I’ve run two installments from the Social Safety chapter of my e-book The Pleasure of Freedom: An Economist’s Odyssey.
Installment one was “Social Security is a Ponzi Scheme,” March 11, 2025.
Installment two was “Flawed from the Start and Ponzi versus Stocks,” March 14, 2025..
Right here’s the ultimate installment. In fact, all of the numbers are dated. I wrote this in late 2000 or early 2001. Additionally, reform is far more durable now than it will have been once I wrote this chapter.
The Injustice of Social Safety
Think about that somebody takes a sure % of your revenue yearly and guarantees to provide it again with some amassed curiosity once you attain 65. There’s just one drawback: You don’t suppose you’re going to succeed in age 65 since you’re now 29 and you’ve got AIDS. You desperately want that cash now to pay for medical payments, lease, and meals, however that individual gained’t let you might have it.
I’ve simply described how the Social Safety system works. Regardless of how desperately you want that cash now, the federal government gained’t let you might have it. In the event you utilized to a Social Safety workplace for a kind to exempt you, the staff there would refuse to provide it to you as a result of no such kind exists. There isn’t any exit. You’re locked in, and so far as the federal authorities is anxious, your needs, wants, and pursuits actually don’t matter.
The AIDS instance is excessive. There are thousands and thousands of much less excessive circumstances, circumstances of individuals with unhealthy well being who’re unlikely to dwell to gather a lot in advantages. One such group is cigarette people who smoke, whose life expectancy is years lower than the life expectancy of nonsmokers. Although people who smoke can count on to gather fewer years of Social Safety advantages than nonsmokers will, they don’t pay a decrease tax charge on their earnings. One other giant group of people that can count on to dwell considerably shorter lives is black males. In 1996, in keeping with the insurance coverage Net web page www.insure.com, a 40-year-old black man might count on to dwell till age 71, in comparison with 76 for a white 40-year-old man. In different phrases, the black man might count on to gather Social Safety for about 5 years (the age for receipt of full advantages will likely be 66 by the point he retires) versus 10 years for the white man.
One other injustice arises from the way in which the Social Safety system treats staff in state and native authorities, who’re the one individuals left who may be exempt from Social Safety. When retired state or native authorities workers spend 10 or extra years in jobs coated by Social Safety, they nonetheless qualify for Social Safety advantages. I don’t advocate that Social Safety be prolonged to them initially of their working lives—the answer, when you might have a deep gap, is to not throw individuals in it. I merely level out that state and native authorities staff have an unfair benefit over the remainder of us.
Social Safety is Not Assured No Matter How A lot You’ve Paid
In July 1956, Ephram Nestor, a Bulgarian immigrant who had lived in the USA since 1913, was deported from the USA for having been a Communist 17 years earlier. Between December 1936 and January 1955, Nestor and his employers had paid Social Safety taxes. In 1954, Congress handed a regulation offering that any individual deported due to previous Communist membership could be reduce off from Social Safety advantages. Nestor sued—sarcastically, given his Communist previous—on the grounds that his rights had been being denied. (Communist governments repeatedly trampled on individuals’s rights and murdered thousands and thousands of harmless individuals.) The Supreme Courtroom, in Nestor v. Flemming, discovered, equally sarcastically given their presumed anti-Communism, that Congress might do what it wished, and if that meant reducing off individuals who had paid right into a fund that they’d mistakenly thought assured them a pension, that was simply too unhealthy. In fact, the Supreme Courtroom dressed it up in fancier language than I’m utilizing, however the tone was remarkably comparable. Right here’s one of many Courtroom’s key sentences:
To engraft upon the Social Safety system an idea of “accrued property rights” would deprive it of the flexibleness and boldness in adjustment to ever-changing circumstances which it calls for and which Congress most likely had in thoughts when it expressly reserved the appropriate to change, amend or repeal any provision of the act.
In different phrases, too unhealthy.
Abolish Social Safety in Gradual Movement
Step one is to acknowledge that we’ve got been lied to. There isn’t any belief fund, Social Safety is a Ponzi scheme, and it’s a awful deal for nearly everybody. Due to this fact, one of the best resolution to those issues is to abolish Social Safety. That means, we could possibly be free to determine when, how a lot, and in what kind to avoid wasting. We don’t have that freedom now.
