What *ARE* We Trying To Save, Anyway?!?

John A. Quayle blueoval at SGI.NET
Thu Jul 15 16:37:26 MDT 1999


[Folks, it is with a great deal of pride that I present the following
piece. Professor Reiland taught me Economics at Robert Morris College and I
am convinced that I was schooled by one of the best........-John Quayle]

                                   Saving Your Retirement
                                          by Ralph R. Reiland

                          My 20-year-old students will be just turning 34
when,
                          according to official projections by the Board of
Trustees
                          of the Social Security Trust Funds, yearly Social
Security
                          payouts will begin to exceed annual payroll
contributions.
                          And by 2030, when these students are still nearly
two
                          decades short of retirement, the so-called Social
Security
                          trust fund, currently over half a trillion
dollars on paper, is
                          projected by the government’s own actuaries to go
                          belly-up.

                          Among these students, there is now a
near-complete lack
                          of faith that Social Security will ever pay them
a dime.
                          They are not, unfortunately, without professional
backing in
                          their cynicism. "Under today’s terms," contends the
                          Princeton Economic Institute, "if you are under
55 you
                          have a greater chance of being abducted by aliens
than
                          ever seeing your first Social Security check."

                          Collapsing Pyramid

                          What is underlying Social Security’s fundamental
flaw is a
                          demographic time bomb. In 1950, the ratio of U.S.
                          workers to retirees was 20 to 1. Today, that
ratio has
                          dwindled to 3 to 1. By 2030, it is likely to be 2
to 1. "What
                          you put into the system to provide for your own
retirement
                          is not money but kids, but baby boomers have
chosen to
                          produce only half as many children as their
parents did,"
                          says Karl Zinsmeister, editor of The American
Enterprise
                          magazine. "As in any pyramid financing scheme, early
                          investors are paid off with cash taken in from later
                          investors," explains Karl Borden, professor of
financial
                          economics at the University of Nebraska. "The system
                          collapses when the demands of increasing numbers of
                          expectant recipients confront the limited
resources of
                          decreasing numbers of new participants."

                          Over the long haul, given the demographics, Social
                          Security has simply become an increasingly bad
deal with
                          each passing generation. For those retiring in
1942, the
                          average annual rate of return on Social Security
taxes,
                          adjusted for inflation, was 36 percent. Even for
those
                          retiring in 1980, total forecasted benefits
exceed total
                          payroll contributions, including interest, by
over 400
                          percent.

                          In contrast, American workers born in 1950 can
anticipate
                          total retirement benefits that will, at best
estimates,
                          represent only a two percent rate of return on
their payroll
                          taxes. For teenagers now entering the workforce,
Arthur P.
                          Hall of the Tax Foundation projects returns of
minus two
                          percent — i.e., less than they put in.

                          But these forecasts of plunging benefits may be
unduly
                          optimistic since they assume the government IOUs
in the
                          Social Security trust fund will be fully paid. In
fact, the trust
                          fund is nothing more than an accounting artifice
— more
                          "trust" than "fund." As it is now set up, the
"surplus" in
                          payroll taxes being paid into Social Security
each year
                          ("contributions" in excess of benefit payouts — an
                          average of $54 billion per year since 1988, and
roughly
                          $100 billion last year) is being immediately
spent by the
                          politicians rather than saved and invested for
tomorrow’s
                          pensioners.

                          ‘‘There is no Social Security trust fund,"
explains Investor’s
                          Business Daily. "It’s a myth. Those extra taxes
are spent
                          through the general budget the day they are
received; the
                          Treasury just puts an IOU in the ‘trust fund.’"
In effect,
                          federal politicians have drained the trust fund
to meet
                          current operating expenses and replaced the money
with
                          nonmarketable government bonds. "The excess money
                          paid into Social Security is just more money for
politicians
                          to play around with," says economist Thomas
Sowell of
                          the Hoover Institute, "used for everything from
                          congressional junkets and other federal
boondoggles to
                          make the national debt look smaller on paper."

                          Senator Daniel Patrick Moynihan (D-NY),
maintaining that
                          trust fund surpluses have simply allowed Congress to
                          spend more than it otherwise would, declared in
1990 that
                          Social Security trust fund accounting is a form of
                          "thievery."

                          Added Trillions in Debt

                          This shell game, while providing a crafty way for
politicians
                          to buy votes and gather campaign cash through higher
                          government spending, has left the Social Security
trust
                          fund with no real assets to meet future
obligations. "If the
                          federal government was required to show its current
                          unfunded Social Security and Medicare liability, the
                          national debt would be $17 trillion, rather than
$5 trillion,"
                          explains Mark Weinberger, former Chief of Staff
for the
                          Bipartisan Commission on Entitlement and Tax Reform.
                          These unfunded liabilities — money that should
have been
                          saved, but wasn’t — are the equivalent of
$120,000 in
                          debt for every household in America.

