Do We Need Private Investment to Save Social Security?
In "good" times, after it has been forgotten that public policy has rescued the nation from "bad" times, the private sector gains the spotlight with suggestions to correct limitations. In debating the future of the Social Security System, the private sector has steered the debate to its preferred conclusions: The present Social Security System is a failure, cannot survive, and requires private investing of some of its funds to give seniors a satisfactory retirement benefit. They point to average returns of 12.2% on stocks over many years compared to Social Security's present investment vehicle, a 5.4% return on Treasury bonds.
The Social Security system's objectives, the causes and effects of poorly forecasted trends upon the system's health, and the proper investments for it, have been strongly debated. Proposals for keeping the retirement system solvent continually circulate without decision. And yet, we have a lack of discussion on what may be the most critical failure of the Social Security retirement plan: It operates as a pay-as-you-go plan rather than a true retirement plan. Changing its stature from pay-as-you-go to a true retirement plan may be the remedy for improving social security, while still retaining its unique advantages. Accomplishing this may yield a retirement system that is more competitive as an annuity than any similar private industry plan, and has advantages that private industry cannot provide. These advantages discourage investment of Social Security funds in private plans.
Can Private Investment Totally Substitute for Social Security?
The Social Security retirement fund, better known as OASI-Old Age and Survivor's Insurance, must be viewed in its entirety and not solely by its retirement fund. Only 69% of the entire payroll payments are directed to the retirement fund. Medicare Insurance gets 19% and disability insurance gets 12% of the payments. Only 1% is charged for administrative costs. Social Security contains opportunities and flexibility in providing all types of insurance coverage for the aged that a private system cannot conveniently cover.
OASI has additional flexibility that private investment of its funds cannot easily consider. OASI rapidly adjusts the benefit to the family's changing condition. The benefits are instantly adjusted for premature disability or death of the wage earner. Widows and minor children are assured benefits and financial protection. OASI funds are also distributed so that low wage earners are assured a satisfactory retirement income. Investing funds outside the federal system limits OASI flexibility and disturbs its complete package of retirement benefits and intentions.
And lost amidst all the rhetoric are other important considerations-OASI can adjust benefits with inflation, and the retirement fund, by purchasing treasury bonds, transfers the interest part of the public debt to a benefit for the retirement fund.
Can OASI Meet its Principal Objective of Providing a Secure Retirement Income?
Investment plans for retirement have a common direction. Firstly, a certain part of the capital must be secured and maintained to provide a definite minimum investment income. OASI serves as the cornerstone for the secure investment. This is OASI's principal mission. Other personal funds, outside of the Social Security system can be invested in opportunities that promise higher returns.
To obtain an annuity of $938/month, which is the presently forecasted average OASI benefit at at age 65, (Ref: Congressional Research Service Report for Congress, 94-27), at an interest rate of 5.25%, requires a contribution to retirement that totals $138,110. To achieve this total after 40 years of contributions, compounded at a 5.25% interest rate, the retiree must contribute only $1080/year. What does this mean?
Simply, that if the OASI retirement plan can be placed on a sound annuity type footing, the plan costs will not be excessive, and the investment return will not be the problem. Why does OASI lack a sound footing? It is well known that OASI had been forced to operate as a "pay-as-you-go" system from the start. Early retirees who made little contributions had to receive benefits almost immediately. Limited in building up sufficient OASI reserves and exaggerated by the inflation during the 1970's, Social Security became forced to increase contributions in order to increase the reserves and increase benefits to offset inflation. According to government calculations, OASI cannot permanently offset the early drain on its funds, and by the year 2032, the fund will be completely drained and will start showing deficits.
Social security contributions already average $6000/yr (worker plus company), and the retirement portion is not anticipated to give future workers greater benefits than the present benefit. Since contributions made today will only partly finance the retiree's future income, and much of it will be used to finance the income of present retirees, the return to the future retiree on total contributions is forecasted to be only about 2%. In order to increase the return, the entire contribution must be utilized for the worker's benefit and the fund must receive a sufficiently high interest rate. Utilizing a worker's contribution only for his/her own retirement, and not partly in a pay-as-you-go plan that subsidizes present retirees, means the present large FICA contributions will not be available to maintain the solvency of the social security system. The finances must come from other sources.
