Social Security II: Privatize it?

Privatizing Social Security (SS) is a major waffle issue for me.  On the one hand, I believe in the market and think that it would be an efficient way to bolster retirement returns.

On the other hand, I find it extremely scary giving the government   power in investing capital in the free market system.  There are countless ethical questions that could be raised of how stocks/funds are invested.  Could the feds go after Enron knowing that retirement funds that they are responsible for could come crashing down?  There are many other well documented and valid points against privatization but that is not my point here.

I have two ideas of how to privatize SS.  My first idea is very simple.  Have the government give a dollar for dollar refund for the first $1000 given to an IRA.  This would privatize a part of SS but it would take away the government control of the investments.  If a person can not afford to put in a $1000 into an IRA and wait for their income tax return,  then they could set up the IRA and the feds could send the check directly to the bank or broker.  There could also be a %100 tax penalty for early withdraw.

Basically this system would give free money to everyone to invest however they like and there would be very little overhead and new bureaucracy at the Fed level.  This would force people to set up IRAs and then they may be more likely to contribute to them with their own funds.

Second idea was borrowed from an editorial I read in Business Week.  It said we should privatize part of SS, but instead of funding it by borrowing from SS.  We should fund it by raising the top income bracket back up to where it was prior to Bush's cuts.  At first thought, I am naturally against raising taxes to fund programs.  But since this money would go directly back into the economy through private investment, I don't see this tax hike hurting the economy. 

I see the combination of taking the investing out of the government's hands, funding from outside of SS, and need based payments could potentially secure SS and also take care of our retirement needs better.  In the 30 years with the privatized IRAs, retirees would not need as big a SS payment and therefore it would have less chance of bankruptcy.

Comments

[Jarrod]

Interesting suggestions. I haven't kept up enough with the SS debates. I'll be back for more later.

[justice]

100% penalty for early withdrawal? Harsh! So in that case it would be impossible to withdraw anything because for whatever amount you withdrew, you would get nothing.

[erik]

Exactly, that would prevent someone from taking early withdraw which is the same as social security.

[Peter]

Sorry for the long and rambling post but here's my 2 cents:

The system is in such a mess we're going to need to make some major changes. If we wanted to guarantee Social Security payments for the next 75 years without raising taxes, issuing more debt, or cutting benefits the government would need to find $3.7 trillion today and invest in real assets earning around 5%. That money plus the interest it would earn would make the system whole for our lifetimes and if you wanted to secure the system forever you would need $10.2 trillion today.

To put this in perspective the government currently collects around $2.5 trillion a year and our entire GDP last year was about $11 trillion.

These numbers make it clear that the government has promised to pay out way more than it plans to take in and it is impossible to keep the system as is. A big confusion in the press is the constant references to the "Social Security Surplus"... there is no such thing. The only reason they can claim a surplus is because the government keeps track of it's finances with cash-basis accounting (i.e. money received for a given year minus money paid out for a given year). Of course this is illegal in the private sector. All companies in the U.S., public and private, must use accrual-basis accounting. This means you not only have to keep track of money coming in and money being paid out today, but you must keep track of the current value of future income and future liabilities. The government conveniently ignores all its future liabilities which are mentioned above.

In addition, the excess money that it is currently collecting is NOT being saved. They don't take that money and put it in real assets like the stock market or gold... they take the money from the SS system, spend it on military or whatever, then issue the Trust Fund an IOU, otherwise known as a government bond. But when those IOUs are due, the Trust Fund will head to the Treasury to collect, but the Treasury's only source of revenue is taxes or borrowing. In short the SS Trust Fund is meaningless. Starting in 2018 or thereabouts SS will need more money than it is taking in from taxes, and while small at first, over time this will grow to unstable levels unless we fix the system

I'm in complete agreement with Erik over making it need based/means testing the system. Bill Gates should not be collecting a Social Security check and neither should I if my Roth IRA grow to $1 million + by the time I retire. I'm also a proponent of changing the increases in benefits to inflation instead of wage growth. This will guarantee tomorrows retirees will receive the same amount in real terms they do today and reverse the decision made by the govt back in the 70s to index the benefits to wages (the reason behind the change then was that in the 70's inflation was growing faster than wages which was an unfair way for them to fix the system).

Okay.. I'm really rambling now but a few more points. If we turn SS into a true safety net you don't need 12.4% of your wages going into the system to pay retirement of current retirees. Private accounts 1) prepay some of these unfunded liabilities 2) give you property rights over your payments so the govt can't arbitrarily take them away in the future and 3) gets current retirement savings in real assets which is the only way that people can rely on their own savings for retirement, instead of relying on the tax payments of their future children and grandchildren.

Final comments on Erik's post:

On the other hand, I find it extremely scary giving the government power in investing capital in the free market system. There are countless ethical questions that could be raised of how stocks/funds are invested. Could the feds go after Enron knowing that retirement funds that they are responsible for could come crashing down? There are many other well documented and valid points against privatization but that is not my point here.

Good point but this is the exact reason that they are proposing individual accounts, not the govt investing a portion of the trust fund in equities. Individuals will own the companies so you won't have the govt taking huge ownership postilions in corps. Enron is a great example. Another would be the fact that you could have the DOJ suing Microsoft and at the same time voting their proxies. Take a look down here at CalPERS in California as a perfect example of political influence and why you don't want John Snow or any other Sec or the Treasury influence how companies are run.

I have two ideas of how to privatize SS. My first idea is very simple. Have the government give a dollar for dollar refund for the first $1000 given to an IRA. This would privatize a part of SS but it would take away the government control of the investments. If a person can not afford to put in a $1000 into an IRA and wait for their income tax return, then they could set up the IRA and the feds could send the check directly to the bank or broker. There could also be a %100 tax penalty for early withdraw.Basically this system would give free money to everyone to invest however they like and there would be very little overhead and new bureaucracy at the Fed level. This would force people to set up IRAs and then they may be more likely to contribute to them with their own funds.

The thing is I don't want the govt more involved than they already are. I think the best solution would be to frontload the system so the first $20,000 you make 100% goes into a private account ($2,480)... after that leave the system as is. This way you would guarantee everyone who makes even as little as $10k a year would still have a good portion in an IRA type account, and at the same time, by definition upper income people would be funding the current system.

Second idea was borrowed from an editorial I read in Business Week. It said we should privatize part of SS, but instead of funding it by borrowing from SS. We should fund it by raising the top income bracket back up to where it was prior to Bush's cuts. At first thought, I am naturally against raising taxes to fund programs. But since this money would go directly back into the economy through private investment, I don't see this tax hike hurting the economy.

I'm really against this idea. One of the biggest benefits of Bush's tax cuts is the leveling of the tax playing field on how corporations pay their investors. Returning div taxes to 39.9%, cap gains to 20% and leaving debt payments at 0% causes way too many distortions in the economy. A tax structure like this is exactly what led to cases like Enron, nobody wanted to get paid dividends due to the high tax rate, so they were essentially telling companies to retain their earnings. That's opened the door to all these "paper profits" and accounting tricks.

It's also important to note that according to the last SS Trustees Report, lifting the cap on SS taxes (currently is $90,000) only means that SS would start spending more money than it receives in 2025 instead of 2018. Seven years is all you save. That's the equivalent of taking the top rate to 47.4% from the current 35%. As such repealing only the income tax portion of Bush's tax cuts so they go back to 39.9% won't generate the kind of money we need... and it's still a bad move in an international environment where more and more countries are lowing their tax rates.