The Double Bind That Is Social Security

Originally Posted At Forbes.com
By Lawrence A. Hunter, Ph.D.
March 30, 2012

Or How To Dismount The Tiger Without Getting Swallowed Whole

In this space last week, I wrote in opposition to cutting Social Security benefits for anyone currently participating in the program, by any means, direct or indirect, including changing the way inflation is measured so as to reduce cost of living allowances (COLAs).  I also expressed opposition to transforming Social Security from an earned-benefits program into a welfare program by means testing it and making people work longer to qualify for the handout.  And, I opposed repealing the program outright without compensating everyone currently participating in it for the harm repeal would do to them. 

Instead, I argued for giving everyone the freedom to voluntarily opt out of the existing program into one that more fully reflects the principles of liberty—allowing workers to invest the money they currently pay in Social Security taxes in the private market.  The federal government has become so bloated that the cost of allowing anyone who wants to remain in the program easily could be paid for, without having to alter the program, by cutting and reallocating other federal spending, still leaving plenty of room to reduce overall spending.  It is simply a matter of setting priorities and putting a practical and just solution to the Social Security problem near, if not at, the top of the list.

Giving people the freedom to choose to leave Social Security voluntarily over time is the only practical and just solution to the Social Security dilemma.  Re-engineering the program, as most Republicans advocate, is just another ill-conceived effort at social engineering while repealing it outright without full compensation (the aspiration of armchair libertarians) would actually perpetuate the theft that Social Security has become. It is impossible to justify repealing Social Security to stop the government’s stealing from one group of people if doing so entails perpetuating the theft on another group of people.  Moreover, uncompensated or inadequately compensated repeal is not a viable political solution because of the enormous backlash it would create by hanging so many people out to twist slowly in the wind.

The whole idea of a coercive, government-woven retirement safety net/snare (much less a more broadly defined “social safety net/snare”), for which all are forced to help pay, violates fundamental principles of liberty.  But once the jaws of the snare have closed around so many people, it is difficult to extricate the victims without doing them considerable further harm.  As appealing as uncompensated (or less than fully compensated) repeal might sound to the armchair libertarian, it is fraught with difficulties.  Consider one reader’s comments on last week’s column:

“Why call yourself a libertarian when you aren’t one? Criminal organizations don’t get to keep stealing in order to pay their bills.”

Without taking the bait to engage in the hoary debate over what constitutes a “true libertarian,” I want to address the reader’s second point, which is well taken but leads in a surprising direction when one delves deeper into the question of how and from whom Social Security steals.

“Just stop stealing,” the reader admonishes.  But, it turns out that is easier said than done because the criminal enterprise called government has trapped the country in an intergenerational Ponzi scheme that robs Young Peter to pay Old Paul.  Ceasing to rob Young Peter today means Old Paul gets hung out to dry, uncompensated for the theft inflicted on him during his working career.  And, if Young Peter isn’t young enough, he too will end up worse off post repeal because not only will he be forced to abandon the taxes he already has paid and be stripped of any expectation of being compensated for these abandoned assets at least in part through Social Security benefits; he also will find himself unable to fully replace the lost benefits with accumulated savings earned by investing freed-up Social Security taxes.

So, while repealing Social Security without full compensation would stop the stealing from today’s workers, it also would recommence the theft against yesterday’s workers, which ceased and was set in reverse when they retired and began receiving a kind of restitution in the form of Social Security benefits.  Therefore, repealing Social Security without full compensation cannot be justified on the grounds that it “stops the theft” because it doesn’t actually stop the theft at all; it merely shifts the locus of the theft from one group of (younger) victims to another group of (older, more vulnerable) victims.

One reason some armchair libertarians react negatively to the notion of full compensation is they ignore the fact that the original arrangement—where workers could expect a higher-than-market rate of return in Social Security benefits in exchange for the taxes they paid—has reversed itself.  Workers retiring today can expect to receive a negative return on the exchange.