                          The coming annual cash shortfalls between Social
                          Security outlays and revenues — the result of
fewer births,
                          longer life spans, and the upcoming retirement
bulge of
                          America’s baby-boomers — is expected to reach $90
                          billion a year by 2015, jump to $500 billion
annually by
                          2025, and to $1 trillion a year by 2035. In 2075,
the last
                          year for which the Social Security Administration
provides
                          estimates, the annual cash shortfall reaches an
                          overwhelming $7.5 trillion. Even adjusting for
inflation, the
                          projected yearly Social Security deficits remain
immense,
                          reaching $200 billion annually in 2025 in today’s
dollars
                          and $400 billion a year by 2056.

                          The "present value" of these unfunded liabilities, a
                          measure of how much money would need to be invested
                          today to finance future benefits, reports Daniel
J. Mitchell,
                          a Senior Fellow in Political Economy at the Heritage
                          Foundation, is $5.2 trillion. "Collecting that
much money
                          today," says Mitchell, "would require imposing
tax rates of
                          more than 100 percent on everyone in the country."

                          When President Franklin Roosevelt set up Social
Security
                          during the Depression, he wanted workers’
paychecks to
                          show separate tax deductions for retirement.
"With those
                          taxes on there," he said, "no damn politician can
ever
                          scrap my Social Security program." Clearly, FDR
                          underestimated the cleverness of today’s
politicians.
                          Instead of scrapping the program, they’ve simply
stripped
                          it of its sustenance.

                          Today, after over six decades of rising Social
Security
                          taxation, American workers are faced with the
fact that
                          there is simply no money in any retirement
account for any
                          of them, nothing earning interest or growing with
the
                          market until they retire. Instead, they have been
handed a
                          pile of IOUs with no guarantee that they’ll ever
be replaced
                          with real money. In 1960, the Supreme Court ruled in
                          Fleming v. Nestor that workers have no guarantees or
                          property rights within the Social Security
system, no legal
                          claim to either their accrued contributions or their
                          anticipated benefits. Today’s workers, in short,
will retire
                          with only a political claim on the income of future
                          generations.

                          "Perhaps the biggest misrepresentation is that
the Social
                          Security trust funds represent actual resources
to be used
                          for future benefit payments," stated the
Congressional
                          Research Service in its January 1991 report to
Congress,
                          "rather than what is in reality a promise by the
government
                          to take steps necessary to secure resources from the
                          economy at that time."

                          Coming Crunch

                          The crunch will hit when today’s boomers start
retiring in
                          droves in 10 to 15 years. In order to obtain the
revenues
                          needed to pay escalating benefits and with
retirement
                          payouts outstripping payroll taxes, the Social
Security trust
                          fund will start turning in its IOU bonds to the
federal
                          government. At that point, with the federal
government
                          having no money to pay off the bonds, Social
Security will
                          be hovering on the brink of a financial abyss and
the
                          politicians will have only a limited number of
ways to
                          overhaul the system’s insolvency — raise taxes, cut
                          retirement benefits, or slash non-Social Security
                          programs.

                          Regarding the third option, the Bipartisan
Commission on
                          Entitlement and Tax Reform estimates that unreformed
                          federal entitlement spending, primarily Social
Security and
                          Medicare, will consume 100 percent of federal
revenues
                          within 30 years, leaving no tax revenue for other
programs.

                          In past years, when faced with less massive Social
                          Security shortfalls, the federal government has
simply
                          raised taxes. In the past four decades, payroll
taxes for
                          Social Security were increased 17 times,
producing a real
                          (adjusted for inflation) rise in the maximum
payroll tax of
                          nearly 900 percent. In 1995, with federal, state,
and local
                          taxes taking a record percentage of family
income, the
                          Social Security trustees’ "intermediate cost" and
"high
                          cost" projections forecasted increases in payroll
taxes of
                          50 to 80 percent, respectively, over the next 35
years.

                          "Bringing the Social Security system into balance
today
                          would require imposing a 54 percent increase in
payroll
                          taxes, reducing benefits by 33 percent, or using a
                          combination of both," estimates Daniel J.
Mitchell of the
                          Heritage Foundation. "These drastic measures are the
                          transition cost of maintaining the current system
and
                          workers. Younger workers already face real rates
of return
                          that are barely above zero; in some cases they face
                          negative returns. Forcing them to pay more and
get less
                          hardly represents good public policy."