These of us who determine to spend money on shares linked to such broad indexes because the Commonplace & Poors’ 500 or the Russell 2000 are possible, over time, to build up a a number of of what we might get from Social Safety. Those that need to spend money on bonds as a result of they worry the ups and downs of the inventory market might accomplish that. Those that need to make investments by shopping for a rental property might accomplish that. Those that want to save solely slightly for retirement and to work by means of their sixties and seventies might accomplish that. The nice advantage of freedom is that it will permit every of us to make choices about how we need to spend our cash.
It’s true that the overwhelming majority of us aren’t consultants on how one can make investments our cash. However we are able to rent consultants, which is what we do after we spend money on mutual funds. Furthermore, there may be one subject on which every of us has unbelievable experience that nobody else shares: Every of us is aware of what we wish.
Absent Social Safety, would individuals save for their very own retirement? Many individuals are skeptical as a result of these on the verge of retirement save so little: In 1991, for instance, the median monetary property of households with heads aged 55 to 64 had been solely $8,300, and the median web value, together with the worth of the house, for all households headed by somebody below age 65 was solely $28,000.[1] What these skeptics don’t understand, although, is that Social Safety is without doubt one of the major the explanation why so many individuals don’t save. As Martin Feldstein has identified, somebody with common earnings over his complete lifetime who retires at age 65 with a “dependent” partner receives advantages equal to 63 % of his earnings the yr earlier than retirement.[2] Since such an individual’s Social Safety advantages usually are not taxed, that is equal to about 80 % of pre-retirement net-of-tax revenue. In the event you suppose Social Safety will present to your retirement, why trouble saving?
Most People alive in the present day could be higher off if we didn’t have Social Safety. However how will we get from right here to there? There are numerous doable transitions that would profit nearly everybody. Right here’s a tough sketch of 1 such transition. It’s in two elements. The primary half consists of steps that must be taken even when the objective is simply to protect Social Safety and keep away from steep tax will increase on youthful generations. The second half consists of measures to abolish Social Safety in gradual movement.
First, merely to protect Social Safety with out growing taxes, the three steps wanted are to (1) enhance the retirement age, (2) change the advantages system, and (3) change the indexing of advantages. The present age for receiving full Social Safety advantages is 65, however that quantity was set within the Thirties. Again then, 65-year-old males might count on to dwell an additional 12 years, and 65-year-old ladies might count on to dwell 13 extra years. Immediately these numbers are 15 and 19 respectively, and work for just about everybody is far much less bodily demanding than it was then. The age for full receipt of Social Safety advantages is already slated to rise to 66 in 2009 and 67 in 2027. However this could possibly be raised in phases to 70 by, say, 2017, giving individuals ample time to regulate their plans. Together with this enhance, the early retirement age for partial advantages could possibly be raised from 62 to, say, 66.
Elevating the retirement age, after all, additional hurts people who smoke, black males, and different individuals who are inclined to die earlier. Due to this fact, a associated reform must be an possibility below which anybody who needs it might probably obtain the equal of, say, six years of advantages as a lump sum. That means, those that count on to die early wouldn’t be left excessive and dry, as the federal government leaves them in the present day in the event that they don’t have any dependents.
The profit system may be altered. Constructed into the profit system are regular will increase in actual advantages so long as actual wages rise. The common annual profit per retiree in 1995, for instance, was $7,510. In line with Feldstein and Samwick, if there have been no change within the system, the typical annual profit (in 1995 {dollars}) will likely be $8,790 in 2016 and $9,290 in 2023.[3] As an alternative, advantages could possibly be frozen in actual phrases in order that the typical profit in 2023 is not any greater than it’s in the present day.
Lastly, Social Safety advantages are listed to the Shopper Value Index. The Boskin Fee, appointed by the federal authorities to check the CPI,[4] discovered that the CPI overstated inflation by about one share level a yr. Reforms applied in response to the Boskin Fee’s report have reduce this overstatement to about half a % a yr. The federal government might begin now to index to the CPI minus this half share level. If it did so, then this reform, mixed with the reform to CPI calculations that has already taken place, would trigger advantages to develop much less rapidly. These modifications taken collectively—elevating the retirement age to 70, indexing advantages to a more true measure of inflation, and freezing actual advantages—would eradicate the funding disaster and would most likely permit some modest decreases within the Social Safety tax charge in the present day. Then individuals must be allowed—allowed, not compelled—to avoid wasting the distinction between the previous payroll tax and the brand new decrease payroll tax in an Particular person Retirement Account.
