Rebirth of Reason


Social Security - What a Deal!
by Merlin Jetton

Soon I will be eligible to start receiving Social Security retirement benefits. On the statement sent to me by the Commissioner (Commissar?) of the Social Security Administration (no doubt created by his public relations or advertizing department), there is a simple sum of FICA (OASDI) taxes paid by me. I can expect to get them back in less than 5 years via monthly payments. The statement also shows the sum of OASDI taxes paid by my employers. I can expect to get both sums back in less than 10 years.

Sound like a good deal? Hold on a moment. The above ignores the time value of money. Also, the OADI taxes aren't invested. Most are used to pay current SS recipients. A little is used to support general spending by the federal government. (The bogus SS trust fund only buys U.S. Treasury debt, which is, of course, only a means of funding other government spending.)
Accumulating the OASDI taxes paid by me and comparing it to the present value of Social Security monthly payments, assuming I live to my life expectancy, including a 3% annual CPI increase, and a reduction for income taxes on 85% of the SS payments, the equating interest rate is 6.7%. Doesn't sound so bad? Hold on again. Let's include the employer's OASDI taxes. Including those and doing the same calculation, the equating interest rate is about 3.9%.

But suppose the OASDI taxes (both employee and employer) are accumulated, and future benefits discounted, at an interest rate of 6%. That says I'm getting back about 60% of the value of accumulated OASDI taxes. Doing the same thing with a 7% interest rate, the payback is about 46%. At 8% the payback is about 36%. What a deal!

A self-employed person with the same earnings history as me has some more cause for gripe. A self-employed person pays both the employee and employer part.

Some have argued that SS is a good thing in that it forces some people who otherwise would not save to save for their retirement. The fatal flaw in this argument is that SS doesn't save anything. The money is not set aside in a bank account or investment account to draw down come retirement. The SS administration uses it to pay benefits or buy U.S. Treasury debt. The individual accounts proposed by the current Pres. Bush a few years ago had the same fatal flaw. The proposal was nothing more than gradual switch from a defined benefit plan to a defined contribution plan. The individual account money was probably not going to be set aside in a bank or investment account, and if it were, the result would have been to make SS's cash flows even worse and add to federal government deficits.

Some people, including Objectivists, have applauded what Chile did to "privatize" its SS-like system. José Piñera, a key figure in the "privatization", even spoke at the 1999 TOC (IOS) Summer Seminar. While I approve what he did under the circumstances, it would be a mistake to say the U.S.A. should follow suit. The Chile situation was a lot different. It did not have the high ratio of retirees to workers that the U.S. has and is going to get much worse as baby boomers retire. Chile had substantial budget surpluses (the U.S. has big deficits), a payroll tax of about 25% (FICA is 12.4%), and benefit amounts had been greatly eroded by very high inflation. There was a high degree of public dissatisfaction with the old system.

The Wikipedia article says the new plan allowed workers to opt out of the government-run pension system and instead put the former payroll tax (10% of wages) in a privately managed Personal Retirement Account (PRA). Thus it is a "forced savings" plan. What it doesn't say is what the payroll tax rate was before the reform. However, José Piñera himself says what it was here - about 25%. Ergo, to make a similar reform in the U.S.A., firstly the FICA tax rate of 12.4% would need to be hiked by X% (or whatever goes to the PRA) to 12.4% + X%!
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