Personalization of Social Security: Reviving American Retirement

Social Security is in a financial crisis. The highest funded government program in the world is paying out more in benefits than it is receiving in contributions and is projected to be bankrupt by the year 2034 (OASDI Trustee Report). The existing structure of the program faces tremendous stress as the amount of elderly people receiving benefits rises. Without restructuring it, future retirees will only receive a portion of their promised benefits. Additionally, the growing costs of Social Security will hurt the economy and cause large tax increases on workers.

Congress has known about these problems for decades, but nothing has been done to remedy them because the political parties cannot agree on a solution. Consequently, the financial issues surrounding it will worsen every year and become more difficult to solve. The best way to fix Social Security is to allow younger workers to invest part of their payroll taxes into the marketplace through personal accounts.

To understand why we must move to a system of personal accounts, it is important to know how the present system functions and why it is flawed.

Basically, a worker contributes to Social Security until they reach a certain age, at which point they can claim their monthly benefits. A percentage of their wages goes toward Social Security in the form of a payroll tax. This is currently set at 12.4%, with employers and employees each paying half. The amount that an employee can be taxed in a given year is capped at $128,400, so anything they make over that is not paid into Social Security.

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At age 62, one can retire and collect reduced monthly benefits, or at 67 they can claim full monthly benefits. Many Americans believe that the money they pay during their career goes into a retirement account that collects interest over time and will be available to them in retirement. That is not the case. Social Security has a pay-as-you-go structure, or PAYGO, in which the money that current workers pay into it is used to pay for the benefits of current retirees.

Any surplus of money that is not paid out in benefits is added to a trust fund that can be drawn upon in case of deficit spending. This structure has worked in the past but is now unsustainable due to demographic trends. In particular, higher average lifespans, lower birth rates, and the surge of retirees from the baby boom generation have caused the worker to retiree ratio to drop substantially. According to the Social Security Administration’s annual Trustees Report, 159.4 workers paid for one retiree in 1940. In 1950, that ratio dropped to 16.5:1, and by 2030 it is projected only to be 2:1. There are simply not enough workers to fund the retirement of the elderly under the current system. These factors contribute to the quickly approaching bankruptcy of Social Security. Actuarial estimates show deficit spending in the program for the first time this year since 1982. It is projected to continue to spend more than it earns every year after until 2034, when its reserves are depleted and it can only pay 79% of benefits to retirees.

There are three basic options to fix the financial problems of social security. First, payroll taxes could be increased, but that is the least desirable choice. From the inception of Social Security, taxes have been increased by 14 times the original amount. Moreover, the Trustees Report estimates that payroll taxes would have to be increased from 12.4% to 15.35% to avoid the projected downfall, a further increase of 24% . Shantanu Bagchi, a macroeconomics professor at Towson university, says that a tax hike this high would damage the economy by discouraging work, investment, and saving. Businesses would also face difficulties with affording the high taxes of employees, causing many to go out of business and preventing others from expanding. The second option is to reduce benefits. This would certainly help Social Security move toward solvency, but only partially. Besides, the monthly payments are already just high enough to stay out of poverty. The average earnings from Social Security benefits are only $1,404 each month, just $392 above the poverty level in the United States, hence most retirees cannot afford flat cuts to their income without sinking into poverty.

However, the Congressional Budget Office has proposed reasonable solutions for cutting back benefits. For one, they suggest raising the retirement age to more accurately match the longer lifespans of citizens, which would cut back spending by twelve percent. This, along with other benefit reduction proposals, should be implemented in conjunction with the third option for reform: individual accounts. Individual accounts are the answer to reestablishing long-term solvency to Social Security and providing retirees with a comfortable retirement. George Bush tried to apply this system during his presidency, but the terrorist attacks on 9/11 and congressional disagreement halted his progress. Since then, the Cato Institute, a non-partisan economic think tank, has developed a plan for implementing it into Social Security. Within the plan, young workers would have the option of investing half of their payroll taxes (6.2%) into an account separate from Social Security.

According to Michael Tanner, a senior fellow at Cato, this account would generate much higher returns than Social Security and would not be subject to government control (Tanner). Upon retirement, one could draw a certain percentage from their account each year, which would still accumulate interest, or purchase an annuity. The other half would still be paid into Social Security to pay for scheduled benefits to retirees still in the system. Less workers would draw from Social Security in the future, which would greatly relieve stress from the system, and individuals would have control over their own investments. George Sauter, the chief investment officer of Vanguard Group and council member for the Chicago school of business, wrote for the Wall Street Journal that if a worker dies before they collect their Social Security benefits, the money is lost. With individual accounts, that money could be transferred to family or a charity of their choosing (Sauter).

If individual accounts can offer higher rates of return and greater economic freedom, then why have policymakers not eliminated the old system and implemented the new one? First of all, Congress has not been able to agree on a bipartisan approach. Politicians are afraid to introduce or agree with bold ideas to fix Social Security because they would be risking their political careers if they fail to get enough public support. Small changes have been made to keep the program afloat, but the inherent problems are ultimately pushed onto the next generation of workers and policymakers. Secondly, opponents of establishing individual accounts fear that personal investment portfolios involving stocks would be subject to market downturn, especially if a recession like the one in 2008 happened again.

However, as George Bush stated in his State of the Union address, the investments would be made up of ‘a conservative mix of bonds and stock funds” (Bush). This would combine the low-risk, low-reward aspect of bonds with the high-risk, high-reward aspect of stocks to offer a diversified and safe investment with high returns. If Congress is still doubtful after examining these proposals, they should look at the success it has had in other countries. Chile was the first country to switch from a public, PAYGO system to a similar system of individual accounts in 1981. The man leading this transition, Jose Piñera, says that it is “based on ownership, choice, and personal responsibility”.

Ten percent of a worker’s wage is added to an individual account that grows with interest, tax free. Upon retirement, the worker can purchase an annuity or draw from the account as they wish. Chile has seen tremendous economic success with their private retirement system, and since its introduction, 32 other countries have modeled theirs after it, including Poland, Mexico, Australia, Argentina and the United Kingdom. The future of American retirement is at stake. The small changes that kept Social Security afloat in the past will not solve anything, but instead leave future generations struggling to overcome an even bigger mess. The government can see that the pay-as-you-go structure of the program is weak and that raising payroll taxes will hurt the economy. They can also see that individual retirement systems work, as 32 countries have shown. The only solution left is to allow younger workers to invest part of their payroll taxes into the marketplace through personal accounts.