                          Former Colorado Governor Richard Lamm concurs,
                          stating: "Despite the fact that our kids are
paying so much
                          more into Social Security than we did, they stand
to get
                          back less — much less — than we did. What’s
worse, our
                          grandchildren stand to pay even more and get back
even
                          less than our children will. There’s no end in
sight to this
                          cascading pattern of generational inequity. The
farther we
                          project into the future, the more inequitable the
system
                          looks. The truest measure of our compassion as a
society
                          is whether our children will be freer and more
prosperous
                          than we are. Today, anyone who says that high taxes
                          haven’t undermined the incomes of our young, or
their
                          ability to take care of their own children, is
living in a
                          fantasy world."

                          The current financing structure of Social
Security "robs
                          young workers in America of their right to save
and invest
                          for their futures," says Stephan Moore, director
of Fiscal
                          Policy Studies at the Cato Institute. Put simply,
Moore
                          contends that the system is "generationally
immoral."

                          An article in the August/September 1998 issue of
Futurist
                          magazine, by professors Richard McKensie of the
                          University of California and Dwight Lee of the
University of
                          Georgia, shows how a 22-year-old making a one-time
                          $2,000 investment in the stock market, based on a
ten
                          percent compounded rate of return (the market’s
                          appreciation over the past five decades), would
see his
                          $2,000 grow to $194,000 by age 70. Investing
$2,000 a
                          year, he would see his wealth surge to over $2.l
million by
                          retirement age.

                          Sam Beard, chairman of the National Development
                          Council, lays out an alternative to Social
Security for a
                          20-year-old who is earning $10,000 a year:

                               You and your employer are paying $l,240 a
                               year in Social Security taxes. That’s 12.4
                               percent of your hard-earned income for
                               benefits that you will never see. Suppose
                               instead you could invest that same $l,240, as
                               well as an additional $2.50 a week. By the
                               time you are 65, thanks to the magic of
                               compound interest, you would be a millionaire.
                               You would be assured of a comfortable
                               retirement. Assuming a long-range return on
                               your investment of 8 percent a year, $30 a
                               week in savings turns into a portfolio of
                               $29,000 in 19 years, $110,000 in 20 years,
                               $318,000 in 30 years, $822,000 in 40 years,
                               and in 45 years, the normal working lifetime,
                               $1.3 million.* After 50 years, if you work
until
                               age 70, the value of your portfolio crescendos
                               to an estimated $2 million.

                               * Adjusted for a 4 percent annual inflation
rate,
                               that $1.3 million would be equal to about
                               $230,000 in today's dollars.

                          Push for Privatization

                          "Ironically, Social Security was originally set
up because
                          people trusted the government more than financial
                          markets," says Neil Howe of the National
Taxpayers Union
                          Foundation. "Today, most Americans under 50 feel
just
                          the opposite." In April 1998, for instance, 80
percent of
                          Americans in an Associated Press poll agreed that
                          workers should be allowed to shift some of their
payroll
                          taxes into private accounts. Among adults under
age 34,
                          support increases to 90 percent. Overall, support
for the
                          privatization of retirement funds was expressed by
                          majorities in every sub-group — Democrats,
Republicans,
                          young people, and seniors. In contrast, 75
percent of the
                          respondents opposed raising payroll taxes or
prolonging
                          the retirement age.

                          With this widespread support for fundamental
reform in
                          Social Security now apparent, politicians and
public policy
                          specialists are increasingly advocating individual
                          retirement accounts, funded by existing payroll
taxes.
                          Although the plans now being considered would not
                          constitute a total transition to the free market,
since
                          workers would be making choices within the
framework of
                          the new system, it would still be a huge step in
that
                          direction and would be a vast improvement over the
                          present system.

                          Under a plan proposed by Congressman Mark Sanford
                          (R-SC), for example, current workers would be
allowed to
                          invest eight percentage points of the 12.4
percent payroll
                          tax in individual accounts. In the Senate, Budget
                          Committee Chairman Pete Domenici (R-NM) has
                          developed a plan that would permit workers to put
three
                          percentage points of their payroll taxes into
investment
                          accounts that turn into annuities at retirement.

                          The bottom line? "Assuming historical rates of
return, if
                          individuals born in 1970 were allowed to invest
in stocks
                          the amount they currently pay in Social Security
taxes, they
                          could receive nearly six times the benefits that
they are
                          scheduled to receive under Social Security," says
William
                          G. Shipman, principal with State Street Global
Advisers in
                          Boston. "Even a low-wage earner would receive nearly
                          three times the return expected from Social
Security."

