Cato Institute Offers Policymakers a Primer on Social Security

January 26, 2001

With the inauguration of President George W. Bush, whose proposal to partially privatize Social Security garnered 57 percent support in election-day exit polls, the debate over the future of the nation's retirement system will begin anew. To help lay the groundwork, the Cato Institute today issued a primer on Social Security covering everything from the program's history to its current structure as a "pay as you go" system to the higher retirement incomes possible under privatization.

Written by Thomas F. Siems, a senior economist at the Federal Reserve Bank of Dallas, "Reengineering Social Security for the New Economy" explains that Social Security may have made sense for a Depression-era economy rife with worker insecurity. But as it's now structured-taxes from current workers go to pay the benefits of current retirees, with nothing saved for the future -- Social Security will become an increasingly bad deal for each successive generation of retirees.

"As an unfunded program," Siems writes, "Social Security gives windfall returns to the first generation of participants, since they paid in little relative to the benefits they receive, and gives below-market returns to later generations." This problem is compounded, he says, by the fact that the number of workers relative to retirees continues to decline, from 16-to-1 in 1950 to 3.4-to-1 today.

As a result, the average medium-wage worker born in 1959 now can expect only a 1.8 percent real (inflation-adjusted) return from taxes paid into Social Security, a mere fraction of the return from a mixed stock-bond fund, Siems says. High-wage workers do even worse, earning a 0.03 percent real return on Social Security. And even low-wage workers get a paltry 2.6 percent real return under Social Security. "Returns from Social Security are increasingly unattractive -- a fact that hinders Social Security in its stated goal of preventing poverty," Siems says.

As for proposals to return Social Security to fiscal health by raising taxes or cutting benefits, Siems is skeptical. Social Security taxes have increased from 2 percent on the first $3,000 of earnings to 10.6 percent on the first $80,400 of earnings, and the cost of further increases on future generations may be "politically intolerable." Likewise, reducing benefits may prolong Social Security's solvency but would make the program's returns even worse. Siems favors proposals that would transform part of Social Security into a system of individual retirement accounts, which would give workers more control over their investments and shield their retirement income from legislative changes. But the time to act is now. "The longer reform is delayed, the costlier the fix will be," Siems says.

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