com

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at www.poorandstupid.com. He is also a contributing writer to SmartMoney.com.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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