Research conducted by C. Eugene Steuerle and Stephanie Rennane of the Urban Institute, makes it possible to quantify the magnitude of the theft that must be reckoned with in contemplating repeal of Social Security.  Steuerle and Rennane calculate the “lifetime value” of both Social Security taxes paid by and benefits promised to workers/retirees: 

"The 'lifetime value of taxes' is based upon the value of accumulated taxes, as if those taxes were put into an account that earned a 2 percent real rate of return (that is, 2 percent plus inflation). The 'lifetime value of benefits' represents the amount needed in an account (also earning a 2 percent real interest rate) to pay for those benefits."

A couple of examples illustrate the magnitudes involved.  (All amounts are in expressed in constant 2011 dollars adjusted to present value at age 65 using a 2 percent real interest rate.)

A two-earner married couple both retiring in 2011, who both earned the average wage ($43,500 in 2011) throughout their working careers would pay a lifetime-value of Social Security taxes equal to $611,000 and expect to receive a lifetime-value of Social Security benefits equal to only $560,000.  Right out the gate, then, this typical couple pays nine percent more in Social Security taxes than they can hope to recover in Social Security benefits.

But what if Social Security were repealed and compensation were paid, say, by grandfathering all current retirees so they received all their promised benefits (still a negative return)?  And, what if compensation also were expanded to grandfather in benefits, to a lesser extent, of older workers—the extent of the grandfathering being dependent upon how far past the point of no return a worker had gone in being able to replace Social Security benefits by accumulating retirement savings through private investment of the freed-up Social Security taxes he no longer would have to pay?  Wouldn’t it then be possible to repeal the program for all workers who have not passed the point of no return?  In theory, yes but let’s look at the data to see what it implies. 

A couple of average earners age 47 will turn 65 in 2030.  By then, they will have paid the government a lifetime-value of Social Security taxes amounting to $826,000, and they will receive benefits having an expected lifetime value of only $721,000, a 15 percent discrepancy, which measures the increasing magnitude of the theft Social Security is becoming.  [Had they been permitted to invest that same sum during their working careers and earned the average, after-tax rate of return to capital during that period—approximately three percent real—the lifetime value of their funds would have equaled slightly more than a million dollars at age 65.]  If Social Security were repealed next year, the value of the Social Security taxes this couple already paid since they began work at age 18 in 1983 would amount to $369,000, which would become, in effect, abandoned assets. 

What is this couple’s chance of recouping lost benefits by investing the freed-up income they no longer will be forced to pay in Social Security taxes after repeal?  Using Steuerle’s and Rennane’s same assumptions, the couple would be able to accumulate at age 65 only $277,000 by investing their freed-up Social Security taxes.  So, under uncompensated repeal, this couple not only would be forced to forfeit without recompense all the taxes they had paid prior to repeal ($369,000), they also would fall short of replacing the repealed Social Security benefits ($721,000) by some $444,000.  Without providing compensation well down the age ladder, it is clear the theft problem gets worse after repeal for a significantly sized cohort of workers too old to dig themselves out of the hole Social Security dug them into and too young to benefit from the Social Security windfall that profited their elders.

A few back-of-the-envelope calculations suggest that most workers currently over the age of 30 would be harmed to some extent by an uncompensated repeal solution.  For example, the 47 year-old couple of average earners passed the point of no return around 1995.  In other words, had Social Security been repealed in 1995 when they were 30, the couple would have been able to accumulate a lifetime value of retirement benefits of approximately $692,000 at age 65 by investing their freed-up Social Security taxes at an after-tax, three-percent real rate of return, which still would fall four percent short of replacing the pre-repeal value of their promised lifetime Social Security benefits of $721,000.

Don’t get caught up in the details of a compensation scheme.  The idea of compensation for restitution lost under repeal is used here merely as a heuristic, not a blueprint for further social engineering.  The best and most practical solution to the Social Security dilemma is simply to allow workers the freedom to opt out of the program.  Because Social Security has become such a bad deal, and gets worse everyday, an increasing number of younger workers will opt out, and the program will go the way of the horse and buggy without the need to actually repeal it.  Allowing workers the option to remain in Social Security—unadulterated by benefit cuts, COLA chiseling, means testing, higher minimum retirement ages and other re-engineering devices—eliminates the need to concoct a compensation scheme, which itself is likely to turn into a politically manipulated boondoggle.  As usual, free people exercising their freedom to choose, is the best alternative to anything the criminal enterprise called government dreams up.

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