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May 9, 2004, 3:32PM

 

Making a case for privatizing Social Security

By SCOTT BURNS

Universal Press Syndicate

 

Could your retirement fund use an extra $175,000? I thought so. How about $350,000? Possibly even $400,000 if you swing for the fences. Well, it might have happened — if you had invested a portion of your payroll tax instead of sending it to Washington to support Social Security.

 

It's bothersome that the chairman of the Federal Reserve has now suggested twice that it would be a good idea to reduce future Social Security benefits for people who will be retiring in the future. After all, these are the people who are paying the benefits for those currently retired. Maybe it's time to change Social Security instead. Maybe retirement income should be completely privatized.

 

Think about it. The payroll tax has done nothing but grow. From 1.5 percent on the first $3,000 of income in 1950, it has grown to 5.3 percent of the first $87,900 of income in 2004. Add disability insurance and Medicare, and the total tax rate for employees is now 7.65 percent.

 

Worse, the tax will continue to grow. According to Social Security Online's frequently asked questions, the benefits that people who are now 25 will receive will have to be cut by 27 percent in the year 2042, when they are 63, if the financing of the system isn't improved.

 

Current payroll tax "contributions," in other words, may do far less for future retirees than they have done for current and past retirees.

 

So let's ask and answer two questions.

 

First, how much money could you accumulate if payroll tax contributions were invested?

 

Second, if the money is invested, how will benefits promised under the current system be fulfilled during a transition period?

 

To get an approximation of the first question, I calculated how much you would have accumulated if only half of the payroll tax money that went toward retirement security was invested in a stock index, a bond index or a 60/40 pension-fundlike index. Assuming that you always earned at the maximum income — $37,800 in 1984 rising to $87,000 in 2003 — and that you invested your payroll tax portion regularly, you would have accumulated about $199,000 in the Standard and Poor's 500 index, $175,700 in a

60/40 stock/bond mix and $132,700 in intermediate government bonds.

 

It is important to realize that we are not taking any money from the disability fund or from Medicare. It's also important to realize that this was a period of relatively high returns.

 

On the other hand, this is only the result of 20 years, not a 40- or 45-year career of work. Also, most workers would have paid in less. Only 7 percent of all workers earn more than the Social Security wage base.

 

Caveats not withstanding, real people could have accumulated a good deal of real money if they had invested the money for their own future. Instead, Social Security paid it to those who were already retired. With future prospects for both Social Security and corporate pensions getting worse by the moment, a private Social Security plan is starting to make real sense.

 

Unfortunately, a private retirement plan for future retirees would leave current recipients of Social Security hungry. And there are 40 million of them. The only way to go private is to create an alternative source of support for the retired, a transition fund that would keep the promises already made.

 

The solution that co-author Laurence J. Kotlikoff and I suggest in The Coming Generational Storm: What You Need to Know About America's Economic Future (MIT Press, $28) is simple: a national sales tax. The tax would decline as promises were fulfilled and the liability paid off.

 

The tax would be applied to all consumer purchases. People who don't work would contribute through their spending. Rich people would support the elderly through luxury purchases.

 

Only the elderly poor would be spared, because their Social Security benefits would be adjusted as the sales tax inflated prices.

 

Questions about personal finance and investments may be sent to Scott Burns, P.O. Box 655237, Dallas 75265; e-mail can be sent to scott@scottburns.com. Burns' Web page is www.scottburns.com.

 

 

 

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Joel,

 

Whenever I hear ideas proposing the privatization of S.S. I wonder what will happen to those millions of people who are unfortunate enough to suffer through a large stock market drop within one or two years after they retire. How would they be able to manage with a 20 or 30 percent immediate loss to their life savings?

Funding of SS in the future does appear to be a real serious problem and I for one don't know what the answer (or answers) is. However, it would take a lot more evidence and persuasion to move me over to the privatization camp.

 

Also, I wonder how a massive influx of new investors would affect the market? Would it initially drive up prices so high that one could only reasonably expect very low returns in the following decades?

 

Hal

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A better way to make Social Security solvent would be to exempt the first $30,000 anyone makes from the tax, lower the tax rate to 5% from its current 6.2%...and then remove the wage base of $87,900, applying the tax to every dollar that anyone makes above $30,000. This would carry the dual benefits of generating more income (thus "saving" the system...it might even be possible to make this work with a tax rate of less than 5%), and creating a tremendous tax break for those that need it most in this country.

 

It would (correctly) be interpreted by conservatives as a "tax on the rich," and would therefore likely be defeated if even mentioned. But it's worth a thought.

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A better way to make Social Security solvent would be to exempt the first $30,000 anyone makes from the tax, lower the tax rate to 5% from its current 6.2%...and then remove the wage base of $87,900, applying the tax to every dollar that anyone makes above $30,000.

 

 

Frenchteacher,

I agree with you that all wage earnings above the 87,900 should also be taxed. Have you seen any studies that show how much that would help to ensure the solvency of SS?

I'm not so sure about exempting the first $30k. Seems to me that everyone earning money should pay something in to save SS, whether they are 'poor', 'rich' or somewhere in between.

In any case, the problem is really greater than my little understanding of economics. Am mainly approaching this from a view of what seems fair to me.

Hal

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with all this talk of privatizing SS, when will we see a new message board popping up in here shouting the mertis of TC?

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Pathfinder:

 

Le'ts not jump ahead of ourselves now. In fact whenever privatizing SS comes up it is the Thrift Savings Plan of the Federal Government that is always used as a model for investment. I'm sure there will be a national debate as to the fees, costs to the participant etc before this proposal becomes law. But let's first talk about the merits or demerits of privatizing a portion of the Social Security payroll tax. Pathfinder, what are your thoughts on the matter?

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