Social Security is going broke. The federal governments largest spending program,
accounting for nearly 22% of all federal spending, faces irresistible demographic and
fiscal pressures that threaten the future retirement security of todays young
workers. Only by moving to a system of privately invested, individually owned accounts can
a system of secure retirement be preserved.
According to the 1997 report of the Social Security systems Board of Trustees, in
2012, less than 15 years from now, the Social Security system will begin to run a deficit.
That is, it will begin to spend more on benefits than it brings in through taxes. Anyone
who has ever run a businessor balanced a checkbookunderstands that when you
are spending more than you bring in, something has to give. You need to either start
earning more money or else spend less to keep things balanced. For Social Security, that
means either higher taxes, lower benefits, or both.
Todays senior citizens enjoy Social Security benefits that will be impossible to maintain for later generations. In 1950 there were 16 workers paying into Social Security for every beneficiary. Today there are only 3.3.
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In theory, Social Security is supposed to continue paying benefits after 2012 by
drawing on the Social Security Trust Fund. This trust fund is supposed to provide enough
money to guarantee benefits until 2029, when it will be exhausted. But one of
Washingtons dirty little secrets is that there really is no trust fund. The
government spent that money long ago to finance general spending and hide the true size of
the federal budget deficit. The Trust Fund now consists only of IOUs in the form of
bondspromises that at some time in the future the government will replace that
money, which can only be done through collecting more taxes.
Even if Congress can find a way to redeem the bonds, the Trust Fund surplus will be
completely exhausted by 2029. At that point, Social Security will have to rely solely on
revenue from the payroll tax. But such revenues will not be sufficient to pay all promised
benefits. Either payroll taxes will have to be increased to as much as 28%, more than
double todays 12% rate, or benefits will have to be reduced by as much as one-third.
(If taxes needed to fund Medicare are included, the total FICA payroll tax may have to be
increased from todays 15.3% to as much as 40%.)
Social Securitys financing problems are a result of its fundamentally flawed
design which is comparable to the type of pyramid scheme that is illegal in all 50 states.
Todays benefits to the old are paid by todays taxes from the young.
Tomorrows benefits to todays young are to be paid by tomorrows taxes
from tomorrows young.
Because the average recipient takes out more from the system than he or she paid in,
Social Security works as long as there is an ever larger pool of workers paying into the
system compared to beneficiaries taking out of the system. However, exactly the opposite
is the case.
Life expectancy is increasing while birth rates are declining. As recently as 1950,
there were 16 workers for every Social Security beneficiary. Today there are only 3.3. By
2025 there will be fewer than two. The Social Security pyramid is unsustainable.
Privatizing Social Security
There is a better alternative. Social Security could be privatized, allowing people the
freedom to invest their Social Security taxes in financial assets such as stocks and
bonds. A privatized Social Security system would be essentially a mandatory savings
program. The 10.52% payroll tax that is the combined employer-employee contribution to the
Old-Age and Survivors Insurance (OASI) portion of the Social Security program would be
redirected toward a Personal Security Account (PSA) chosen by the individual employee.
PSAs would operate much like current Individual Retirement Accounts (IRAs). Individuals
could not withdraw funds from their PSAs prior to retirement, determined either by age or
PSA balance requirements. PSA funds would be the property of the individual and, upon
death, remaining funds would become part of the individuals estate.
Social Securitys financing problems are a result of its fundamentally
flawed design which is comparable to the type of pyramid scheme that is illegal in all 50
PSAs would be managed by the private investment industry in the same way that 401(k)
plans or IRAs are. Individuals would be free to choose the fund manager that best met
their needs and could change managers whenever they wished.
Given historic rates of return from the capital markets, even minimum wage earners
would receive more than what current workers will get from Social Security. Therefore, in
the absence of a major financial collapse, the current Social Security safety net would be
required for relatively few people, aside from the disabled and others outside the
The Chilean Example
The idea of privatizing a public pension system is neither new nor untried. Where
privatization has been properly implemented it has been remarkably successful. One of the
best examples is the experience of Chile.
Chiles social security system predated ours, having started in 1926. By the late
1970s its benefit payments were greater than its taxes and it had no funded reserves. On
the advice of Nobel laureate Milton Friedman and other free-market economists, Chile
decided to privatize its system.
The success of Chiles public pension privatization can be measured in many ways.
Chiles private savings rate is 26% of GDP, compared with 4% in the United States.
The infusion of capital into the private sector has contributed in large part to
Chiles phenomenal 7% annual economic growth rate over the past 10 yearsa rate
that is double ours.
But most importantly, beneficiaries are receiving much greater benefits. Since the
privatized system became fully operational on May 1, 1981, the average rate of return on
investment has been more than 12% per year. As a result, the typical retiree is receiving
a benefit equal to nearly 80% of his average annual income over the last ten years of his
working life, or almost double what U.S. retirees are receiving from Social Security after
A Texas Example
A loophole in the Social Security law once allowed states and municipalities to exempt
their government employees from the Social Security system. In 1981, three Texas counties
opted out of the federal system and created their own private retirement program. Under
the private plan, employees paid the same amount of taxes, but instead of being funneled
to Washington D.C., it went to a private insurance company that had competed for the right
to invest that money (while guaranteeing a rate of return). To date, the private system
has outperformed its federal counterpart. Some years have shown returns on investment of
12%, as opposed to an average of 2.2% under Social Security for a worker born in 1950.
What Michigan Can Do
In 1997, Oregon became the first state to pass a resolution asking that it be allowed
to design a privatized alternative to Social Security for workers living in that state.
Oregon based its request to opt out of Social Security on waivers that it has received to
design its own welfare and Medicaid programs. Michigan could do the same. The American
Legislative Exchange Council (a nonprofit legislative organization) has adopted the Oregon
resolution as model state legislation.
Social Security privatization is an idea whose time has come. For our childrens
sake, it could not possibly have come too soon.
Editors Note: How does Social Security compare to what you could earn from
private investment? You can check it out for yourself at www.socialsecurity.org. This Web site
contains an interactive calculator which allows you to compare future Social Security
benefits to what you could receive through a privately invested system.