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Obama von Bismarck

Where's the change, Chancellor Barack?

By 6.18.08

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For all his talk of a new politics of change and unity across partisan lines, Barack Obama said last week that as President he would deny working people the freedom to choose a better deal for Social Security. No real change for that program, adopted over 70 years ago, following the model adopted by German Chancellor Otto von Bismarck in 1889.

Indeed, Obama even voted against legislation to stop the longstanding raid on the Social Security trust funds. The supposedly old and stodgy John McCain, however, voted for the legislation to stop the raid, and supports allowing each worker the freedom to make their own choice regarding personal accounts.

This reveals yet again the sad truth about Barack Obama. Despite all of his empty rhetoric, he supports no change whatsoever from the liberal left welfare state adopted in the 1960s, and even the 1930s, based on the cutting edge social theories of the late 19th century. Instead, what he really wants is to go back to the old, outdated policies of those bygone eras with a rigid vengeance

McCain has supported the modern, truly progressive idea of personal accounts for Social Security, which has been adopted in some form in at least 30 countries around the world since Chile first did so with astounding success in 1981. Each worker would be allowed the freedom to choose to put at least some of his taxes in a personal savings and investment account that would accumulate returns over the worker's lifetime. In retirement, benefits from the account would substitute for a proportionate share of current Social Security benefits, depending on how much in taxes the worker is allowed to shift into the account over his working years. This would relieve at least some of the financial burden on Social Security, which everyone knows is unable to pay all of its promised benefits to today's workers.

But even worse than Social Security's projected long-term financial collapse is that the program is no longer a good deal for today's young workers. Even if the program could somehow pay all of its promised benefits to these workers, those benefits would still represent a low, below market return on the huge taxes workers and their employers must now pay into the program over each worker's career.

This has been shown in studies, books, and articles I and others have done for the Cato Institute, the Heritage Foundation and others. It also has been shown in the real world in Chile and elsewhere. The best summary of this work is that for most workers today, even if Social Security could somehow pay all of its promised benefits, the real rate of return paid by the system would be 1 to 1.5% or less. For many, it would be zero or even negative. The actuarial value of all promised Social Security benefits was included in these studies.

A negative real return is like putting your money in the bank, but instead of the bank paying you interest, you pay the bank interest for holding the money. This is what Barack Obama says we must not change. Thank you for that innovative insight, Barack.

OF COURSE, IF TAXES are raised or benefits cut to close the long-term financial gap of Social Security, the rate of return paid by the program will become worse, pushing more and more workers into the range of negative returns. Under the current system, this is where Obama would lead all working people, in the name of the glory of maximum dependency on government.

By contrast, the long-term real return on stocks, going back close to 100 years, is 7% or more. The long-term real return on corporate bonds has been 3.5%. Compounding a lifetime of investment at these returns as compared to the miserable returns Social Security even promises today, let alone what it can pay, would make an enormous difference for working people.

Social Security performs so poorly for workers today because it is completely a tax and redistribution system, with no real savings and investment anywhere. Close to 90% of the funds paid into the system each month are immediately paid out to finance the benefits of current workers. Even any surplus left over is lent to the Federal government and spent on other government programs. Without any investment, the system does not produce any investment returns to advance the prosperity of workers over the long run.

In 2005, Rep. Paul Ryan (R-WI) and Sen. John Sununu (R-NH) introduced the most advanced and comprehensive legislation for personal accounts ever developed. The bill would allow workers to contribute to the accounts roughly the employee share of the Social Security payroll tax. But it included a progressive feature that would allow lower income workers to contribute somewhat more while limiting higher income workers to contribute somewhat less, so that the gains would be roughly equivalent for all workers.

Workers would choose investments from a list of alternative investment funds managed by top private sector firms, all approved by the government for this purpose, and regulated for safety and soundness. So workers do not have to be investment experts to succeed. They just need to pick one of the approved funds, where proven industry leaders would maximize diversification and other investment strategies. This is precisely the system that has worked so well in Chile and elsewhere, with many workers with little sophistication or experience in investment.

