The original Social Security tax was just two percent on the first $3,000 that a worker earned, a maximum tax of $60 per year... Today's workers pay a payroll tax of 12.4 percent.

Weighing the Risks of Social Security Reform

Much of the national debate on Social Security reform has focused on the potential risks involved with President Bush’s proposed personal retirement accounts.  Some opponents of the proposal have been using this to their political advantage and are exaggerating the risks.  

For example, Congressman Pete Stark (D-CA) recently complained, “Some members of Congress want to throw America’s retirement funds into the hands of uneducated investors.” Apparently, Congressman Stark needs a tutorial on the President’s proposal, because his comments are simply wrong.

Personal retirement accounts as envisioned by President Bush would not allow “uneducated” investors to cash out of the Social Security system and “let it ride” on the ponies.  Instead, the President’s reform measure would be based loosely on the Thrift Savings Plan, the long-term retirement plan currently enjoyed by 3.4 million federal employees.  That means personal retirement accounts would be invested in a well-balanced, relatively safe mix of bond and stock funds. The president’s plan would also offer a “life cycle portfolio,” which would automatically adjust the level of investment risk as the beneficiary aged and offer protection from wild shifts in the market as retirement neared.

Furthermore, while government should be cautious, an exaggerated fear of the stock market ignores the facts of history. 

Since World War II, there have been only two occasions during which the market fell for two consecutive years—1973 and 1974, and 2000 and 2001, which would be inconsequential to a long-term investor or today’s workers preparing for retirement.

Of course, such a system of reform could never entirely shield Americans from all risks associated with investing.  So let’s take a comparative look at the risks associated with doing nothing; with letting the present pay-as-you-go system run its course.

As Federal Reserve Chairman Alan Greenspan pointed out in his Congressional testimony recently, "Beyond the near term, benefits promised to a burgeoning retirement-age population under mandatory entitlement programs, most notably Social Security and Medicare, threaten to strain the resources of the working-age population in the years ahead … Real progress on these issues will unavoidably entail many difficult choices … But the demographics are inexorable, and call for action before the leading edge of Baby Boomer retirement becomes evident in 2008." 

Greenspan’s sentiments echo President Bush’s.  In 1950, 16 workers financed the benefits for a single retiree.  Today, that ratio has been shaved to 3 to1.  When today’s younger workers retire, the ratio will be a paltry 2 to 1. 

Fewer workers for more retirees mean each worker bears an increasing financial burden to pay the benefits that Social Security has promised. The original Social Security tax was just two percent on the first $3,000 that a worker earned, a maximum tax of $60 per year. By 1960, payroll taxes had risen to six percent. Today's workers pay a payroll tax of 12.4 percent.

If no reform is implemented, the burden is going to get much worse.  

Consider this.  In order to continue funding retiree benefits under the current Social Security system, the payroll tax will likely have to be raised to more than 18 percent. That's nearly a 50 percent increase.

The alternative to massive tax increases is equally grim.  Because Americans have no legal right to their retirement benefits, Congress can cut them at any time.  In fact, a cut in benefits is the default method of keeping the system solvent, a 27 percent cut in benefits by 2042 and a 35 percent cut in benefits by 2077, to be exact.  And the cuts will become perpetually deeper. 

Are there risks involved in allowing younger workers to invest a portion of their Social Security payroll taxes in personal retirement accounts?  Absolutely, but history tells us those risks are minimal, and far less dangerous to our economic well-being than doing nothing and allowing the system to go bankrupt.

March 10, 2005
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