Means-Test and Privatize Social Security

with 2 Comments

Social SecurityWe need to move beyond good intentions and craft public policy that actually works. The first step in building a viable system is to acknowledge that Social Security as it exists today is a failure either way you look at it.

If you look at Social Security as a system of taxation and redistribution, it takes from a single minority male worker and gives to married white women who never contributed. And if you look at Social Security as a forced retirement savings program, it produces such a terrible return we might as well invest in gold. Neither perspective is worth continuing. Social Security as we know it needs to be abolished.

There is a method for doing just that if liberals are willing to accept privatizing half of the contributions and conservatives are willing to accept using the other half as a safety net for those retirees with the least resources. I’m not sure if either faction is willing to make that compromise, but it would be in everyone’s best interest.

Every year we analyze the investment returns for those countries with high economic freedom. We always find that economic freedom produces superior gross domestic product growth that translates into better investment returns. What is interesting to note is how many of the countries with high economic freedom or lower debt and deficit also have privatized their Social Security systems: Hong Kong, Australia, Switzerland, United Kingdom, Sweden, Netherlands, Denmark, Chile, as well as a host of others.

In those countries with privatized retirement accounts, the citizens are thriving. Their legislation can be used as a model for compromise in the United States. Here is how we might implement the best of each way of looking at Social Security.

In broad strokes, the employee’s 6.2% contribution would be put in an inheritable private retirement account. There would be both safeguards on the range of risk for investment choices as well as protections for gradual safe withdrawal rates during retirement. More than 30 countries have vetted good models for those policy issues.

The other 6.2% provided by the employer would be collected as a tax and used to fund the retirement of anyone with inadequate means from their own contributions. This would ensure a safety net and provide a minimum retirement income. It would redistribute income to low earners and also protect retirees from catastrophic loss.

At first, participants close to retirement age would not have anything in their private accounts. But gradually, nearly everyone with a private account would be retiring with more money than current Social Security benefits and the 6.2% safety net tax could be reduced or more of it privatized. The biggest challenge is getting from here to there.

During the transition from our current system to private accounts, there is only half the revenue to support those who are retiring using the safety net. The remainder starts to fund the private accounts of the next generation. The easiest way to shoulder that burden is to means-test Social Security and deny benefits to the wealthiest half of retirees.

We need a private system. Then the money you put in it is yours and does not get spent on someone else’s retirement.

It is a tough to contemplate, but some generation has to be heroic. Earlier generations had to fight World War II. We must battle the leviathan of Social Security and Medicaid and make sacrifices by not taking benefits ourselves to privatize the system for future generations.

Means testing is unfair but necessary. We’ve been deficit spending for decades. Whenever you have years of living above your means, you have to balance it by years of living below your means. Someone has to take the hit financially. The price we pay is only worth it if we can end Social Security as we know it and put America on a firmer financial footing.

Means testing Social Security is better than the proposed alternative tax increases. First, it is not a tax increase. It reduces benefits for the wealthy, which should satisfy both political parties.

Second, it does not burden the small business owners who create jobs and encourage economic growth. Instead, it eliminates benefits for those who already have their wealth. These two groups are not the same.

IRS statistics show that between 2007 and 2009, 4 in 10 Americans with incomes over $1 million vanished. At the same time, the number of millionaires supposedly increased. These statistics show the two groups are very different.

Those who insist we should be heaping more taxes on the rich and point to the growing number of millionaires as some type of proof routinely ignore the fact that in letting the Bush tax cuts expire we aren’t taxing wealth, we are taxing income. Those productive small business owners with higher earnings are a different group from the ultra-wealthy with a higher net worth.

Eliminating Social Security benefits on the basis of net worth is a better solution than tax increases on the basis of net income. It is better to eliminate Social Security for those with alternative means during their retirement than to tax the small business owner whose business profits put income on their tax returns. Those with a high net worth can take care of themselves and don’t need handouts from Social Security. And the business owner needs to be free to start new ventures.

There is plenty of room in this outline for negotiating the threshold of means testing, the level of the safety net and the restrictions for private accounts. These are the areas where compromise should focus.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.

2 Responses

  1. Michael Haden

    I am afraid that you have presented a false premise. To say Social Security is a failure because it fails to provide a large return demonstrates a misunderstanding (to be generous) of the basic intent of the program. The idea of a safety net is really quite simple; to provide an adequate income for those in need. It was never intended, nor should it be, that anyone enrich themselves with Social Security.
    This idea that we might not be making enough money on a program intended to provide safe, basic sustenance, is indicative of the greed that has become endemic in our society.
    For those of us who are able to invest for larger returns, there is ample opportunity to assume any level of risk we desire, while Social Security provides a fallback position for any mistakes we might make, at the same time providing a secure future for those who do not have the desire or means to take such risks.

    • David John Marotta

      I’m of the opinion that government programs should – at least – be measured against some objective standard and not merely the kind heart and good intentions of those supporting them.

      Even the worst, fee-laden insurance products would provide a positive return on investment coupled with a secure guaranteed rate of return.

      Social Security is a failure *not* because it fails to provide a “large” return in order to “enrich” society, but because it fails to provide any decent return while tying up a worker’s capital for a generation. In financial planning terms you want the best return you can get for a given level of risk. Choices on that path are on what is called “the efficient frontier.” Social Security is nowhere near the efficient frontier. Why would we want to experience a negative 7.0% annualized return for 45 years when positive guaranteed returns are available?

      To call wanting to be on the efficient frontier “the greed that has become endemic in our society.” and we should be content with “basic sustenance” is to argue that we should be thankful for government programs whose inefficiencies impoverish our country. I am not, especially not when the private sector could have guaranteed a much better return simply by investing the money in Treasuries.

      Even by your own description Social Security has failed. You said it was “to provide an adequate income for those in need.” but it does not. You said that it was intended to provide “safe, basic sustenance” but it is neither safe, nor does it provide basic sustenance. It is imperiled precisely because it did not produce any return for the investment. And as a result the level of support it can provide is below basic sustenance.

      You seem to want to impoverish everyone as though this equality of poverty is a virtue. I admit that I have never understood such reasoning. Additionally you seem to believe that Social Security does the best it can for a guaranteed return. It does not.

      The point I made in the article is that at least 95% of Americans could do better with half of the Social Security taxes than the current system does with all of it. And you could collect the other half of Social Security to provide a larger safety net for the 5% who could not. In other words, you can have your fallback system with better funding if you would release the majority and let them “enrich” themselves.