LET'S LOOK AT AN AVERAGE income two earner couple that invests in the Ryan-Sununu personal accounts over their entire careers. With half invested in stocks and half invested in bonds earning the standard long-term returns discussed above, they would reach retirement with close to $700,000 ($668,178) in today's dollars, as calculated in a study I produced for the Institute for Policy Innovation. This fund would be enough to buy an annuity paying them about 60% more than Social Security even promises, let alone what it could pay. Investing two-thirds in stocks and one third in bonds, they would reach retirement with over $800,000 ($829,848) in today's dollars. That would be sufficient to pay them over twice what Social Security promises but cannot pay. All of this with just half the total payroll tax invested in the accounts.

Now let's take the case of a single low income worker who earns little more than the minimum wage over his entire career. Investing in a Ryan-Sununu personal account each year half in stocks and half in bonds, and earning standard long-term returns, he would reach retirement with over a quarter million ($271,505) in today's dollars. That would be enough to finance an annuity that would pay him 84% more than Social Security promises but cannot pay. If the fund was invested two-thirds in stocks and one-third in bonds earning standard long-term returns, then he would reach retirement with $347,827 in today's dollars, which would be enough to pay him well over twice what Social Security promises but cannot pay.

Workers would own this money, personally and directly. They would be free to leave some of it, or all of it, to their families and children. Every worker in the economy would own a share of America's business and industry. The ownership of financial wealth would be far more equal throughout our society. The new savings and investment flowing through the personal accounts, and the reduced payroll tax burden, would cause an economic boom that would create new jobs and increase the wages of workers today. This would all be nothing less than a revolution in the personal prosperity of working people.

But Barack Obama says no, he would not even leave workers free to make their own choices. He is still back there with Otto von Bismarck in 1889.

Instead Obama mocks the idea of such worker prosperity. He says, referring to recent stock market declines, "Imagine if your security now was tied up with the Dow Jones. You wouldn't feel very confident about the security of your nest egg." Even though Obama himself owns substantial retirement investments through the Federal Thrift Savings Plan, when it comes to average working people, such investment is just too risky.

The huge gains available to workers through the accumulation of real investment returns leaves plenty of leeway for occasional downturns. Moreover, workers would be free to choose to forego personal accounts and rely on the old Social Security framework if they prefer. In addition, workers with personal accounts are not required to invest in the stock market. They could just invest entirely in bond funds or other more stable investments.

BUT THE RYAN-SUNUNU BILL had another answer to Obama. It provided for a government guarantee that all workers with personal accounts would get through the accounts and their continuing Social Security benefits at least as much as promised by Social Security under current law. So the bill maintained the current safety net provided by Social Security in full. This is feasible because market investment returns are so much higher than Social Security can even promise that workers with such accounts are quite unlikely to end up needing the benefit guarantee. This follows exactly the model in Chile, where all workers with personal accounts were guaranteed a minimum benefit equal to 40% of pre-retirement income, which is actually a bit more than Social Security in America currently promises to average income workers.

Obama says that personal accounts "would eventually cut guaranteed benefits by up to 50%." But the Ryan-Sununu guarantee shows that this is completely wrong. Indeed, the bill provided for no cuts in promised Social Security benefits even for those who refused the personal account option.

When the Chief Actuary of Social Security scored the Ryan-Sununu bill, he concluded that the proposed personal accounts were such a good deal that all workers would choose them. This is why the bill did not need to include any benefit cuts, or tax increases, for anyone.

The Chief Actuary also concluded that the personal accounts would eventually take over so much of the burden of paying for Social Security benefits that the bill would achieve full solvency for Social Security, completely eliminating all long-term deficits, even though it did not cut benefits, or raise taxes, for anyone. Instead of Social Security payroll taxes eventually climbing from a total of 12.4% of wages today to close to 20% or more to pay all promised benefits, the payroll tax under Ryan Sununu would eventually decline to 4.2%, enough to continue payment of all promised disability benefits. This is the largest tax cut in world history.

