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. These state-managed pensions have become pyramid schemes that are fiscally unsustainable and undermine the broader economy. The solutions are not complicated, what’s required is political will.
The Problems with Social Security
Do you know how much money you will get when you retire? Probably not. Social Security, along with many national pension schemes around the world, are a complicated mess. They are anachronisms, designed when life expectancy was under 70 years, and families had four or five children.
Policymakers have failed to comprehensively update these systems as society has changed, leaving them hopelessly opaque and outdated. America’s Social Security system, for example, uses a complex formula to determine retirement payouts. Indeed, so complex that beneficiaries have no idea what they will receive when they retire.
The formula is also unfair and regressive, redistributing wealth from double earning families to single earning ones, and from people who worked long careers to those who worked short ones.
Furthermore, those benefits are funded through a crude regressive payroll tax. This tax is 12.4 percent of one’s income, ostensibly split with their employer. In reality, however, payroll tax is not split with the employer because they can pass their portion of the tax onto employees in the form of lower wages.
With opaque benefits and depressed wages, Social Security discourages working, earning, and saving. It stands alongside many of the world’s pension schemes, promoting unfairness, encouraging poverty, and depressing economic productivity.
A Simple Solution
The best solutions are often the most parsimonious in nature. It is possible to reform Social Security and other pensions system to make them 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. This 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 could be funded by progressive and rational taxation, such as a Land Value Tax. This form of tax engenders no deadweight loss on the broader economy, doesn’t depress employee wages, or disincentivize work.
The universal benefit will be paired with a retirement account that all employees are automatically enrolled into. This retirement account would be akin to a 401(k), a tax-advantaged personal account. Unlike a 401(k), however, this account would be portable and would follow you as you switched jobs.
Employees would be auto-enrolled 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 age. This protects the subscribers’ nest egg from market downturns. The fund portfolios might also include the ISAs we proposed to fund higher education.
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 more predictable and transparent. Further, as this money is invested into the private market, it is used more efficiently than it would be sitting in government-run trust funds.
Conclusion
This two part system would ensure that everyone is cared for in their later years. It would also provide sufficient incentive for people to earn and save for retirement, while also unleashing trillions of dollars in private investment into the economy. It’s time for welfare programs to work for the people and not against them.