                          Clearly, raising the rate of return on Social
Security taxes
                          has special significance for low-wage earners who
expect
                          to have no retirement income except Social
Security. For
                          these workers at the bottom end of the pay scale,
David
                          R. Henderson, professor of economics at the Naval
                          Postgraduate School in Monterey, California,
compared
                          the economic payoff from Social Security with a
privatized
                          account earning seven percent a year. Someone
retiring
                          last year after working his entire life at
minimum wage,
                          Henderson says, would have been better off by
$100,000
                          without Social Security.

                          Today, the poorest fifth of past wage earners in
the U.S.
                          rely on Social Security for 81 percent of their
retirement
                          income. In contrast, the richest fifth of past
wage earners
                          rely on Social Security for only 20 percent of their
                          retirement income. Given that dissimilarity, it
is America’s
                          poorest families who stand to benefit the most in
terms of
                          changes in their standard of living during
retirement by a
                          privatized system that delivers greater returns
to payroll
                          taxes. A recent Cato Institute study projected
that a typical
                          low-wage worker born in 1950 would receive a monthly
                          retirement check of $2,490 if his payroll taxes were
                          invested in the stock market, compared to $631 from
                          Social Security, a difference of $22,308 per
year. The
                          economic facts, in short, dispute the popular
belief that it
                          is low-income workers (those who, on average,
start work
                          earlier, have shorter life expectancies, and have
fewer
                          years to collect Social Security) who are
expressly helped
                          by the current system.

                          Race Issue

                          "Black men get the worst deal of all," reports
Investor’s
                          Business Daily. "The average life expectancy of a
black
                          man is projected to be 64.8 years in 2000, down from
                          65.4 years in 1995. The current retirement age of 65
                          means black men on average can expect to see
little or
                          none of the money they paid into the system."

                          Economist William Beach concludes that "a low-income
                          African-American male age 38 or younger is likely
to pay
                          more into Social Security than he can ever expect to
                          receive in benefits after taxes and inflation."
Beach
                          estimates that for the average black male,
"staying in the
                          current system will likely cost him $160,000 in
lifetime
                          income."

                          For American males who reach age 65 (fewer black
men,
                          proportionately, than white men), the U.S.
Department of
                          Health and Human Services reports that blacks
live an
                          average of two years less — 24 Social Security
payments
                          — than whites. Similarly, the National Center for
Health
                          Statistics reports that black women born in 1990
have a
                          life expectancy four years shorter than white
women. A
                          study by the RAND Corporation, Socioeconomic
                          Differentials in the Returns on Social Security,
found that
                          the lifetime inter-racial income transfer through
Social
                          Security from blacks to whites was as much as
$10,000
                          per black worker.

                          Social Security, says Deroy Murdock, Adjunct
Fellow at
                          the Atlas Economic Research Foundation, "essentially
                          transfers money from working black men and women,
who
                          die earlier, to older white women, who live the
longest."
                          Murdock recommends replacing Social Security with
                          individual pension accounts invested in private
capital
                          markets. "Money accumulated in these accounts
could be
                          handed down to one’s heirs," he says, "something
today’s
                          system forbids." Additionally, on top of allowing
black
                          parents to bequeath larger estates to their own
children,
                          individually-owned, privately-controlled retirement
                          accounts would supply a huge asset base that
could be
                          directly invested in the black community, replacing
                          dependency on government with higher levels of
                          commerce, economic independence, and self-reliance.

                          Ironically, those who have led the most aggressive
                          campaigns against privatization of Social
Security are the
                          key Democratic special interest groups — unions,
senior
                          citizen groups, feminist organizations, and black
groups,
                          the very organizations that claim to represent
the financial
                          interests of America’s least privileged
constituencies.
                          Congressman Pete Stark (D-CA), two weeks before the
                          House vote on impeachment, declared, "If Clinton
votes to
                          privatize Social Security, I’ll vote to impeach
him." On
                          December 3rd, Jesse Jackson, Patricia Ireland of the
                          National Organization of Women, and AFL-CIO head
John
                          Sweeney announced their staunch opposition to any
kind
                          of Social Security privatization.

                          Under current government promises, a typical
35-year-old
                          union worker earning $33,000 a year will receive
about
                          $1,500 a month from Social Security at age 67. In
                          contrast, a Cato Institute study projects that
the same
                          union worker would have accumulated "enough money to
                          purchase annuities paying $2,671 a month at
retirement"
                          by investing Social Security taxes in "bonds, a
virtually
                          risk-free investment." With a "balanced
portfolio," divided
                          equally between stocks and bonds and assuming a four
                          percent rate of return on bonds and seven percent on
                          stocks, that same union worker "could purchase
annuities
                          of $5,002 a month." With Social Security taxes
invested all
                          in stocks, the $33,000 a year union worker "would
be able
                          to purchase annuities paying an astounding $9,575 a
                          month." That is $114,900 per year, compared to
current
                          Social Security promises of $18,000 per year. It
is a pretty
                          safe bet that AFL-CIO chief Sweeney, rejecting
privatized
                          accounts for his own union members, has the bulk
of his
                          retirement assets firmly invested in today’s
bullish market.