The Chief Actuary also found that after just the first 15 years with the Ryan-Sununu personal accounts, workers would have accumulated $7.8 trillion in today's dollars in the accounts. After just the first 25 years, workers would have accumulated $16 trillion, again in today's dollars, double the size of the entire mutual fund industry today. This is broader worker ownership than could ever be achieved through Obama's socialist economics.

BUT OBAMA THINKS he has a better idea -- raise taxes on the rich! Now ain't that special.

Obama proposes to impose the full Social Security payroll tax on everyone earning over $250,000 per year. He said last week that it is unfair for the middle class to pay Social Security taxes "on every dime they make," while millionaires and billionaires pay the tax on only "a very small percentage of their income."

The Social Security payroll tax has always been paid on wages up to a maximum annual taxable income limit, which now automatically grows each year with the average growth in wages. For 2008, the maximum taxable income is $102,000, meaning workers and their employers do not pay taxes on wages above that income limit.

About 10% to 15% of workers exceed the maximum taxable income each year. But while workers do not pay taxes on income above that limit, they also receive no benefits based on that income. Benefits are calculated under a formula based on income earned each year. So there is no unfairness involved in the income limit. Once workers have provided for enough retirement income through Social Security to provide a basic foundation for retirement, no one has ever thought that they need to be required to pay more into the system. Providing for additional benefits is left up to each family. Indeed, Social Security pays a negative effective real return for workers around the maximum taxable income, so requiring them to pay still more and reduce that effective return further would be rapacious.

Such a tax increase policy, moreover, leaves workers without all of the enormous advantages of personal accounts discussed above. Working people would still be suffering with the poor deal offered to them by the program today. They still have to waste the enormous payroll taxes they and their employers pay, more than the income tax for most workers, on a tax and redistribution system rather than a highly productive savings and investment system.

In addition, this proposed tax increase needs to be seen in the context of the rest of Obama's tax increase proposals. He has proposed to raise the rate of every significant Federal tax. He has proposed to raise the top rate of the individual income tax from 35% to almost 40%. The Social Security tax increase proposal would add another 12.4% to the top marginal tax rate. He has proposed to raise the capital gains tax rate by somewhere between 33% and 100%. He would almost double the tax rate for dividends. He has proposed to reinstate the death tax in full. He would raise taxes on corporations as well. All of these tax increases would be used to massively increase Federal spending, eventually by over a trillion dollars a year.

Is this likely to raise our sluggish economy out of the doldrums and bring back robust economic growth? Or is it more likely to tank our economy further? Amity Shlaes, author of The Forgotten Man, which provides a new history of the Roosevelt era, points out that in proposing to sharply raise marginal tax rates and adopt protectionist trade restrictions, Obama has the exact same policies that transformed the 1929 downturn into The Great Depression.

FINALLY, OBAMA IS SO STUCK in the past that he would not even vote in favor of stopping the raid on the Social Security trust funds. He voted against Sen. Jim DeMint's proposed bill to stop that raid, and end the practice of using surplus Social Security funds to finance other government programs. John McCain, however, voted for the DeMint bill.

If Obama's rhetoric about change and post-partisan unity meant anything, he would consider personal accounts for Social Security, with their enormous benefits for working people. But his rhetoric is just meant to bamboozle the simple-minded. He has never departed from the standard liberal-left line on any policy issue, or reached across the partisan divide to work on any issue raised by the other side.

Rather, it is precisely John McCain who has done that. Conservatives disdain him for having done so. But at least he has the substantive audacity of Obama's false hope.

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About the Author
Peter Ferrara is Director of Entitlement and Budget Policy at the Heartland Institute, General Counsel of the American Civil Rights Union, Senior Fellow at the National Center for Policy Analysis, and Senior Policy Advisor on Entitlements and Budget Policy at the National Tax Limitation Foundation. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.