David Barcelo
Eric Saphir
POS201
8 March 2017
Back Into Your Hands
Let’s get back to basics before we jump in. What is Social Security? The Social Security Act was signed into law in 1935 by President Franklin D. Roosevelt. The SSA created a system of benefits for workers and their families. In 1956, this was expanded to include disability benefits. Social Security is composed of two separate entities: The “Old-Age and Survivors Insurance’’ program and the “Disability Insurance” program. Both programs have separate finances handled through two separate trust funds. The term social security describes a tax payer funded government program in place to provide limited economic security to the public. In the United States, it is required for employers and their employees to pay Social Security taxes. The funds raised from these taxes provide the benefits for folks who have reached retirement age and those who are otherwise eligible. Our workforce pays into the system, and those currently retired draw the benefits. When our current workforce reaches retirement age or suffers a disability, the next generation’s workforce will fund their benefits. The Social Security benefits you’re entitled to depends on the amount you’ve paid in taxes to the Social Security system. People with greater incomes are entitled greater Social Security benefits.
The program also unfortunately pays a wildly disproportionate amount to low income earners. They are in greater need of the benefits, and their dollar paid into the system yields a higher payout than someone with a greater income. The structure of Social Security operates as a pay-as-you-go system. As we pay into the system, our elders and the disabled community benefit off of our pay-ins. Privatization would upend this process. Instead, your contributions as a taxpayer would be invested into a separate account for your own retirement. When the program was implemented in 1935, US life expectancy was 62 years old for women and 58 years old for men. Also, only 54% of men who make it to 21 would make it to 65, which was when they would be able to collect benefits. In 1940, there were only 6.7 million Americans actually 65 or older. Today, the number of people past retirement age is 40 million. If you made it to 65, your average remaining life expectancy is an additional 20 years. The poor and those who rely more on their Social Security benefits are those who would gain the most from privatizing the Social Security system. By providing a much better rate of return, privatization of the Social Security program would raise the incomes of retirees who are most in need. Although the program is designed to transfer wealth to the elderly poor, the system has not done much to close the wealth disparity gap.
This trend has been slowly but surely growing worse, with our most disadvantaged seniors relying more and more on Social Security. The disparity between wealthy and poor seniors is going to widen in the future. The disadvantaged elderly are going to continue to become increasingly dependent on Social Security while those with higher incomes will further themselves from the program and rely on private pensions and other sources of income. The question is now whether the benefits offered by Social Security will be enough to provide an adequate income after retirement for the elderly poor who have no other income.
Consider the total benefits that a retiree receives over his lifetime. Clearly, a person who dies the day after he turns age 65 receives less money from Social Security than does an individual who lives to be 100. There is a well-established relationship in this country between wealth and longevity. Put simply, wealthy people live longer than poor people. Therefore, wealthy retirees will probably receive Social Security for a longer period of time than will their poorer counterparts. As a result, another question is whether the longer period of returns offsets the system’s progressive benefit structure. In short, do the wealthy get a better deal than the poor? The poor tend to start work right after high school, if not before, while the middle class and the wealthy are more likely to delay full- time entry into the workforce until after they have completed college. Therefore, the poor will begin paying taxes several years earlier than will the wealthy, but paying taxes for those additional years does not earn any additional benefits.
To take a dark turn, the poor also are much more likely to die before age 65 than their wealthier counterparts. Individuals who die before 65 who spent the passed 40-50 years paying into the system do not receive any of their retirement benefits. If they had spouses or children, than those dependents would be entitled to survivor’s benefits. This only partially offsets the significancy of retirement benefit loss. But for a tiny fraction of what that person paid into the Social Security system, they could have purchased a life insurance policy. A life insurance policy that would have paid out just as much if not much more than what the social security benefits might have been. But those survivor’s benefits are not where the majority of Social Security taxes go towards, those funds go to retirement benefits. If our unlucky example is single or had no survivors, then they will receive nothing in return for their years in the workforce. So anyone who dies before age 65 and did not have preparations in place, then they will definitely get the short end of the stick. And our example person, who never felt the need to protect their dependents or their worth, is far more likely to be poor as opposed to rich.
