Mises Daily

Social Security Reform: A Free-Market Alternative

Considerable public discussion and debate now rages over Social Security and how to reform it. As the system currently stands, as early as 2018, it will be necessary to finance a growing portion of its outlays to retirees by means of outside sources of funds, since at that point the sums paid into the system in the form of payroll taxes will begin to fall short of the sums it is obligated to pay out. What will bring this about is a substantial increase in the number of retirees, who draw from the system, relative to the number of workers, who pay into it.

Some observers believe that the difficulties faced by the system will not begin until later, in 2042 or 2052. Between 2018 and that time, they believe, the system can draw down its vast accumulations of United States Government securities, which it has acquired over the many years in which it took in more in payroll taxes than it has had to pay out.

I believe that 2018 is in fact the time when the difficulties will begin. The reason is that the government securities held by the Social Security system are not any kind of actual asset. They are a claim against the US Government to pay money that it does not possess and which it cannot obtain in any way other than by raising taxes, borrowing from the public, or inflating the money supply. Probably, just as has been the case many times since the system was established seventy years ago, social security payroll taxes will be increased one or more times again between now and 2018, and that will provide the funds. In other words, the tax system of the United States will come to resemble that of Sweden more than it does now.

Perhaps to avoid such further payroll tax increases, President Bush has put forward his proposal to partially “privatize” the system. According to the President’s proposal, workers below the age of 55 will be allowed to have a portion of their and their employers’ contributions to the system invested in stocks and corporate bonds rather than in United States Government bonds. The presumably higher rate of return they will earn thereby will supposedly reduce the need of the government to rely on Social Security taxes in the future as the source of meeting its pension obligations.

Unfortunately, implementing the President’s proposal entails trillions of additional dollars of government borrowing or new taxes in the years before any reduced need for Social Security taxes can materialize. This is because the funds being invested in the so-called private accounts will largely be at the expense of funds available to meet the system’s pension obligations. Under the President’s proposal, as much as almost a third of the contributions made by the eligible workers and their employers could be funneled into the stock market and thus would not be available to pay current pensions. Since the government is still obligated to pay those pensions, this shortfall can be covered only by additional borrowing, new taxes, or inflation of the money supply. As Lew Rockwell has pointed out, the President’s proposal is thus actually one of a new and additional government program rather than being the mere reform of an existing program.

Another, and potentially more serious, problem is that implementing the President’s proposal would almost certainly mean a major increase in the government’s power over business. Unless the government were prepared to give full freedom to the individual to invest in any stocks of his choice, it would, as a minimum, have to draw up a list of stocks that it approved for purchase. The result of this would be that a very large number of publicly traded companies would be under pressure to convince the government to add their stock to the list and to keep it on the list. In order to do this, of course, a company, and all the individuals prominently associated with it, would have to avoid doing anything that might displease government officials and thereby lead the government to shun the company’s stock. Thus a major new avenue of arbitrary government power would be opened up.

Almost certainly, however, the government would not be content with merely drawing up a list of approved stocks and then leave the choice of the specific stocks within the list, and the timing of their purchase and sale, to the discretion of the individual taxpayers. Doing so would contradict a major underlying premise of the whole Social Security system. That premise is that the average person cannot be relied upon to provide adequately for his old age even under conditions in which all he would have to do is regularly deposit money in a savings account at a bank or pay the premiums on an endowment-insurance policy.

The truth, of course, is that the average person, and the great majority of people even of substantially below-average ability, certainly could do this much, provided that they could take the future buying power of their savings for granted. But the government long ago destroyed the gold standard, and the resulting chronic inflation has left an enormous number of people in a situation in which they really are unable to cope with the requirements of saving and investing on their own. They are unable to cope precisely because investing in the stock market has been left as practically the only viable form of investment, since it at least offers hope of keeping up with the rise in prices. Such people—tens of millions of them—do not possess the necessary knowledge or, indeed, the necessary time, to seriously follow the ever changing conditions of the stock market and of the individual companies and industries whose shares are traded. Alleged concern for these people must almost inevitably lead to the government taking full and direct charge of any stock-market investments that might be made under the auspices of the Social Security system.

The consequences of the government’s necessary control over such stock-market investments would be extremely grave. It would mean that the government would come to control a substantial portion of the stock of most major corporations in the United States. As a further result, the government would come to appoint members of the boards of directors of those corporations, in the same way that other substantial stockholders do. Just imagine practically every major business in the United States having one or more government members on its board of directors! The distance between such an arrangement and the government’s management of the economic system—i.e., socialism—is certainly not very great.

