The Mises Institute monthly, free with membership
Volume 14, Number 10
Social Security Reform: True and False
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
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
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.
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
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
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
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
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.
Dale Steinreich is a graduate student in economics at Auburn University