Social Security’s pay-as-you-go financing mechanism reduces national savings, which leads to a decline in capital investment, national income, and economic growth. Among the areas that suffer most as a result are America’s inner cities and other regions of high poverty and unemployment. Obviously, the imposition of needing to pay into the Social Security system reduces private savings. You do not have a choice of if you would like to pay into the system. Employers and their workers are required by law to pay Social Security taxes. You do not have the opportunity to invest those lost wages, your earned wages, into investments or decide to save it. And by reducing the opportunity to save your earnings privately and accumulate capital, Social security reduces the ratio of capital that goes to workers. This leads to less economic activity coming from those workers. And when less investments are made, those that are made usually have higher interest rates to which ensures higher returns on capital. Average Americans and middle class workers primarily depend on wages, while the wealthy make their earnings in far greater numbers from capital. Social Security perversely redistributes wealth from the poor to the rich, widening even further the wealth disparity gap mentioned earlier.
Upwards of 90% of the funds collected by Social Security are used to pay out benefits. As the community of retired individuals continues to grow and expand, our payroll taxes will not be sufficient to pay all the benefits that are promised. The system is a static trust fund that does little to no investing. And still insists seizing parts of your wages, denying your options to save privately and limits the amount of capital available for new investment. That lack of investment opportunities is especially concerning to high-poverty areas. When investment capital is scarce, of the first areas to feel it are where investments are risky, low-income neighborhoods and inner-cities. Places with higher crime rates & a less-educated workforce. As economist Jude Wanniski explains, “The people who lose the most . . . are the poorest, the youngest, those at the beginning of their careers, those who are furthest from the sources of capital.” Although all Americans will benefit from increased savings, investment, and economic growth, the poor will be among those receiving the biggest boost.
Social Security privatization must be looked at as a genuine alternative compared to the current Social Security system’s future. Because of Social Security’s possible future insolvency, failure to privatize the system will almost certainly result in a reduction in benefits, an increase in payroll taxes, or -more likely- both. This looming possibility would be particularly devastating for the poor. It is important to remember that the payroll tax is an extremely regressive tax. First, it is a tax only on wages, leaving other income sources, such as capital gains, interest, and other profits on investment, untaxed. Since wages represent a high proportion of the poor’s income, a payroll tax will take a higher percentage of total income of the poor than of the wealthy. That effect is compounded because the amount of income subject to the payroll tax is capped. Likewise, as we have seen, a reduction in benefits would disproportionately hurt the poor since they are more likely than the wealthy to be dependent on Social Security benefits. Those elderly poor who receive most or all of their retirement income from Social Security can ill afford any reduction in benefits. Yet benefit cuts of as much as one- third may be required to keep the system solvent. A one-third reduction in Social Security benefits would leave the elderly poor with a post-retirement income equal to only 50 percent of their preretirement wages. Such a benefit cut would likely plunge millions of elderly Americans into poverty.
Social Security privatization offers substantial benefits to the poor. Privatization would benefit them directly by providing them with higher benefits and removing the link between benefits and longevity. As a result, the poor elderly would have a more secure and more comfortable retirement. Privatization would also benefit the poor indirectly by increasing both overall economic growth and the pool of investment capital available in poor neighborhoods. That would result in more jobs and higher wages for the working poor, while helping to revitalize our inner cities. At the same time, Social Security privatization would provide poor workers with greater participation in the American economic system by making them stockholders. Finally, privatizing Social Security would avoid other potential Social Security reforms, such as raising taxes or cutting benefits, that would hurt the poor.
What’s more, the “privatization” of retirement savings is already well underway — ever since Congress passed the Employee Retirement Income Security Act of 1974, which established the first tax-deferred Individual Retirement Accounts. Those plans, and their cousins, employer-sponsored 401(k) accounts, seem to be working just fine. Americans have already socked away an estimated $1.9 trillion in 401(k) plans and another $3 trillion in Individual Retirement Accounts. That means there’s roughly three times as much money in private retirement accounts already as there is in the Social Security trust fund. Now, it is debatable whether investing in the stock market will improve returns enough to pay for future and existing benefits at current promised levels. But no one can deny private accounts would change the conversation about entitlements. It clarifies what people expect to earn in retirement.
Privatization provides an answer to the problem of lifetime return in three ways. First, by transforming Social Security from a defined benefit to a defined contribution plan, privatization would disconnect total benefits from life expectancy. The benefits an individual would receive would depend on what was paid into the system plus the investment return on those payments, not on how many years the person received benefits. Second, under a privatized system, individuals would have a property right to their benefits. If a person were to die with money still in his or her retirement account, that money would become part of an estate, to be inherited by that person’s heirs. Finally, individuals who begin work earlier, and therefore contribute for additional years, would earn additional benefits as a result of their contributions.