Amazingly, such obvious considerations seem to have escaped the politicians, the news media, and even “Wall Street,” which looks forward only to higher stock prices, more commissions, and more investment-management fees if Social-Security funds are invested in the stock market.

Social Security is in trouble. A reform is needed. But not the one suggested by the President. What is needed is a reform that reduces the role of government, not enlarges it.

Here is an alternative, pro-free-market reform of Social Security that I suggest. It is one that many readers will find extremely radical and perhaps frightening as well. I put it forward in the hope that it will serve as a starting point for further discussion leading to the achievement of the ultimate goal of economic freedom.

First, following a period of two to three years to allow time for necessary adjustments to be made, immediately raise the Social Security retirement age from 66 (which it is scheduled to be as of 2009) to 70.

This, of course, would be a major disappointment to everyone who had counted on starting to receive a Social Security pension sooner. Fortunately, there is a way to give these people a substantial form of relief, which would go a long way toward alleviating their hardship. That is, at the same time that sixty-six year olds are denied entry into the Social Security system, enact for their benefit a “senior citizens’ employment-income tax exemption” in the amount of, say, $90,000 per year, which is equal to the current maximum income subject to the Social Security tax. The far greater part of the taxes thereby waived for these seniors on their income derived from employment would be taxes the government would never have collected in the first place, since most of the seniors would not have been working otherwise. The elimination of the government’s payment of pensions to this group would far outweigh any loss of revenue from those sixty-six year olds who would have worked and paid taxes on their incomes even in the absence of the rise in the Social Security retirement age.

This income-tax exemption should be extended and enlarged year by year until it embraces everyone in the 66 to 69 year-old age group. And, of course, it should be progressively increased from year to year to keep pace with rising prices and rising wage rates. Indeed, it should eventually be extended to apply to everyone 66 years old or older. States with income taxes of their own should be required to adopt the same tax exemption. In this way, the years remaining in life past today’s customary retirement age might become truly “golden years” for millions of people, who at last would be freed of the burden of income taxes on their earnings derived from employment.

The retirement age of 70 should be retained perhaps for as long as fifteen years, to make it possible for all workers aged 55 and over at the time of its enactment to take advantage of it. Thereafter, however, the Social Security retirement age should be gradually increased further, to 75, over, say, a twenty-year period, rising at the rate of one calendar quarter for each passing year. Thus, workers aged 54 at the time of the reform’s enactment would be eligible for social security at the age of 70 ¼, while those aged 35 at the time of its enactment would not be eligible until the age of 75.

The Social Security system should accept no new pension recipients after the end of this twenty year period. In other words, it would be closed to workers 34 years of age and younger at the time of the reform’s enactment. These workers, who would be ineligible for Social Security, would all have ample time to make their own provision for the future. The Social Security system itself would progressively decline and ultimately disappear as its pensioners passed away.

The government’s very considerable savings from reduced pension obligations over an initial phase-out period totaling almost forty years from start to finish, should be earmarked for reductions in the Social Security taxes of the workers who will never be able to enter the system, i.e., in the above scenario, workers aged 34 and less at the time of the reform’s enactment. As these workers advance in age, new workers will be entering the labor market. There will thus be an increasing number of workers to bear the burden of the Social Security system’s final phase. This will permit Social Security tax rates to be steadily reduced on this group, until they disappear altogether.

The end of Social Security would be the end of something that should never have been started in the first place. The root of the system is the philosophy of collectivism, in that it forces everyone into a giant stewpot as it were, in which individuals are compelled to support the parents and grandparents of total strangers, whether they want to or not, in exchange for themselves later on being compulsorily supported by the children and grandchildren of total strangers.

And, of course, standing between the generations has been a mass of politicians and government officials who have used whatever excess has existed of these forced exactions over current pension payments, to fund ordinary, current government spending.

If a private insurance or annuity company had done such a thing and used its excess of premium income over current payments, to finance the consumption of its owners and employees, for whatever purpose, including the funding of charities and public works, the company officials would now be spending long terms in prison. For it would be very clear that they had embezzled the funds of their clients. Yet exactly that in essence is what politicians and government officials have done, on a scale far surpassing all private financial frauds combined over the whole of human history.

But what is worse is that under a collectivist system such as Social Security, such embezzlement is preferable to its alternative, which would be government investment of the funds and thus government control of much of the economic system, which latter is where the President’s proposal leads.

The end of Social Security and its diversion of funds into government consumption—the return to private, individual saving and provision for the future—will mean a great increase in saving and the accumulation of capital, because the savings of individuals will be invested, not squandered. This, in turn, will mean a more prosperous and more rapidly progressing economic system, in which the standard of living of everyone, young and old will greatly improve.

The only really proper reform of Social Security is the gradual abolition of the whole system.


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