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October 1996
Volume 14, Number 10

Social Security Reform: True and False
Dale Steinreich

In an episode of "Married With Children," Jefferson Darcy tells Al Bundy that he can get fast cash by suing a mall for his stress-related injury. "Malls set aside millions for this type of thing," says Darcy. "If we don't get it, it'll go to Social Security and then no one will get it!"

Everyone laughs, but the reality is no laughing matter. Every year $400 billion is drained from the private economy to pay for this collapsing Ponzi scheme. Politicians of all stripes tell audiences the program is wonderful and safe. Regular people have caught up with what number crunchers have known for years: Social Security will go belly-up unless action is taken soon.

Experience teaches us that "reforms" of government programs can be as dangerous as the programs themselves. More often than not, the reforms involve higher taxes, more spending, and more controls. These days, reforms (farming, welfare, taxes) are even touted as steps toward "privatization" or the "market," when the real purpose is to put off big government's day of reckoning for as long as possible.

No program has been "reformed" so often and so fraudulently as Social Security. For example, in his farewell speech to the Senate, Bob Dole said that one of his proudest achievements was "saving" the program in 1983, when he was on the National Commission for Social Security Reform.

But what was this "achievement"? The presumed purpose of the 1983 reform was to fix the program's long-term financial problems. But this was deja vu all over again. In 1977, another reform was undertaken to fix problems that resulted from the 1972 reform, which indexed benefits to the zooming inflation rate.

The most recent commission was formed on December 16, 1981, and President Reagan named Alan Greenspan, now Federal Reserve board chairman, to head it. From the beginning, its mission was to bail out the program and provide bipartisan cover for any negative political fallout. Its final report appeared in 1983, and recommended increasing the program's income relative to outgo with a scheme heavily weighted toward tax increases rather than spending reductions.

The resulting legislation roped ever more citizens into the scam, and bilked present payers even more. It moved tax increases scheduled for the future into the present, raised self-employment taxes, taxed benefits for single people with incomes of $25,000 and couples with incomes over $32,000, expanded the program to new federal employees, and prohibited state and local government employees from leaving the system. The reform delayed one cost-of-living increase, but this was more than outweighed by the onerous tax increases.

The only other good change was to raise the "retirement age" to 67. However, this prudent attempt to adjust for increased life expectancy was ultimately worthless: the increase to 67 doesn't occur until the year 2022. Meanwhile, the forced inclusion of new payers herded practically every worker into the Social Security leviathan in order to sustain its life.

Self-employed people, a fiercely independent bunch, are still smarting from the bill; it forced them to fork over both the employee and the employer contribution to the tax police. And it caused a drop in the number of people willing to be self-employed--at a time when self-employment was becoming more and more feasible.

Signing the new legislation on April 20, 1983, Reagan called it a "monument to the spirit of compassion and commitment that unites us as a people." Actually it showed how profoundly hypocritical the government's tax policy was, and how far politicians were willing to go to keep a system of redistribution going.

One year after the reform passed, tax attorney Helen Rogers has shown, working and middle-class people paid more to the government. The supply-side tax-cutting revolution lowered rates in one place, but vastly increased taxes elsewhere, a fact which its propagandists are still shy about admitting.

Such legislative patchwork will no longer save the system, but several "radical" proposals could actually make matters worse. The last thing the taxpayers need is another reform disaster, especially one that occurs under the label of "privatization."

Is Chile a Model?

One model watched closely by these reformers is that enacted by Chile. The original system, adopted in 1924, was anything but secure by the late 1970s. Payroll taxes averaged more than 26%, and the system was still imploding into insolvency. Something had to be done, so in 1981 the government began to dismantle it.

Workers are taxed 10 percent, and enter into a mandatory system comprised of 21 quasi-private investment companies. The content of portfolios is strictly regulated. They must hold no less than half the assets in government securities and no more than a third in common stocks (no foreign securities are allowed in this financial protectionism).

Workers can only switch between accounts four times per year. Early retirement is forbidden except under restrictive conditions. Even then, Chileans cannot withdraw their money in lump sums, but have to accept predetermined allotments from the government or the funds. The government insures both the return and the accumulated earnings.