By using a major portion of the taxed FICA contribution to provide present benefits, Social security is unable to create sufficient reserves for future retiree benefits. On paper, OASI is being financed by FICA rather than by the general revenue fund. Yet, to workers, a major part of the FICA payment is only another form of taxation, and the result is the same as if they paid that part of FICA to the general revenue system. They don't recover the payment and therefore it is the same as any tax. If OASI incurs a yearly deficit, its deficit can be "zeroed" by using general revenue funds. Instead of paying the total FICA to the Social Security system, the FICA can be reduced and income and corporation taxes can be equivalently raised to offset the FICA loss. Instead of FICA taxes financing the government debt, government taxes can finance an OASI deficit.
This resonates as a sleight of hand operation, moving money from one department to another and achieving the same result, and it is just that. The benefit of the result is that OASI will become a true retirement plan, actuarially and financially. For citizens and businesses, the tax assessment will be the same. For the government, the tax revenue will also be the same. Only the bookkeeping will change. The bookkeeping operation changes the OASI from a pay-as-you-go plan to a true retirement plan. It does not solve the financial problems. Nor do any of the present proposals that only whirl around without facing the truth. Only an ingestion of money can place OASI on sound basis.The proposed change places them in better focus. And this focus allows more careful scrutiny of means to further improve the retirement plan and finally resolve the financial issue.
Many schemes have been proposed to improve the social security system. There is no need to repeat these proposals. Some simple proposals that may assist in strengthening the present system are:
(1) Invest the retirement fund in Brady bonds that include an inflation adjustment.
This will allow the retirement benefit to grow with inflation.
(2) Raise the contribution and retirement benefit in the same proportion as wages increases.
Wage increases reflect inflation. A proportion of additional wages should go to a retirement plan.
(3) Continually adjust the retirement age and contribution in accord with actuarial tables.
This will assure that the system is always sound.
Proposed means to resolve social security financial problems
(1) Maintain in the Social Security system all revenues received from taxation of social security benefits .
The present dispersal of taxes on social security benefits transfers social security benefits to general revenue and is unfair. The taxes on Social Security payments cancel a part of the retiree's benefit. The retirement fund has paid the retiree and the retiree then transfers a small part to the general fund. The tax should be returned to the retirement fund.
(2) Remove the CPI adjustment to the retirement benefit.
The inflation adjustment can be better performed as described above.
(3) Involve the local authorities, state, county and city in resolving the social security financial problems. Some part of their revenues should also be used. After all, social security recipient spending includes real estate taxes, sales taxes, drivers licenses, eta. Some of that spending could be returned to the retirement fund.
(4) Make the financing of each year's OASIS deficit (resulting from the revised FICA contribution plan) a top priority. Transfer the FICA contribution that pays for present benefits to the present budget and present tax revenue. Add whatever is necessary, which will be slight, so that OASIS deficits are reduced to nothing within 40 years, the time when those starting with the new retirement plan will receive their retirement checks. It may not be as complicated or as costly as we have been led to believe.
Can OASIS Beneficially Function as a True Retirement Plan?
The proposal to modify the present Social security system so it functions as a proper investment vehicle for retirement is not revolutionary. OASI has the capability to provide a pension for retirees that has more security, gives a larger return and has more advantages than private industry can provide. More security results from the strength of the government system and its opportunity to invest in specialized government long term bonds. The increased return is due to the ability to purchase government instruments without commission and to manage the large pension system with economies of scale, less administrative costs and at no profit. The added advantages allow quickly adjusting retirement benefits according to family status, inflation trends and total income. Establishing Social Security as the first tier of a retirement plan will eventually succeed in lowering the FICA tax. As the general tax revenue used to offset the Social Security deficit is reduced, the added income can be used for other purposes-either for consumer spending or investment in growth and speculative issues.