                          Scare Tactics

                          At the close of last year, following a sharp drop
in the
                          stock market, Solidarity, the magazine of the
United Auto
                          Workers, trumpeted a bold "At Risk" across its
cover.
                          "The summer decline," declared the UAW, "has been a
                          bracing slap of cold water in the face of the new
wave of
                          politicians that see individual stock market
investments as
                          the best route to secure, happy retirement for
Americans."
                          The National Committee to Preserve Social
Security and
                          Medicare weighed in with full-page newspaper ads:
"On
                          Monday, the stock market dropped by over 500
points. On
                          Tuesday, millions of Americans received their Social
                          Security checks. Aren’t you glad Social Security
hasn’t
                          been privatized?" In fact, by year’s end, the
Standard &
                          Poor’s 500 was up by 26.7 percent for 1998, the DOW
                          gained 16.l percent, and the NASDAQ composite soared
                          a startling 39.6 percent — a pretty straight
route to a
                          "secure, happy retirement."

                          Observing these scare tactics each time the
market takes
                          a dip, one can only speculate about why these
leaders
                          who speak on behalf of millions of Americans are so
                          opposed to giving individuals the freedom to run
their own
                          lives, invest their own money, and plan for their
own
                          retirements. In fact, the privatization of Social
Security
                          taxes into individual retirement accounts would
ensure a
                          more even distribution of U.S. wealth, an
enduring goal of
                          America’s liberal politicians. Currently, the
poorest half of
                          American families own only two percent of the
nation’s
                          financial wealth. Harvard economist Martin Feldstein
                          estimates that with Social Security
privatization, allowing
                          for the creation of new wealth in workers’
private accounts,
                          the concentration of wealth in America would be
reduced
                          by 50 percent.

                          As a fallback position, seeing the increased
prospect for
                          the privatization of retirement funds, President
Clinton,
                          Senator Ted Kennedy (D-MA), Congressman Earl
                          Pomeroy (D-ND), and other Democratic politicians
have
                          recommended a collective solution, proposing
                          government-directed investment of payroll taxes.
                          Centralized government control, contends Pomeroy,
would
                          be less risky than individualized investing and more
                          shielded against political influence. In
contrast, months
                          prior to President Clinton’s State of the Union
proposal for
                          government-directed investing of a portion of the
Social
                          Security surplus in the market, Federal Reserve
Chairman
                          Alan Greenspan flashed a caution light to the
idea of the
                          government controlling billions of dollars in
private
                          investment. That kind of collective investing in
the private
                          sector, warned Greenspan, "has far reaching
potential
                          dangers for a free American economy and a free
                          American society."

                          Following the State of the Union speech, Greenspan
                          attacked President Clinton’s Social Security
proposal,
                          saying he feared that government investments in the
                          market would fall victim to political
manipulation. "I do not
                          believe," he said, despite Administration
promises that
                          money would be invested apolitically, "that it is
politically
                          feasible to insulate such huge funds from government
                          direction." Additionally, Greenspan warned that
the Clinton
                          investment plan would lower the efficiency of
capital
                          allocation, reduce productivity growth, and hurt
living
                          standards. Citing studies showing that returns on
state
                          and local pension funds have been usually two to
three
                          percentage points lower on average than comparable
                          private pension funds, Greenspan said he was
"fearful that
                          we would use those assets in a way that would
create a
                          lower rate of return for Social Security
recipients."

                          Politics as Usual

                          One need only look to the recent proposal by the
Clinton
                          Administration to require private pension funds
to invest a
                          portion of their assets in "socially responsible"
projects to
                          spot the inherent dangers in putting Washington
in charge
                          of investing retirement funds. As the Clinton
plan explicitly
                          illustrates, it is foolish to assume that
politicians can be
                          consistently relied upon to invest assets with
the objective
                          of wealth maximization for fund participants, or
                          consistently be relied upon to resist the
temptation to
                          dictate which hoops American companies should jump
                          through in order to qualify for "public" support,
in order to
                          be on the receiving end of billions of investment
dollars.

                          "State and local public funds have been used to
preserve
                          local jobs or to make moral statements by dumping
stock
                          in tobacco companies and, in one case, shares of
Walt
                          Disney," notes Wall Street Journal reporter Greg Ip.
                          "Looking at the experience around the world," states
                          World Bank economist Robert Palacios, "we haven’t
                          found any examples of a well-insulated pension-fund
                          investment-management system."