Returns have averaged 13 percent, but that's exaggerated by the economic trends of the period in question. Over the long run, the return will fall somewhere in the range of about 2-3%. If trends reverse, their mandatory and insured system could be bailed out. Then the cry for employers to contribute will grow louder. The "private" system will then be branded a failure, and the call for the old government pyramid scheme will be renewed.

This is precisely what happened when the U.S. government "deregulated" the thrift industry in the early 1980s. Loan rules were loosened, and along with extant deposit insurance, caused the system to crash into insolvency. Meanwhile, the free market caught the blame and a quarter trillion dollar bailout resulted.

Moreover, the Chilean system is not immune from political manipulation. The 21 funds are political powerhouses that reward friends and punish enemies. This is also what's wrong with the Clinton administration's push to have private pensions invested in "socially responsible" ventures, and Jesse Jackson's long-held plan to seize retirement savings for "public-works" projects.

Not Good Enough

Bad as the Chilean system is, it did actually lower the taxes that people had to pay into the system. None of the plans studied by the Clinton administration's advisory panel (appointed in June 1994) have that minimal virtue. After two years of work, the panel has released a report suggesting three bad options, each of which is said to increase the role of markets in the system.

The first and most expensive was conceived by Washington economist Carolyn Weaver and drafted by Sylvester Scheiber of the Wyatt Company. A payroll tax of 5% would be taken from the current 12.4% total and directed to IRAs. The government would guarantee a pension floor of 2/3 the poverty line to all retirees. Anything additional would come from "worker-selected" stocks and bonds.

Where the system falters--as with all these plans--is in dealing with existing liabilities, which are talked about in terms of trillions. They would be covered by a new 1.5% payroll tax to be paid for by you and me, a tax not to be eliminated until the year 2067. All additional liabilities will be "phased out" by borrowing an additional $1.2 trillion in what Scheiber calls "Liberty Bonds."

The second proposal is made by the panel's chairman, Edward Gramlich of the University of Michigan. His proposal jettisons any attempt to increase the return on investment, reduces government benefits slightly, and implements a new 1.6% payroll tax to fund the remaining liabilities.

The old guard's proposal has been put forth by 82-year-old Robert Ball, a former Social Security commissioner who joined the agency under Roosevelt. His plan is to take 40% of the trust fund and use it to purchase stocks, while allocating the rest to corporate bonds. In real terms, the amount invested in stocks could end up being $800 billion by the year 2015.

Of all these, Ball's is the most frightening. It represents a back-door socialization of the economy. By some estimates, the value of the trust funds in the next century could climb to $12 trillion. This would undoubtedly be Washington's "carrot" for rewarding friends in the private sector, and 1000-pound "stick" for clubbing enemies.

Friends of the government would be rewarded with huge windfalls of cash, while enemies would be harassed and bankrupted. As a former Social Security commissioner Stanford Ross told the WSJ, "if you would have proposed in the 1930s to invest in the private market, you would have been accused of being a socialist or fascist."

The other two plans are attempts at trying to emulate Chile's flawed system. Although Weaver says she wants to give individual investors control over where to put their money, in the end the choice of securities would be tightly regulated. And politics would hardly be removed from the system by this regulation.

Even worse is the imposition of a "temporary" 1.5% payroll tax. It would not only be retained beyond the 70-year adjustment period, but gradually be increased to fund other programs. In addition, we'd be saddled with an additional $1.2 trillion of extra debt in the form of the misnamed bonds.

Ever Higher Taxes

Other unofficial plans are equally bad. Consider the proposal put forth by D.C. policy man Michael Tanner. He would force people to contribute a specific proportion of their income into a government-regulated retirement account, which would then invest in private mutual funds. It would pay annuities at a predetermined retirement age. Lump-sum withdrawals at retirement would be forbidden, as would non-government approved investments.

Again, the program fails on the question of the $3 to $4 trillion in unfunded liabilities. Tanner suggests a new benefits program that would provide a subsistence standard of living to current and future recipients. Additional liabilities, Tanner says, will be covered by spending reductions or tax increases, whichever is most politically viable.

Can we guess whether Washington will opt for spending cuts or tax increases? The 1983 reform is a test case. Out of a total 5-year deficit of $169 billion, 75% (or $126 billion) was paid for with tax increases, not benefit reductions. Even raising the prospect of tax increases guarantees that they will be the option of choice. In Washington, giving an inch to the tax police means they will take a mile, and then some.

