Our current Social Security system began in 1935 when President Roosevelt, as part of his New Deal, signed the Social Security Act into law.
This legislation created a kind of social insurance designed to ensure the economic security of all citizens. The retirement portion of the legislation was designed to provide a social safety net for individuals who would be unable to save enough during their lifetime. This was intended to specifically help the working poor by providing them with a guaranteed stream of income after retirement. Despite these lofty intentions, the cost of this policy actually falls hardest upon the shoulders of those earning low or moderate incomes.
Social security is financed by a payroll tax of 6.2 percent gross earnings – an equal amount is withheld by the employer. However, these taxes only apply to the first $90,000 of income earned. Every subsequent dollar that you earn is completely untouched by this tax. This makes Social Security a highly regressive tax. For every dollar you make in excess of $90,000, you pay a lower total percentage in social security taxes. For illustrative purposes, imagine someone who makes a princely salary of $500,000 a year. They only pay tax on the first $90,000 of their income. This means that a mere 2.2 percent of their total income goes towards social security payments, while anyone earning less than $90,000 pays the full 12.4 percent. Talk about a tax break for the rich!
This regressive taxation schedule ultimately displaces private savings in low and moderate income households. In turn, these households are forced to rely on Social Security to provide a larger portion of their retirement income. This makes the system’s abysmal rate of return especially damaging for individuals at this socioeconomic level. Imagine a hypothetical female who earns $43,000 annually and is expected to live until age 80. If she begins working today at age 20, then by the time she dies she can expect a negative annual return from Social Security of approximately -0.31 percent. If she instead invested this money in a conservative mix of stocks, she could expect a significantly higher return of 7 percent annually. A privatization plan that allows you to invest a portion of your Social Security taxes in these financial instruments would provide significantly higher returns and would have the additional benefit of creating a secure property right in these assets.
Opponents of privatization argue that saving for retirement is too important to be left to the vagaries of the stock market. While equities are quite volatile in the short run, they become relatively stable in the long run. In fact, it is not entirely clear whether one system is riskier than the other – because private accounts are not exposed to certain risks that are inherent in a “collect as you live” system.
Under this system, total benefits received are almost exclusively determined by one’s length of life. Suppose our hypothetical female pays security taxes her entire life. If she lives to the age of 100, she comes out ahead by $750,000. If she lives to 81, she will break even. If she has the bad fortune to pass away at age 64, just one year before she would typically begin collecting benefits, then she can expect to lose nearly $650,000 over the course of her lifetime. Problems become apparent when you take into account the large spread in average life expectancy among different demographic groups in this country.
According to the Center for Disease Control and Prevention, white females can, on average, expect to spend 80.5 years on Earth, while black females typically live four years less. Black males fare the worst with a life expectancy of 69.2 years. These differences in longevity translate into huge differences in expected returns. Based on an estimate by the conservative Heritage Foundation, black males can, on average, expect to get back only 88 cents for every dollar that they pay into the system. This problem of low returns due to low life expectancy is further exacerbated by the fact that reduced life expectancy is closely linked to higher rates of poverty. This creates a situation where individuals most in need of a safety net find themselves caught under the weight of their Social Security payments.
A partial privatization plan would mitigate many of these problems because retirees would be allowed to cash in on their investment when it made sense for them personally. If a beneficiary has no relations, she can spend all of the money that she has saved up before it is too late. Or conversely, if she wants to pass on a large portion of the money to her next of kin, she can choose to consume only a portion of the income during her lifetime. Either way, she is able to spend her payroll tax contributions in ways that would have been impossible under the current system. These new options are available to her because she now has an ownership right in these assets. Including such a right is crucial to a successful system because it allows individuals to utilize their own personal information about how much to consume and how much to save.
Social Security was originally envisioned as a kind of social safety net, but it has increasingly become a shackle for those individuals who need it most. A privatization program that allowed for greater private investment opportunities would go a long way towards reducing the unintended inequities of our current system. Such a program can only succeed if the needs of the poor are allowed to take precedence over usual partisan bickering.
If you are interested in learning more about this important topic, there will be a panel discussion on Social Security reform Wednesday, March 23 in Lower Strong Auditorium at 7 p.m.
Miller can be reached at email@example.com.
Lasonde can be reached at firstname.lastname@example.org.