Even with all these modifications, although, we might nonetheless be left with a government-run obligatory Ponzi scheme. However authorities just isn’t our guardian; it merely has no enterprise telling us how a lot we should save for our previous age. It has even much less enterprise pooling our “savings” (taxes) with different individuals’s taxes after which deciding how a lot we get again, primarily based loosely on how a lot we paid in (don’t earn an excessive amount of), our revenue when retired (don’t save an excessive amount of), our marital standing (marry somebody who didn’t pay Social Safety taxes), and our age (dwell lengthy). Due to this fact, we must always finish Social Safety step by step.
Why finish it step by step fairly than instantly? As a result of Social Safety is a series letter that makes many present and future retirees rely on having the ability to tax youthful generations with the intention to get one thing again for his or her taxes. That, as Franklin Roosevelt rightly figured, is what makes the transition drawback so robust. The one solution to finish this system is to begin someday. The federal government might begin by telling everybody below a sure age, say 30, that she or he won’t accumulate Social Safety. Then reduce the payroll tax charges of individuals below 30 to, say, 5 % (break up between employer and worker) of their incomes. Enable these youthful individuals to avoid wasting the 5.6-percentage-point distinction (between the previous 10.6 % tax and the brand new 5 % tax) in an Particular person Retirement Account.
If polling information are to be believed, 70 % of Era X thinks that Social Safety won’t be there after they retire. That implies that 70 % already suppose they’re paying taxes for nothing in return. The unhealthy information is that my proposal merely confirms their suspicion; the excellent news is that it cuts their tax charge as a bonus. Social Safety would then be just about abolished in about 60 years.
Such a transition just isn’t best for younger staff, who would do higher if they may make investments the entire 10.6 %. So, if I had been advising Franklin Roosevelt in 1935, I might have mentioned, “Franklin, don’t do this.” Sadly, in 2001, we’re making an attempt to plan our means out of the mess that this Machiavellian man created. Underneath this transition, individuals below 30 would proceed to pay right into a system from which they’d get nothing. It sounds unfair that folks below age 30 could be paying for nothing—and it is unfair. Nevertheless it’s not worse in precept than making them proceed to pay the next payroll tax right into a system from which they will earn a really low—and even adverse—charge of return. Furthermore, those that took the quantity by which their payroll tax was reduce and invested in stock-index funds would possible find yourself higher off than if the present system went on unchecked.
Contemplate, for instance, a employee who decides, at age 20, to take a position all of his or her 5.6 % in shares, does so till age 67, and reinvests dividends alongside the way in which. Then, if the inventory fund yielded an actual return of seven %, she or he would find yourself with annual retirement revenue equal to 122 % of his or her pre-retirement revenue, versus the a lot smaller 42 % that’s promised below present regulation, and the even smaller 29 % that’s payable with the present Social Safety tax charge.[5] That very same employee, if she or he invested in a 50/50 mixture of shares and bonds yielding a return of 5 %, would find yourself with retirement revenue equal to 56 % of pre-retirement revenue, which continues to be effectively above what she or he can get from Social Safety.[6]
I might add one different reform. I might permit anybody who’s a minimum of 45 years previous and who has paid Social Safety taxes for a minimum of 10 years to instantly depart the Social Safety system. An individual who left would by no means be allowed again in and would quit all declare to previous taxes paid and future advantages; however she or he would now not pay Social Safety taxes. I haven’t actuarially costed out this proposal. I don’t even understand how it will have an effect on me. However right here’s one factor I do know: If this alternative had been supplied to me, I might take it in a New York minute. I wouldn’t trouble to compute the quantity I might lose from now not qualifying for Social Safety and the quantity I stand to realize from by no means once more paying Social Safety taxes. Why would I, a rational, numerate, analytic economist, not make these calculations? As a result of I worth freedom extremely, and I might quit lots to not have the federal authorities deal with me like a helpless, irresponsible waif. (However in case you wait and provides me the selection once I’m say, 55 or older, I’ll do a way more cautious calculation.) I could be excessive on this respect, however I’d guess a couple of million different persons are like me. With us out of the system, the federal authorities loses our tax revenues for the following 20 years—nevertheless it doesn’t want them as a lot throughout this era as a result of it’s going to accumulate payroll taxes in extra of profit payouts. Then, when the federal government faces a monetary crunch in the course of the 2020s and 2030s, it won’t must pay us advantages.
