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Redesigning Social Security
Several years ago, President Bush proposed privatization as a means to reform the US Social Security system. The debate that followed showed that while most Americans were highly skeptical of privatization, there was a lack of consensus regarding how to frame the problem.
Since a problem is unlikely to be solved before it is well understood, I wrote this essay as an exercise in understanding the fundamental flaw in the US Social Security system. If we can agree on the problem, then perhaps the solution becomes obvious (though not necessarily easy).
Redesigning Social Security
Matt Fulkerson
1 Social Security Design Flaw
The US Social Security system has a built-in design flaw relating to fluctuating age demographics. The system is designed to pay retirees the same amount per person, with adjustments for inflation, from one generation to the next. If the population of a given generation swells relative to the rest of the population, it is inevitable that the system will produce a big surplus while that generation is employed, followed by a big crunch at retirement.
The fixed-payout-per-person model, considered alone, will not necessarily lead to an inevitable big crunch. The other key ingredients are the Social Security Trust Fund coupled with the requirement that the federal government not run a surplus. These ingredients lead to inequity among the generations.
2 Generational Inequity
Generational inequity arises from the following characteristics of the current Social Security system.
The net result is that more populous generations receive more from the system and less populous generations receive less.
The current Social Security system operates roughly in the following manner. Workers pay social security tax, and the amount they receive at retirement is based on how much was paid into the system. Any surplus funds are invested in the Social Security Trust Fund. The money invested is quickly spent by the federal government.
Let us examine the most rosy scenario where the non-social-security deficit is zero, and a more populous generation is succeeded by a less populous generation. (Presumably, it is already understood that any non-zero deficit increases the tax burden of future generations.) Throughout the working years of the more populous generation, a social security surplus will be generated. That surplus reduces the tax burden of the more populous generation, due to the requirement that the federal operating budget must not run a net surplus. When the more populous generation retires, the social security surplus will turn into a deficit, and the less populous generation must pay higher taxes as retirees draw down the Social Security Trust Fund. The less populous generation gets stuck with the bill.
Contrary to popular perception, the Social Security Trust Fund is not really an investment. Rather, the Social Security surplus is used to make up a tax shortfall during the working years of a more populous generation. The Trust Fund effectively becomes a vehicle for transferring the burden of a tax shortfall on to less populous future generations.
3 Transparent Solution
There are many possible convoluted solutions to the inequity problem. However, one solution stands out as being particularly transparent, and is therefore more likely to be readily acceptable to Americans of all ages.
Social Security could operate on a total-fixed-payout-per-generation basis rather than a fixed-payout-per-person basis, while avoiding any Social Security surplus altogether. This means that a more populous generation would pay lower social security taxes and receive proportionately lower retirement benefits. Such a system would completely eliminate the Trust Fund and the accompanying generational inequity. A more populous generation would be well aware that they were paying lower Social Security taxes and could take action to increase personal retirement savings. A less populous generation would be squeezed a little more during its working years, but could expect to receive a higher level of retirement benefits in return. The level of retirement benefits should be low enough so that the burden on the least populous generation is not too large.
4 Convoluted Solution
It is also possible to keep the current system, but adjust for generational inequity. For example, taxes on a more populous generation’s retirement benefits could be raised. However, absent any understanding of the generational inequity issue, the higher taxation level would lead to a perception that the more populous generation of retirees is getting a raw deal. Thus, a transition to the transparent solution is preferable as it makes the issue of generational inequity explicit.
5 How To Understand Social Security
We have seen that the Social Security Trust Fund is not a true investment. Rather, it has the effect of transferring the tax burden from a more populous generation on to future generations.
Social Security is really a compact between workers and retirees. Current workers agree to support current retirees and expect that future generations will continue the tradition.
This is not how Social Security is most commonly viewed, but the common view of Social Security as a personal investment leads to general confusion and a lack of understanding of generational inequity. As such, any attempts to privatize Social Security should be resisted as an unnecessary blurring of lines between a social program and private investment. Rather, the appropriate topic of debate for society is the desired level of Social Security benefits.