A reform like none other for the 21st century.
On September 12, the pioneering Rep. Thaddeus McCotter introduced trailblazing legislation providing workers the freedom to choose personal savings and investment accounts to finance half of their future Social Security benefits. This legislation would completely solve the future Social Security financing problem, without cutting benefits or raising taxes, as officially scored by the Chief Actuary of Social Security.
Indeed, because standard, long-term market investment returns are so much higher than what Social Security even promises, workers with personal accounts will enjoy higher rather than lower benefits. Moreover, the legislation would result in the greatest reduction in government spending in world history, as explained below.
Why Social Security Is Fundamentally Broken
Next year the Baby Boom begins to retire on Medicare in earnest, and the year after that on Social Security. For decades now, the federal government’s own official reports have been showing that Social Security would not be able to pay all promised benefits to the baby boom without dramatic, unsustainable tax increases.
Last year, Social Security began running a cash deficit, for the first time since President Reagan saved the program in 1983. Under what the government’s actuaries call intermediate assumptions, those deficits will continue until the Social Security trust funds run out of funds to pay promised benefits by 2037. After that, paying all promised Social Security and Medicare benefits financed by the payroll tax will require eventually almost doubling that tax from 15.3 percent today to nearly 30 percent.
Under what the government’s actuaries call pessimistic assumptions, the Social Security trust funds will run out of funds to pay promised benefits by 2029. After that, paying all promised benefits to today’s young workers would eventually require raising the total payroll tax rate to 44 percent, three times current levels, and ultimately more.
Social Security operates as a pure tax and redistribution system, with no real savings and investment anywhere. Even when it was running annual surpluses, close to 90 percent of the money coming in was paid out within the year to pay current benefits. Even the remaining annual surpluses were not saved and invested. They were lent to the federal government and spent on other government programs, from foreign aid to bridges to nowhere. The Social Security trust funds received back in return only internal federal IOUs promising to pay the money back when it is needed to pay benefits. Those federal IOUs are rightly accounted for in federal finances not as assets but as part of the Gross Federal Debt, subject to the national debt limit. That is because they do not represent savings and investment but actually additional liabilities of federal taxpayers.
Consequently, when Social Security runs cash flow deficits, which it will until the trust funds run out around 2030-2035, those deficits represent immediate new burdens on taxpayers. Social Security then returns some of its trust fund bonds to the federal government, asking for the cash to cover the deficits to pay all promised benefits. But since the trust fund bonds do not involve any real assets that can be used to pay back Social Security for the past borrowed funds, the government can only cash out the bonds by raising taxes, in addition to all the payroll taxes workers and their employers will have to continue to pay, or by issuing new federal bonds to the public, increasing the national debt burden on the public and the economy further.
In my recent book, America’s Ticking Bankruptcy Bomb, I calculate that the increased taxes between now and when the trust funds run out would amount to $7 trillion, again on top of the continuing payroll taxes. Or the national debt held by the public would have to increase by $7 trillion, more than 50% above current levels.
Social Security’s pay-as-you-go tax and redistribution system does not earn the investment returns that a fully funded savings and investment system would. As a result, over the long run the system can only pay low, inadequate, below market returns and benefits. That is why studies show that for most young workers today, even if Social Security does somehow pay all its promised benefits, those benefits would represent a real rate of return of around 1 percent to 1.5 percent or less. For many, the real effective return would be zero or even negative. A negative rate of return is like putting your money in the bank, but instead of earning interest on it, you have to pay the bank for keeping your deposit there. That is effectively what Social Security is for many people today.
Moreover, on our present course, that is what Social Security will be for everyone in the future. Whether the long-term deficit is closed ultimately by raising taxes or cutting benefits, that will mean the effective rate of return from the program will be lower, ultimately falling into the negative range for everyone.
McCotter’s bill provides a complete solution to these problems, benefitting both future seniors and taxpayers, based on proven reforms that have already worked in the real world. The bill empowers each worker age 50 and below with the freedom to choose a contribution to a personal savings and investment account equal roughly to half of the employee share of the Social Security payroll tax.
One important innovation in McCotter’s bill is that instead of financing the contribution from Social Security payroll taxes, with general revenues paid into Social Security to maintain continued payment of current Social Security benefits, the contribution would be financed out of general revenues directly, with no reduction in the payroll tax revenues flowing into Social Security. That avoids AARP’s chief past criticism of personal accounts, that they would drain from the program the payroll taxes needed to pay for today’s benefits, even though AARP has not raised a peep about Obama’s temporary payroll tax cuts, which Obama has proposed to extend and expand for next year.
Moreover, under McCotter’s bill, the general revenue contributions to the accounts are financed by reductions in other government spending. The bill provides that the accounts are to be financed only out of a Spending Reduction Account reflecting spending reductions already enacted. That will primarily involve block granting dozens of federal means-tested welfare programs back to the states, modeled on the enormously successful 1996 reforms of the old AFDC program, with further legislation now being drafted to provide for that.
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