How to Replace
Social Security

By STEVE FORBES

Social Security is going bust both morally and financially. Now is the time to be honest about the problem and creative about the solution for making Social Security work in the 21st century. There is an answer that will keep our promises to current recipients and soon-to-be recipients as well as providing much more to the next century's retirees--personal retirement accounts funded by the federal payroll tax.

Americans increasingly realize that something is seriously wrong. The existing government-run system operates on a pay-as-you-go basis, meaning payroll taxes that come in today are immediately paid out to current Social Security recipients. Any surpluses are "loaned" to Uncle Sam at below-market interest rates to subsidize the deficit. This Ponzi scheme once worked. There were relatively few retirees, plenty of workers supporting them and a booming economy to boot. But times have changed. In 1950, there were 16 workers paying taxes to support one Social Security recipient. Today there are only 3.3 workers per recipient. By 2030, there will be only two workers per recipient. And economic growth is sluggish, one-third to one-half of that in the 1960s and 1980s. The Social Security Administration warns the system is in dire jeopardy and will go bankrupt by 2029 at the latest, and perhaps as early as 2016.

Washington 'Reform'

Washington-style "reform" of Social Security has always meant raising taxes, and in the last "reform" in 1983, gradually raising the retirement age as well. But that won't work anymore. Right now this tax is $6,200 for a family making $50,000 (that includes the employer contribution of $3,100). Factor in the cost of Medicare, and in order to meet projected demand, total payroll taxes would need to triple, devastating the American economy. That $50,000 family could pay $18,000 in payroll taxes alone.

The latest version of this approach is rejiggering the consumer price index to prevent seniors from collecting tens of billions of dollars in cost-of-living-adjustments over the next few years. This kind of change is both inadequate and unfair. Remember the big picture. Last year, congressional Republicans got hung up on co-payments and deductibles for Medicare--and the real reform, medical savings accounts, was virtually emasculated.

To avoid a similar zero-sum approach to Social Security, why not phase in a market-based retirement system, one controlled by you, not Washington? To be sure, we must retain the current Social Security system for those already in it. Washington should not change their benefit formulas. Taxes should not be boosted yet again. And Washington should not monkey around with the consumer price index. Similarly, we should keep the current system for those entering it in the next 12 to 15 years. People have made decisions based on the current system, and we must honor our commitments.

But we must create a new Social Security system for younger Americans. The new system would deposit part or all of a young person's payroll taxes into a personal savings account, similar to an individual retirement account or a 401(k) plan. The account would be controlled by the worker, not politicians. This stands in sharp contrast to a scheme being advanced by some Democrats that would have the government invest in the markets, which would give Washington a dangerous degree of control over private enterprise. Instead, individuals should decide where to invest their money. They could invest in stocks, bonds, mutual funds, certificates of deposit--but obviously not race horses or wild schemes. All workers would get a monthly statement, but they could not withdraw their money until a certain age. The federal government would guarantee a minimum safety net for protection.

Over the long haul, the returns on their invested income would far outpace the meager returns available from the current system. For example, the average worker retiring today receives a lifetime return of only about 2.2% on the taxes he has paid into the system, and workers retiring 20 years from now will actually get back less from Social Security than they paid into the system. Contrast this with the historic 9% to 10% annual returns from stock market investments.

The advantages of an IRA-type approach are overpowering. Instead of a busted or crippled system when they retire in the next century, young people will have a real retirement fund. They will have control of their own money, and they will have more when they retire. The American economy will be stronger. We will no longer have debates about retirement ages--above a certain age, say 60, you would make your own choice as to when you would retire. In fact, you could deposit more of your earnings into your retirement accounts to help finance an early retirement. There would also be no more debates on how to measure inflation.

Criticisms of this kind of change really don't hold up:

• If younger people are not paying into the current trust fund, how will we pay current beneficiaries? Not a problem. Thanks to baby boomers, the system is generating annual surpluses of $25 billion to $50 billion a year, which will continue for a decade or more. This is a unique window of opportunity. The Social Security Trust Fund also has, on paper, an additional surplus from recent years of about $500 billion. If these phantom IOUs were converted into real bonds, the money could be used to help finance the transition over the next decade and a half.

Social Security actuaries assume that in real terms the American economy will grow by at most an average of 2.5% annually. An extra 0.5% or 0.75% of real growth would provide huge additional sums in the next century. Such growth is easily achievable if we remove tax and regulatory barriers. After all, we have had average real growth rates of 3% to 3.5% per annum during the previous 200 years. An IRA-type system would make the economy more vibrant by generating more capital for risk takers. Under some proposals, bonds would be issued to pay remaining transition costs, which could total $500 billion or more over the next 15 to 20 years. Then, with the resulting savings from the new system, the bonds could start to be amortized. Any way you slice it, such interim costs would be vastly less than the horrific obligations we face if we keep the current system.

• The American people cannot be trusted to invest their own money. By that standard, we shouldn't be trusted to handle our paychecks, to choose our own leaders, to pick our own careers and spouses. Tens of millions of Americans already own mutual funds. Tens of millions more have savings accounts. One wonderful advantage of an IRA system is that young people will be asking questions about economics, taxes and financial markets that they wouldn't have asked otherwise. They will thus have less tolerance for Washington's fiscal shenanigans, since they will readily see how such games will affect their nest eggs.
• Using Social Security surpluses for such a transition will boost the budget deficit. Right now, Washington counts those Social Security surpluses as revenue. But the financial markets are not fooled and the national debt would not be affected. Our Treasury Department currently borrows those surpluses to help finance its shortfalls. In fiscal 1995, for example, the reported budget deficit was $160 billion. Yet the actual national debt went up $290 billion.
• Wall Street would make money. If that's an overriding concern, we should simply nationalize banks and mutual funds companies. The key is, will America be better off with this kind of change? The answer is, obviously, yes.

Outpacing

• The stock market won't rise forever. When it falls, liberals claim, people will realize the folly of an IRA-type system. But despite ups and downs, private investments have historically far outpaced what Social Security is now yielding.
• What about people in their 40s and early 50s--are they stuck with the old system? No. Various proposals are being formulated that would allow them to stay in, or get out, or opt for some kind of hybrid.

This need not be a partisan issue. All Americans have an interest in ensuring that they will have a secure retirement plan. Rather than demagoguing the issue, now is the time to educate the American people about the opportunities to make positive changes.

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