One Probably Unhealthy, and Two Positively Unhealthy, Proposals for Social Safety Reform
Some economists and politicians who’ve studied the long-run issues with Social Safety have advocated two different methods to vary the system. One change is privatization, whereby the federal government lets individuals out of a considerable portion of the payroll taxes they pay and forces them to avoid wasting the distinction in a private financial savings account. There are two variations between privatization and my proposal for abolition. First, below just about the entire privatization proposals, individuals could be compelled to avoid wasting. So such proposals do little for individuals who want to spend their cash by means of their lifetime and to work past regular retirement, or for individuals who are in poor health now and need to use their cash for well being care. The federal government continues to be left dictating to individuals how a lot, and when, they need to save. If a 40-year-old would fairly spend that cash on a visit to California or to Europe, for instance, she or he can not. The federal government says she or he should save and is prepared to implement that at gunpoint. The second drawback is that the majority such proposals would reduce the payroll tax by a bigger quantity than below my proposal, and since they don’t change the retirement age or regulate the advantages system or the over-indexing of Social Safety, they would go away the system with a big shortfall between payroll taxes collected and advantages paid out to present recipients.
Some individuals have prompt that the federal authorities promote its land and different property as a means of constructing up the shortfall. Asset gross sales are a superb concept, however their energy shouldn’t be overstated. Pete Peterson, chairman of the Blackstone Group, a personal funding financial institution, estimated that the federal authorities’s property, as of September 1995, had been value $2.3 trillion, in comparison with unfunded liabilities for Medicare and Social Safety totaling $15.3 trillion.[7]
Different privatization advocates, particularly economists, have thought-about the massive shortfalls sooner or later and have detailed how the transition could be dealt with. Right here’s the place privatization will get nasty as a result of, in all these proposals, taxes would enhance dramatically and really quickly.
Take, for instance, Kotlikoff’s proposed Private Safety System. He would finish the portion of the present payroll tax that’s used to fund old-age advantages.[8] This isn’t a foul concept, however to finance the transition, Kotlikoff would impose a nationwide gross sales tax at a charge of near 10 %. The speed would fall to about 2 %, declare Kotlikoff and Harvard economist Jeffrey Sachs, inside 40 years.[9] When’s the final time you’ve heard of a gross sales tax charge falling that a lot? In U.S. historical past, gross sales tax charges have nearly all the time gone in a single path, and that path is up.
5 pro-privatization members of President Clinton’s advisory council on Social Safety voted for a plan formulated by Carolyn Weaver of the American Enterprise Institute and Sylvester Schieber of Watson Wyatt Worldwide that might enhance taxes. They might divert 10 share factors of the payroll tax, half of which might finance a flat profit paid to all retiring staff and half of which might go into a private safety account. To make up the shortfall, Weaver and Schieber advocate a further payroll tax of 1.5 share factors that might final 70 years, and extra federal debt of $1.2 trillion.[10]
Privatization advocates fear that if nothing is finished now, taxes will rise much more sooner or later. But when nothing is finished now, then advantages will likely be reduce later as a result of there may be merely no means that the U.S. authorities can get away with imposing payroll tax charges of 18 %. The truth is, one of many major supporters of the present system, former Social Safety Commissioner Robert Ball, has mentioned that he fears a taxpayer revolt towards present payroll tax charges.[11]
The irony is that many believers in freedom who would in any other case lead that revolt are as an alternative advocating their very own tax enhance. They might change the potential for a serious tax enhance later with the understanding of a tax enhance in the present day. Would-be privatizers ought to as an alternative draw a line within the sand and say, “No more tax increases.” Then those that need the present system must deal. Social Safety is a multitude. However as Martin Feldstein has mentioned, once you’re in a gap, a minimum of stop digging.
The second unhealthy proposal, which many individuals have advocated just lately, is to have the federal government spend money on shares. The issue is that the federal government’s Social Safety tax revenues are so big that inside 10 years or so, the federal authorities would personal a considerable fraction of U.S. shares. What authorities controls it has nice issue leaving alone. The federal authorities would nearly actually use its energy to dictate enterprise coverage for most of the companies by which it held substantial possession. Additionally, the federal government might use its funds to make unhealthy investments. That is what Pennsylvania’s authorities workers’ pension plan did within the Seventies when it financed a Volkswagen plant that closed only a decade later.
The third unhealthy proposal, made by Pete Peterson and others, is to impose an “affluence test” for receipt of Social Safety, Medicare, and different advantages. In case your revenue exceeds $40,000, in keeping with Peterson’s proposal, you’ll lose 10 % of your federal advantages for each extra $10,000 of revenue you make.[12] So, a household making $50,000 and receiving $12,000 in federal advantages would lose $1,200. A household making $100,000 and receiving $12,000 in advantages would lose 60 % of that $12,000, or $7,200.