                          In the long run, the practice of the government
massively
                          investing in private securities would allow a
gradual
                          government takeover of American businesses as the
                          escalating trust funds assumed an ever-larger
ownership
                          share in the private sector. It is a statist’s
dream, a clear
                          formula for the merging of state and business
leadership.
                          Based on the Clinton Administration’s projection
of an
                          investment of $650 billion of Social Security
funds in
                          stocks over the next 15 years, the federal
government
                          would wind up owning four percent of the stock
market by
                          2014. By comparison, the stock holdings of the
nation’s
                          largest single fund manager, Fidelity Investments,
                          represent about three percent of U.S. market value.

                          The American public seems to recognize the
dangers of
                          government-directed investment. White House pollster
                          Mark Penn found that 67 percent of registered
voters and
                          52 percent of Democrats favor personal investment
                          accounts over government-managed investment. Across
                          the world, the victory of the free market
paradigm is the
                          top economic story of our age. Applied to
retirement, both
                          Chile and Britain provide remarkable
illustrations of the
                          superiority of free market performance and
privatization. In
                          Britain, a two-tiered system now permits workers
to invest
                          a portion of their payroll taxes in private
retirement plans.
                          The first tier is state-run, paying a safety-net
pension. The
                          second tier allows workers to opt out of the
state-run
                          retirement plan and invest their payroll taxes in
either
                          personal retirement plans or company-based private
                          pension plans. In personal pension plans, workers
may
                          deposit up to 17.5 percent of tax-free earnings.
Similarly,
                          in the company-based plans, employees and employers
                          may contribute up to a combined 17.5 percent of
tax-free
                          earnings. Company-based pension plans must be
                          voluntary, approved by the government, portable
to the
                          plans of other companies or personal plans, and
provide
                          guaranteed minimum pensions at least as good as the
                          government plan. In both plans, investment
returns, until
                          cashed in, are free of both income taxes and
capital gains
                          taxes.

                          Today, given the choice, more than three-quarters of
                          British workers have chosen to be enrolled in
private
                          pension plans, earning an average of 13.3 percent
per
                          year on their payroll taxes since 1986. Younger
workers in
                          private plans can now expect pensions that are
twice that
                          provided by the state-run plan. Further, in a
nation faced
                          with the demographic problem of a declining ratio of
                          workers to retirees, British pension reforms have
curtailed
                          pressures for benefit cuts and tax hikes by
significantly
                          reducing the long-term liabilities of the state
pension
                          system.

                          Miracle in Chile

                          In Chile, the retirement system was privatized in
1981. At
                          that time, retirees were grandfathered under the old
                          government system and paid out of general revenues
                          instead of payroll taxes, while current workers
in the
                          government retirement system were given the
option of
                          switching to a new privatized system. Under the
private
                          plan, workers are required to contribute ten
percent of
                          their annual salaries to private pension accounts.
                          Management of pension funds is left to privately-run
                          investment firms, and the government provides a
safety
                          net for those whose pensions at retirement are
                          inadequate. Additionally, another three percent
mandatory
                          payroll deduction buys life and disability
insurance with
                          private firms, plus workers have the right to
contribute an
                          additional ten percent of after-tax wages to
their accounts,
                          compounded tax-free.

                          Today, over 90 percent of Chilean workers have
switched
                          out of the government- run system, choosing among 21
                          competing private mutual funds that invest in
stocks and
                          bonds. Since 1981, the real,
adjusted-for-inflation, annual
                          rate of return on these private retirement
accounts has
                          averaged 13 percent. In the late 1970s, there
were virtually
                          no savings in Chile. Today, the cumulative assets in
                          retirement accounts total over 40 percent of the
nation’s
                          gross domestic product.

                          At retirement, Chilean workers may withdraw their
                          accumulations on a phased basis linked to their life
                          expectancy, or use their retirement nest egg to
purchase
                          an annuity from a private company that will pay them
                          monthly for the rest of their lives. Prior to
retirement age,
                          workers may withdraw from their accounts at any
time if
                          they have accumulated more than what is required
to fund
                          an annuity paying 70 percent of their final wage.
At death,
                          any balances left in a worker’s account can be
                          bequeathed to heirs. Today, the typical retired
worker in
                          Chile is receiving a yearly retirement income
equal to
                          nearly 80 percent of his average annual wage over
the last
                          ten years of his working life. In terms of
equity, with rates
                          of return in the new privatized systems much
greater than
                          in the old state-run system, it is the poorest in
Chile —
                          those who lack capital assets and are most likely to
                          depend exclusively on a basic pension — who have
been
                          helped the most by privatization.

