The Real Solution to Social Security Insolvency

by Sven Larson, Ph.D. for the Grassroot Institute of Hawaii

As this is written, in August 2010, the Social Security system is running a deficit. Its ability to support future retirement benefits for Americans is rapidly withering away. Fixes have been offered, but they all center in on postponing the inevitable: neither higher taxes nor cuts in benefits will save the system from its demise. Those methods have been tried before and failed.

Unsurprisingly, this truth has not yet set in everywhere. Many still offer regurgitated versions of the same old “fixes”. One example is the Peter G Peterson Foundation’s plan, which was presented by Lowell Kalapa in the Hawaii Reporter on August 3.

The Peterson plan essentially combines higher taxes with benefit cuts, thus representing a concentrate of a half-century long stretch of “fixes” during the latter half of the 20^th century.

Instead of repeating old mistakes it is time for America to face the hard truth: the government cannot provide us with sustainable retirement security. In the case of Social Security this is manifested in three flaws.

• First, it does not save your taxes for your retirement, but uses them to pay other people’s retirement. All you get is an IOU from the government.
• Secondly, the IOUs that one generation accumulates over time will by necessity always exceed what the average working American can pay in taxes, at a given tax rate. As a result, Congress needs to repeatedly cut benefits or raise taxes, or both.
• Third, the Social Security system was constructed at a time when economic growth was much higher than it has been the last few decades. It was designed for a different kind of American economy, one with much smaller government and economically more free citizens and businesses.

As a result of its inherent flaws, Social Security has become a perpetual problem for the president and Congress since 1950 when they raised the Social Security tax for the first time. Over the next half-century Congress raised the Social Security tax another 19 times and made numerous adjustments to erode benefits. And Social Security still is not solvent – on the contrary, its future is more precarious than ever.

It is not enough to match the current system with a small system of private accounts. Nor is it enough – or even desirable – to raise the taxes and cut benefits in the current system. Small private accounts in today’s system will not address the second flaw mentioned above, and higher taxes with lower benefits will only save Social Security when everyone is a taxpayer and no one is a beneficiary.

There is but one sustainable solution to the problem that Social Security represents. Only a complete phase-out of the current system, and a complete phase-in of private accounts, will provide the sustainable retirement solution we all need and want.

In a model currently being developed at the Wyoming Liberty Group, private accounts will be phased in gradually over a long period of time. The current system will have obligations to honor for decades, and will need cash until the last entitlement is paid out. At the same time, a gradual phase-in of private accounts will allow the financial industry to gradually develop responsible investment products to care for people’s retirement savings.

Private accounts are better because they shore up our own money and can be invested against an annual return. Those in most urgent need of the financial safety that private accounts provide are low-income families. Therefore, the Wyoming Liberty Group model suggests a phase-in strategy that has a bias in favor of low-income families.

Privatizing Social Security is not easy, but a slow, steady phase-in of private accounts combined with a low-income bias secures a stable, predictable transition out of a flawed government system and in to a properly managed, responsible private system. It will take up to 30 years before private accounts have completely replaced the government system, but it is worth the long stretch.

It will also take a tremendous amount of political fortitude and bipartisanship, both of which are all too absent in today’s politics. At the same time, our elected officials in Washington, DC have summoned enormous fortitude and bipartisanship to maintain the current system, which is full of flaws and constantly heading for insolvency. It is only fair to expect similar commitments behind a privatization reform.

Dr. Larson is a Research Fellow with the Wyoming Policy Group, a free-market think tank in Cheyenne, Wyoming. He wrote this piece for the Grassroot Institute of Hawaii, www.grassrootinstitute.org.