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Reform Thursday: Bonus Graphic- The Undeniability Of Social Security's Problems.

There is a certain undeniability to the problems Social Security faces, which makes the "there is no crisis" folks seem more than a little dishonest.

Social Security was structured, from the beginning, like a Ponzi scheme, also called a pyramid scheme. These schemes do not have any real money-making capabilities, but they promise great returns down the road.

And they seem so wonderful! People, initially, make money faster than they can count it.

The only catch is that pyramid schemes involve finding an ever-increasing base of dupes to pay for the scam. Eventually, there simply are not enough new people to fund the scam, and the pyramid collapses.

Social Security, from the beginning, was set up like a pyramid scheme, destined to failure. Over the years it became a slave to demographic changes, with ever-growing numbers of beneficiaries outnumbering ever-shrinking numbers of contributors.

So why didn't the pyramid of Social Security collapse (in the 1950s or 1960s, perhaps)?

Basically, because of three fixes:

1. The government increased the tax rate dramatically.
2. The government expanded the tax base drastically.
3. The government upped the retirement age.

In the future, the options will be less palatable, because tax rates have already gotten so high. Raising the retirement age by a few years between now and the crisis would not even make a dent in the real solvency issues. Thus, the most likely option would be some combination of large tax rate increases, substantially raising the cap on the tax, a higher retirement age, drastic benefit cuts, and frantic borrowing.

Not great options, really.

But there is a better alternative. Instead of applying the same old cosmetic fixes, which simply kick the can down the road a little further, we have an opportunity to reform the system fundamentally, removing its pyramidical nature and making it permanently self-sustaining. The only way that can happen is through personal retirement accounts.

Critics say the personal accounts would be too expensive, forcing the government to go into deep deficit borrowing.

This is simply false. Actuarily, the government has an obligation to pay out the benefits, either way. It's just a matter of less now or more (more than 11 trillion dollars) later. And the relevant markets have already priced in the cost of Social Security over the long run. Reforming it would not add additional burdens, it would merely recognize and take care of existing obligations, much like paying off the car or house earlier than originally planned.

Critics say that personal accounts do nothing to achieve solvency.

On the contrary, personal retirement accounts must be part of any serious, long-term, self-sustaining solution.

Alone, personal accounts do not solve the entire crisis that already exists in the system. Over the long-run, however, personal accounts do make the system self-sustaining.

Additionally, personal accounts, on their own, without other changes, do not solve the entire crisis, but they are an important and necessary part of the solution. Part of the solution is that the government reduces the benefits it pays out in the traditional pyramid scheme method. But an individual will not see that reduction. The individual will go on receiving a check, and likely a larger check than he would have ever gotten under the Ponzi funding method. The government, under a reformed system, just does not have to find the money to cover that check.

The problem with these reductions in government payouts is that those against reform eagerly demagogue the issue, saying that the reform is a guaranteed benefit cut for retirees. This scares people, particularly the elderly, a group which derives much of its income from Social Security.

The personal retirement accounts, for younger workers, would allow an individual to essentially fund his or her own retirement. Many people are under the impression that when you pay Social Security taxes, that money goes into an account with your name on it, earning compound interest over time. Unfortunately, although that method would make absolute sense, Social Security just does not work that way. Personal retirement accounts would allow the government to "cut benefits" from its perspective by changing, from wage-indexing to price-indexing, the way benefit increases are calculated. But, from the perspective of the retiree, benefits would be cut not at all.

The reductions in benefits are on the government payout side, therefore personal accounts do solve much of the funding shortfall inherent in Social Security today.

Ultimately, the critics are disingenuous when they talk about benefit cuts. Not only would the personal retirement accounts almost certainly allow for greater, not lower, benefits, if Democrats have their way and nothing changes, there will indeed be a sizeable and guaranteed benefit cut for the WILLisms.com generation. Guaranteed. There's really no way around that one, even with massive tax hikes. Andrew Roth notes that those options would be "business as usual" for Washington. But personal accounts must be part of any effective solution; they are not a sideshow, they are THE SHOW. We cannot take personal accounts off the table entirely, as Democrats are demanding, if we're going to be serious about reform.

Many critics of reform like to compare personal account reforms against the status quo, but they conveniently leave out the important little detail that the status quo is absolutely broken.

The idea behind Social Security is noble. Our country's grandparents should never face the effects of extreme poverty, such as going hungry and lacking heat during the winter. Social Security represents an important promise between and among generations, and that is precisely why it must be reformed, to make it solvent, to make it work better for individuals, and to allow it to benefit (rather than harm) the free market economy.

Posted by Will Franklin · 10 March 2005 10:36 AM

Comments

Posted by: DANEgerus at March 10, 2005 04:18 PM