Most developed countries now face the twin challenges of funding social security/pension-like benefits for a growing number of aging individuals, while also having fewer young workers to pay for them. In America, Social Security has become a complex pyramid scheme that is opaque to beneficiaries, fiscally unsustainable, and yet still manages to disincentivize work, savings, and undermine the broader economy. But fixing Social Security isn’t difficult, it just requires political will.
The Problems with Social Security
Do you know how much money you will get monthly when you retire? You don’t, do you? Social Security is a complicated mess and is funded through a regressive payroll tax on income that engenders significant deadweight loss on the economy and is unfair to the subscriber.
The payroll tax that funds Social Security, despite popular beleif, is not split with the employer. Indeed, the mechanics of the tax means that employers actually pass their portion onto employees in the form of lower wages, and then the employees are taxed on those lower wages. In effect, workers pay the tax twice.
Lacking a clear benefit and depressing wages means that Social Security discourages work and savings. Just ask most Americans, do they believe that they will ever get out of Social Security what they put into it through taxes? Most will say no. They see Social Security as a tax, not a benefit. This perception disincentivizes people from earning and working.
Additionally, the complex formula that Social Security uses to determine how much money you get when you retire is neither fair nor truly progressive. Social Security redistributes wealth from double earning families to single earning ones, and from people who worked long careers to those who worked short ones.
Social Security, as currently designed, isn’t fair, actually encourages poverty, and depresses economic productivity for everyone.
A Simple Solution
The best solutions are often the most parsimonious in nature. It is possible to reform Social Security to make it predictable and sustainable, while still encouraging work, savings, and growing the economy.
The answer is a two part system, roughly in line with that pioneered by Andrew Biggs: a flat universal benefit combined with a personal retirement savings account.
The flat universal benefit would fulfill the social obligation the nation has to its people. It ensures that no one retires in poverty by providing a steady monthly retirement income above poverty line. This monthly benefit would be indexed to chained CPI to account for inflation. Everyone would be eligible, regardless of how little or much they earned during their working years, or how many years they worked.
The universal benefit would cost less than the existing system and would be funded by progressive and rational taxation, such as an LVT or Severance Tax as discussed here. These taxes engender low deadweight loss on the broader economy and don’t depress employee wages or disincentivize work.
The universal benefit will be paired with a retirement account. This retirement accounts would be akin to a 401(k), a tax-advantaged personal account, that employees are automatically enrolled in. Unlike a 401(k), however, this account would be portable and would follow you as you switched jobs.
Employees would be auto-enrolled into the savings account with a standard contribution of 3.0% of salary. Of course, employees can change the contribution amount at any time, and their employer is free to match contributions as they wish.
These plans, like many 401(k)s will invest is basic index funds with low (or zero) fees that would automatically adjust to more conservative bond investments as the employee neared retirement. This protects the subscribers’ nest egg from market downturns.
This solution works because it is not a tax…it’s your own money, therefore, it does not discourage savings or work. No one works less because they have a 401(k). Such a plan is also predictable and transparent. Further, as this money is invested into the private market, it is used more efficiently than it would be sitting in goverment-run trust funds.
This two part system would ensure that everyone is taken care of in their later years. This system would also provide sufficient incentive for workers to save up for retirement, while also unleashing trillions of dollars in private investment into the economy. It’s time for Social Security to work for the people and not against them.
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