                          "Workers now carry passbooks in their pockets
because
                          they are capitalists," says Jose Pinera, Chile’s
former
                          Labor Minister and a key architect of Chile’s new
                          privatized system. "We have made a nation of
owners."
                          Further, with workers now having a greater stake
in what
                          happens in the overall economy, Pinera maintains
that tax
                          hikes and ill-conceived regulatory proposals
aren’t as
                          likely to succeed because workers simply won’t
stand for
                          the drag on their investments. "When workers feel
that
                          they own a part of the country, not through party
bosses or
                          a Politburo," he says, "they are much more
attached to the
                          free market and a free society."

                          Closer to home, municipal employees in three Texas
                          counties voted in 1981 to opt out of Social Security
                          (before it became illegal in 1983) and invest in
a private
                          pension system. In Galveston, by a 78 percent to 22
                          percent vote, employees elected to join the
Alternate Plan.
                          In Brazoria and Matagorda Counties, municipal
                          employees soon followed.

                          In the Alternate Plan, an employee contributes 6.13
                          percent of his income and the employer
contributes 7.65
                          percent, with 9.737 percent of that 13.78 percent
going
                          into the employee’s individual retirement
account, earning
                          6.5 percent interest, guaranteed by an investment
                          company (the remaining contribution pays for life
and
                          disability insurance). Today, with virtually the
same payroll
                          costs as Social Security, an employee earning an
                          average of $50,000 per year for 40 years can choose
                          among several annuities at retirement or a lump sum
                          payment of $956,303. With an average salary of
$20,000
                          or $30,000, an employee will receive,
respectively, a lump
                          sum of $383,032 or $573,782, or an annuity that pays
                          guaranteed monthly benefits. Under one annuity
option, for
                          example, a $20,000 per year worker will receive a
monthly
                          retirement check of $2,740, compared to $775 from
                          Social Security. With a $50,000 salary, the
annuity’s
                          retirement check jumps to $6,843 per month,
compared to
                          $1,300 from Social Security.

                          "More than l million state and local government
employees
                          in the United States have been exempted from Social
                          Security," says Daniel J. Mitchell, McKenna
Senior Fellow
                          in Political Economy at the Heritage Foundation,
"and are
                          now enjoying higher levels of retirement income
through
                          private pension plans." In December 1998, federal
                          lawmakers suggested making the Social Security
                          program mandatory for some five million teachers,
state
                          and local government employees, and law enforcement
                          officials around the country who are now exempt. The
                          response? In a letter to President Clinton in
December,
                          Robert Scully, executive director of the National
                          Association of Police Organizations, said that "a
proposal
                          of mandatory Social Security taxes for public safety
                          officers is one of the greatest and most detrimental
                          attacks on public safety organizations and their
respective
                          members." The 40,000-member United Teachers of Los
                          Angeles called the plan "a bailout of the Social
Security
                          trust fund on the backs of school teachers and
other state
                          and local workers who didn’t create the problem."
In Ohio,
                          the heads of five government retirement associations
                          warned of "the anger among millions of working
adults
                          and retirees and subsequent political backlash
that will
                          likely follow if mandatory coverage is imposed."

                          "Opportunity Costs"

                          As for the rest of us, Eugene Steuerle of the Urban
                          Institute has calculated the price of Social
Security in
                          terms of "opportunity costs," i.e., the cost of
doing A
                          compared to alternative B. Based on receiving a
seven
                          percent return on payroll taxes invested outside
the Social
                          Security system, today’s 40-year-old married sole
                          provider earning $60,000 a year has a net loss of
                          $750,000 from Social Security, comparing projected
                          Social Security benefits to the estimated returns in
                          individually invested retirement accounts. For a
married
                          sole provider earning $25,000 a year, the loss is
                          $268,000. With both spouses working, one earning
                          $60,000 and the other earning $25,000 a year, the
loss is
                          $1.2 million.

                          That comparison, of course, rests on two
assumptions: 1)
                          a seven percent privatized return; and 2) the
assumption
                          that today’s workers won’t be subjected to hikes
in Social
                          Security payroll taxes or cuts in benefits. As it
now exists,
                          the Social Security system is simply a
tax-and-transfer
                          program in which participants earn no contractual
claim to
                          any future benefits. "The open-ended
appropriation that
                          Congress has granted Social Security expresses its
                          long-term support for the program, but it does
not say
                          anything meaningful about how the long-term cost
will be
                          funded — or, indeed, whether the cost is
affordable at all,"
                          explain Neil Howe and Richard Jackson, economists
and
                          senior advisers at the Concord Coalition. "Actuarial
                          solvency thus rests on nothing more than Congress’
                          promise to spend money that it has yet to raise."