Other than the problem of implementing such a plan (“Mr. Smith, we just learned that your income last year was $10,000 higher than the previous year; please send us a check for $1,500, which is 10 percent of the cost of your hip replacement.”), there’s a elementary ethical objection. The affluence check would penalize individuals who make the identical revenue as others their complete life, however who save extra and earn a return on these financial savings. Somebody who by no means saved, however as an alternative spent cash on restaurant meals, good vehicles, or journeys to Europe would profit greater than somebody who gave up a few of life’s luxuries to construct a nest egg. The tax system—with taxes on dividends, curiosity, and capital features—already discriminates towards savers. An “affluence” check would enhance this discrimination.
You may argue that occasions exterior individuals’s management, reminiscent of excessive medical payments or giant inheritances, are the reason for a lot of the disparity in wealth of individuals nearing retirement. However in keeping with economists Steven Venti and David Smart, such uncontrollable life occasions have little impression on individuals’s wealth at retirement. As an alternative, a lot of the variations in individuals’s wealth of their later years are as a consequence of one easy issue: the share of their revenue that they selected to avoid wasting.[13] The affluence check can also be economically objectionable: It could deter retirement saving, which is, in spite of everything, one of many major ways in which individuals save.
Conclusion
The federal government can’t be trusted with our pensions. Authorities officers have little incentive to look after us in addition to we might look after ourselves. They’re significantly unhealthy relating to long-term planning as a result of they not often look past the following election. And after they do look far forward, as Roosevelt did, it may be extra for mischief than for good. Johnson and Nixon elevated Social Safety advantages dramatically, despite the fact that this meant that taxes must enhance dramatically within the Seventies and Nineteen Eighties. They didn’t appear to care a whit about that. As a result of the Social Safety system is unsustainable in its present kind, merely to maintain the system in existence with out additional tax will increase requires that the federal government step by step increase the retirement age to about 70, apply extra correct inflation indexing to advantages, and cut back the true development in advantages that’s at the moment scheduled to happen. However that might nonetheless depart us with an costly Ponzi scheme that’s all the time threatening to worsen. It could additionally depart us with a system that arbitrarily and unjustly takes wealth from black males, people who smoke, high-income individuals, individuals with AIDS, and single individuals, and provides to white males, nonsmokers, low-income individuals, and married {couples} with one associate not working. It additionally would hold the federal government within the place of constructing our pension selections for us.
Due to this fact, the Social Safety system must be abolished. This may be completed in order to permit retirees and people inside 30 years of retirement nonetheless to get advantages, whereas liberating youthful individuals to avoid wasting for their very own retirement and be higher off than they’d have been below the present system. Our pensions shouldn’t be primarily based on a scheme that, when carried out by personal events, causes them to be despatched to jail.
[1] Martin Feldstein, “The Missing Piece in Policy Analysis: Social Security Reform,” Nationwide Bureau of Financial Analysis, Working Paper #5413, January 1996, p. 13.
[2] Feldstein, “Missing Piece,” p. 13.
[3] Feldstein and Samwick, “Transition Path,” p. 22, Desk 2.
[4] “Toward a More Accurate Measure of the Cost of Living,” Ultimate Report back to the Senate Finance Committee from the Advisory Fee To Research The Shopper Value Index, December 4, 1996, p. ii.
[5] Derived from Stephen J. Entin, “Private Saving vs. Social Security: Many Happier Returns,” IRET Congressional Advisory, September 4, 1996, No. 56, Institute for Analysis on the Economics of Taxation.
[6] Entin, p. 4.
[7] Peterson, Will America Develop Up?, p. 18.
[8] Laurence J. Kotlikoff, “Privatizing Social Security at Home and Abroad,” American Financial Assessment, Might 1996, Vol. 86, No. 2, p. 368.
[9] Kotlikoff and Sachs, “It’s High Time to Privatize,” Brookings Assessment, Summer season 1997, p. 22.
[10] Bob Davis, “Senior Project,” Wall Avenue Journal, July 9, 1996, p. A14.
[11] Bob Davis, “Senior Project,” p. 1.
[12] Peterson, Will America Develop Up?, p. 167.
[13] Steven Venti and David Smart, “Choice, Chance, and Wealth Dispersion at Retirement,” Nationwide Bureau of Financial Analysis, Working Paper No. 7521, February 2000.
