NTF Issue Paper: SS1doc

NTF Issue Paper: cong.41. 3-05.

NEBRASKA TAXPAYERS FOR FREEDOM ISSUE PAPER:

PRIVATIZE SOCIAL SECURITY NOW.

BACKGROUND. The March, 2004 Social Security Trustees Report states that, without alteration, SS currently pledged benefits are not sustainable. Workers will not receive amounts promised at retirement. Tax revenues will fail to provide sufficient revenue to pay retirees in 2018. The feds will have to either drastically raise payroll taxes, cut benefits, or both. Paying all benefits promised to youthful workers today would require a total SS payroll tax rate of 27% and later 40%. SS trust funds hold no real assets, only a claim against future tax revenues.1 Counting on Social Security is like signing a contract that permits the other party to change contract terms without notice but does not allow you to change terms. Whatever the federal government promised you or what you thought you would receive, the feds can pass a law to change it. Yet, one still must make payments according to the contract. Conversely, private annuity plans managed by private insurers legally must pay one what and when promised and hold enough assets to redeem promises.2 Only shifting to a private system of decentralized investment accounts controlled by individuals or a central authority can resolve looming SS financial catastrophe. A 2002 Gallup Poll found that 2/3rds of Americans favor personal retirement accounts to supplement SS. Zogby International polls consistently have found that 2/3rds of Americans favor privatization. Federal Reserve Chairman Alan Greenspan supports privatization as a means to support the abysmally low American savings rate. Edward Prescott, winner of the 2004 Nobel Prize for Economics, supports privatization.

THE BASIC PLAN. Several plans promoted would establish voluntary individual savings accounts for those 55 or older, working under SS provisions, and willing to forego a reduction in SS retirement and aged-survivor benefits. Individuals could invest a single digit % of payroll tax in a private account. Each would receive a recognition bond based on former contributions to SS. Individual accounts could base on 3 tiers: a centralized pooled collection, a limited series of investment options, and a wider range of investment options that accumulate a minimum level in an account.3 Participants would secure a guarantee that total monthly benefits offered from both SS and personal accounts would at least equal SS benefits scheduled under current law, if they selected a default investment option. The guaranteed benefit total requires investment in the default option throughout an employee working lifetime. Annuitization of part of the accumulated funds would assure total payments equal to currently scheduled SS benefits pegged at retirement. Employees automatically would invest individual accounts via a preferred local financial institution or central administrative authority, which would keep all records of personal transactions and balances and send periodic statements to account holders, with a default allocation of a % of funds in a wide index of U.S. equity funds and a % in U.S. corporate bond funds and real estate. Management would mirror the government-employee Thrift Savings Plan. Qualified private investment firms would offer workers a variety of investment options. Administrative costs would total about .25%-.3 of assets. Individual account contributions, for example, 10% of the first $10,000 earned, plus 5% of salary over $10,000, (both indexed for increases), a part of the payroll tax contribution, would redirect from SS trust funds to personal accounts. The guarantee of SS trust funds necessary to pay benefit obligations would stem from transfers from the U.S. Treasury General Fund. Under such proposal, SS would stay solvent and meet its benefit obligations past 2077.4 Funding the early years of privatization transition would come from selling national assets like excess federal lands.5

THE BUSH PLAN. Voluntary personal account monies would go into a conservative mix of stocks and bond funds that earn a higher rate of return than current SS payments. A young employee who earns an average of $35,000 annually would see over $250,000 saved in an account at retirement, to pass along to heirs.

NON-PARTICIPANTS. All privatization plans are voluntary, no one forced to invest in the stock market.

Workers not participating in private account options would receive scheduled benefits presently offered. Workers could disenroll from personal accounts any time during their working life. However, funds redirected to personal accounts earlier would stay in the account until distribution. Private plans would provide certainty that available retirement benefits would reach a higher sum if enrollment continued.

REACHING RETIREMENT. After the retirement party, an enrolled worker would buy an inflation-insulated lifetime annuity with Consumer Price Indexed-payments, using a part of his personal saved assets needed to provide a total monthly payment at least equal to benefits specified under current SS law. The central administrative authority would administer this annuity, private investment companies managing investment of assets. To obtain this guarantee, an annuity would need to base on the assumption of investment of “X” percent in an equity index and “X” percent in a corporate-bond index. Annuity computing would use the assumed long-term future returns on equities and corporate bonds figured by the central administrative authority at the time of annuitization. The central administrative authority would assume all financial risk associated with guaranteeing this yield, regardless of actual investment returns. The U.S. Treasury would financially guarantee the central administrative authority. If one dies before retirement, assets will transfer to an account of a surviving spouse, allocated to provide annuities for surviving children. If no surviving family, the account balance transfers tax-free to the deceased estate. Or, an individual could begin a programmed withdrawal of money. Funds in excess of providing income above a minimum level one could withdraw in a lump sum. If an individual accumulated sufficient money in an account to purchase an annuity that would keep him above minimum income level throughout retirement, he could opt out of the SS system entirely.1

REDUCTION IN SS BENEFITS. Retirement and survivor benefits will shrink, based on the participation by a worker in a personal account option. Benefit reduction would equal the present scheduled benefits multiplied by the ratio of (a) the present value of all contributions redirected to a private account, to (b) the present value of all potential contributions that might have arisen, if the plan had existed throughout the working lifetime of the contributor.