                          Michael Tanner, director of the Cato Institute’s
Social
                          Security Privatization Project, underlines the
risk: "A
                          young worker entering the Social Security system is
                          gambling on what a Congress and president 45 years
                          from now will decide to do. Given the system’s
$9.5 trillion
                          unfunded liability, and the inevitable tax hikes
and benefit
                          cuts to come, the political risk of staying in
Social Security
                          far exceeds the market risk of private investment."

                          As is the case with risks, there are transition
costs both to
                          staying in the current Social Security system and in
                          moving to an individualized retirement system.
With the
                          latter, for instance, given the moral obligation
to continue
                          benefits to today’s recipients and to those nearing
                          retirement and the fact that payroll taxes
diverted to
                          private accounts will no longer be available to
pay those
                          benefits, the transition costs with privatization
are
                          significant. In effect, today’s workers will have
the burden
                          of simultaneously paying for two retirements —
their own
                          pre-funded plans and that of current
beneficiaries who
                          continue to collect under the current state-run
                          pay-as-you-go system.

                          "Yes, privatization entails a sizable transition
cost," states
                          Daniel Mitchell of the Heritage Foundation, "but
keeping
                          the current system in place and putting it on a
sound
                          footing would involve a large transition cost as
well." The
                          key issue, Mitchell contends, "is whether the
price tag for
                          moving to a private system is larger or smaller
than the
                          amount of money lawmakers would have to find to
fulfill the
                          promises of the current system." As it turns out,
                          "privatization is less expensive." A valid economic
                          analysis, in short, must look at the cost of
privatization in
                          light of Social Security’s current unfunded
liabilities. In that
                          sense, says Tanner, "privatizing Social Security
will
                          actually reduce the total debt we owe."

                          "While any financing mechanism will be political —
                          involving some combination of debt, transfers from
                          general revenues, asset sales, and the like — the
                          expected budget surplus offers a good place to
start,"
                          says Tanner. The notion of a budget "surplus"
separate
                          from Social Security is deceptive, in fact, since
it is the
                          result of robbing the supposedly off-budget Social
                          Security trust fund of money collected for the
Social
                          Security program. Senate Finance Committee Chairman
                          William Roth (R-DE) has offered a plan that
basically
                          leaves the current system untouched while using the
                          surplus to create individual retirement accounts
for all
                          working Americans. In July, the Congressional Budget
                          Office reestimated that the Social Security
surplus will be
                          $1.6 trillion over the next ten years.

                          In another plan, proposed by Senator Rod Grams
(R-MN),
                          workers would be allowed to shift ten percent of
their
                          payroll taxes to individually held personal
retirement
                          accounts. The transition cost, says Grams, would be
                          financed by cutting federal spending by five percent
                          across the board — federal spending that is now
                          budgeted to be some $300 billion higher next year
than
                          when the GOP took over the reins of Congress in
January
                          1995.

                          Given the superior long-range rates of return in
the private
                          sector, additional tax hikes to keep the current
Social
                          Security model afloat is basically throwing good
money
                          after bad. On top of a total federal, state, and
local tax
                          burden that now consumes nearly 40 percent of a
typical
                          family’s income, the projected string of benefit
cuts and
                          tax increases which are unavoidable in the
current system
                          is certain to further weaken the nation’s anemic
savings
                          rate, restrict new capital investment, hamper
productivity
                          expansion, impede wage growth, and restrain
                          improvements in the general standard of living.

                          On the other hand, the private investment of Social
                          Security taxes in personal retirement accounts,
is most
                          likely to have exactly the opposite effects — an
increase in
                          national savings, greater investment, higher
productivity,
                          more growth, enhanced American competitiveness, and
                          more jobs at higher wages. Harvard economist Martin
                          Feldstein estimates that the disincentives and
distortions
                          of the current Social Security system have
reduced private
                          savings in the United States by 60 percent and
lowered
                          gross domestic product levels by five to six
percent.

                          Put simply, we have arrived at a crossroads. With
                          privatization, we go in the direction of more
individual
                          responsibility and the creation of a larger and
richer
                          economy, exactly what is required to meet the
nation’s
                          obligations to its future retirees. On the other
path, we go
                          in the direction of more dependency on the
government,
                          fewer choices, and increased generational
inequity as
                          each new birth of Social Security participants
receives a
                          worse deal than the last.

                          Most of all, by taking back our own income, we
take back
                          independence and offer ourselves, our children,
and future
                          generations of Americans a dramatically different
vision of
                          the role of government.



Mr. Reiland is Associate Professor of Economics at Robert Morris College in
Pittsburgh.



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