Consider the end result of this planned "privatization": government-coerced saving, government-mandated annuities and investments, and a massive tax increase on already over-taxed citizens to fund the liabilities and a brand-new welfare program for poor retirees.

This is no solution at all. It's an attempt to fund yesterday's illegitimate promises with the earnings of today's taxpayers. The far-flung hope is that a higher rate of return will make everything work out in the end.

Opting Out

The measure of real reform is whether it reduces (and preferably eliminates) taxpayer liabilities, mandated contributions, the government's role in determining savings schedules, and the coercive manipulation of people's income stream. None of these plans qualifies. And these are the best ones on the table: a president Dole or Clinton will do much worse.

If any reform is going to benefit today's workers, it must eschew any new taxes or it's simply not worth pursuing. It must also allow people to escape from the system. As with Britain's reform, workers must be allowed to forego any claim on future benefits in exchange for no longer paying into the system. For people who know their taxes have already been spent, this would not be a difficult decision.

This change would cause an immediate jump in the national savings rate. It would be clear that people are responsible for saving over their lifetimes, just as people did during the first 160 years of our nation's history. Financial responsibility would begin to be restored.

Yet that still leaves the problem of unfunded liabilities that has tripped up every reform plan to date. If today's workers stopped paying into the system, how will the Ponzi scheme stay afloat? In the long run, it cannot, and no reform, no matter how well constructed, can change that. It's time to contemplate abolition.

The Evils of Retirement

The surest way to kill the Social Security vampire is to drive a stake through its heart: by scrapping the New Deal concept of "retirement." Before the institution of retirement, there was no such thing as a period of independent, post-occupational leisure. The living standards of older people were sustained by a combination of employment income, savings, and help from children.

In 1930, 54% of men over 65 were still working. Hardly anyone "retired" out of choice. Five years later with the Social Security Act, that began to change. Today it is closer to 20%, despite increases in life spans, and most of those still working classify themselves as "self-employed." This is a consequence of an especially malicious form of government planning.

According to New Deal theory, there were too many workers chasing too few jobs. How can the unemployment rate be reduced without further lowering wages? Just as crops were plowed under and hogs killed and left to rot, older people were booted out of the work force in order to prop up the labor market.

It was the easy answer, no matter the human cost. Following Bismarck, FDR set the age to start receiving benefits at 65. Anyone over that age who was employed lost benefits (or, later, had them heavily taxed). From that point on, the right to Golden Years of Leisure was enshrined in law and custom.

Retirement is among the most economically wasteful and socially destructive institutions created by government. The most experienced and knowledgeable workers are bumped from productive employment to the world of golf courses, bingo parlors, and TV watching. Costly resorts and even entire towns were constructed to entertain retirees who have more time on their hands than activities to fill it.

Retirement punted older people out of the active community of enterprise, where they are most needed for both their skills and their positive cultural influence. They have also been marginalized in society at large, so that young people tend not to interact with them on a daily basis.

As a result, older people are perceived as burdens on society, a greedy special interest group, and net tax takers, despite a lifetime of tax payments. This is the key to understanding the huge decline in respect for older people, and even the rise of the euthanasia movement.

That doesn't mean that older people shouldn't have the option to retire. But they shouldn't be bribed out of the work force with the taxes of the young. In a free market, most people probably wouldn't choose to retire. For those that did, retirement would be a freely chosen reward for a productive life, not the outcome of a government attempt to "create" jobs and lift wages. And it would be done at no one else's forced expense.

In a truly free market--where workers are not taxed in the name of savings, and where older people are not pushed out of employment--the savings rate would increase, and we'd start accumulating capital instead of drawing it down. But under the present statist system, people born on or after 1993 will face an average effective tax rate of 84% throughout their lifetimes.

That's why the real choice is to stay on the present path to disaster, or abolish government planning altogether. In-between solutions--at least those detailed above--run the risk of making the system worse, precipitating huge bailouts, and causing political backlashes.

The "liabilities" of the system cannot and should not be paid. The entire structure of "Social Security" must be wiped out, along with all its mandates, before we can begin to repair the social and economic damage FDR's disaster has wrought.

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Dale Steinreich is a graduate student in economics at Auburn University

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