ADVANTAGES. Personal retirement account accumulations and distributions, including annuity payments, are not subject to federal income tax, unlike SS benefits. The guarantee for all individual account participants who maintain the default portfolio allocation would assure their total benefits no lower than if they do not exercise the option but probably higher.2 Private investment will offer a higher rate of interest and retirement benefits than SS. Investors already consider risks in formulating investment decisions. They can utilize diversified portfolios rather than an arbitrary reduction of expected returns via SS. A majority of youthful employees will zip ahead financially by switching to privatization.3 SS finances retirement benefits by taxing employee wages. With the tax rate constant, total benefits can increase by no more than the payroll increase, about 1.6% yearly, or equal to a portfolio of stocks and bonds that earns only 1.6% annually. For the past 75 years, the compounded annual real return from a balanced fund of 70% stocks and 30% bonds was 6.2%! Stashing $1,000 per year for 44 working years would earn $63,000 from SS and $211,000 from the free market. The pay-as-you-go SS program pays lower benefits at higher cost than free market alternatives.4 If the average retiring worker had invested his payroll taxes, he would have $460,000, an annuity of about $4,000 monthly compared to $1,000 from SS. Global Advisors Co. states that the market would have to drop 65% for the average employee return in 2001 to glean personal account benefits lower than SS payments. Examining a portfolio of 60% stocks and 40% bonds, the stock market would have to crash hard to make individual accounts reap less than SS. If the stock market dissolved on retire- ment day, bonds would pay higher benefits than SS, which always produces below market returns.5 Personal accounts will permit workers to retire earlier financially sound. Presently, a low-wage worker can pay 1/8 of wages into SS and retire into poverty. Privatization would guarantee that even minimum wage employees would retire above the poverty level, offering people dignity. One has no legal right to SS benefits. The U.S. Supreme Court ruled that Congress may raise SS taxes or decrease benefits any time by any amount for any reason. Private accounts give people a legal property right to savings. SS actuaries admit that personal account plans would pay higher benefits at lower cost than current disbursements, aid SS financing, strengthen the SS safety net, and reduce poverty, while permitting workers to accumulate wealth and pass it along to heirs.6 A worker who invested his payroll taxes in a stock mutual fund could retire in 2002 with income over 3 times greater than with SS. SS actuaries admit that counting retirement, disability, and survivor benefits, the SS actual annual return for the average single male born in 2002 is only 1.2%.7 The stock market jumps up and down weekly, but one does not invest today and retire next week. One begins paying premiums when first working and then retires years later. More total wealth generated via privatization offers hope of solving the problem of inadequate monies to pay pensions that SS promised.8 Phased out is the transfer of resources from young to old. Privatization will increase personal savings, capital stock, and output of goods and services.1 Hiking private savings via individual accounts could increase Gross Domestic Product by 1.4% permanently. Privatizing SS could increase the value of national wealth by $7 trillion. Tax rates cannot rise as in the past, so most future retirees can earn only 2.6% return from SS, whereas corporate capital has earned a 9.3% rate of return annually. Examine a 45-yr. old employee who contributes $1,000 to SS for benefits. At 2.6%, his $1,000 pays out $2,160 30 yrs. later. At 9.3%, this $1,000 contribution pays $14,408. SS causes a huge drop in private savings, which causes lowering of capital stock.2

TAKE ACTION NOW. Contact your two senators and congressman today to vote YES on privatizing at least a part of Social Security. We must privatize now or face retirees paying inflated payroll taxes into a bottomless pit and not receiving SS payments that equal their contributions.

Research, documentation, and analysis for this issue paper done by Doug Kagan and Steve Sfiers. This material copyrighted and notarized by Nebraska Taxpayers for Freedom, with express prior permission granted for its use by Citizens for Local Control, Cherry County Taxpayers, Dawes County Taxpayers, and other groups in the Tax Freedom Network. 3-05 C

2 Thomas Sowell, Privatizing Social Security, 9-28-04.

5 Martin Feldstein, Privatizing Social Security.

3 Michael Tanner, Cato Institute Paper, 10-2003.

4 William Shipman, Private Social Security Accounts, 8-2002.

5 Andrew Biggs & Michael Tanner, Still Good to Privatize SS, 3-2001.

6 Andrew Biggs, President’s Plan for Privatization, 6-2002.

7 Andrew Biggs, Americans Favor Savings Accounts, 3-2002.

8 Thomas Sowell, Privatizing Social Security, 9-28-04.

1 Privatizing Social Security, National Center for Policy Analysis, 7-1998.

2 Martin Feldstein, Privatizing Social Security.