When I sought the Republican presidential nomination in 1988, I proposed a plan to convert Social Security from the current pay-as-you-go system to a fully funded retirement program. Eleven years later, both Republicans and Democrats have come to agree that the current system is facing financial collapse, and reforming Social Security is finally on the Washington agenda.
What's the problem with Social Security? Under the pay-as-you-go system, each generation of retirees depends on the government to provide Social Security benefits by taxing the next generation. When the first Social Security payments were made in 1940, there were 42 workers for every retiree. But no more. Today the ratio is about 3.3 workers for every retiree, and by the middle of the next century, the ratio is expected to fall to less than 2 workers for every retiree. Thus, each worker will be supporting more than half of the cost of an elderly person in addition to all other taxes and all other family responsibilities.
This means that our pay-as-you-go approach is on a collision course with reality. Today, spending on Social Security takes about 11.5 percent of the nation's taxable payroll. By the year 2045, when today's 21-year-old college students will be eligible for Social Security, 17.4 percent of employee earnings — about 50 percent more than at present — will be needed to pay Social Security benefits, according to the intermediate forecast of the Social Security trustees. Under the trustees' pessimistic assumptions, workers would have to pay more than 22 percent of taxable payroll.
It will come as no surprise to most readers that Social Security has a problem, but it may not be clear to many people that the burden promises to be as heavy as those numbers imply. And bear in mind that this is only for Social Security. When you add in the payroll tax for Medicare, taxes for elderly entitlements alone could be greater in 2045 than today's entire tax burden — and that's not counting other taxes, or money for food, clothing and shelter.
Dealing with elderly entitlements will inevitably become a greater and greater problem as long as the taxes paid by workers today are used to pay retirees' benefits today. While President Clinton deserves credit for making Social Security a front-burner issue, his proposed reform is too deeply flawed to deserve serious attention. What is needed is a system where today's workers fund their own retirement, and a transition plan to get from here to there.
Senators Phil Gramm (R-Texas) and Pete Domenici (R-NM) have proposed an attractive plan for basic reform of Social Security — attractive because it does solve the problem of pay-as-you-go financing in an aging society. Attractive too because nobody would fare worse than under the current system and because, over a 50-year period, Social Security would make the transition to a fully funded system.
The Gramm-Domenici plan is called Investment-Based Social Security. Current workers who choose the private option would save for retirement in individual accounts which would be their property and which would be invested in a conservative, diversified portfolio of real assets by professional, private money management funds. The government would guarantee a safety net for those whose accounts won't provide a minimum pension, and it would provide some oversight to guard against fraud or mismanagement. But government's role would be minimal, and in 50 years it would be non-existent.
Funds for the transition would come from three sources: (1) projected federal budget surpluses; (2) recapture of the increased corporate income tax revenue from additional investment generated by the individual accounts; and (3) redemption of 29 percent of the Social Security Trust Fund's assets. The redemption of this portion of the Social Security Trust Fund will require the federal government to pay Social Security back 29 percent of what it has taken out of the system to fund other government activities.
Fifty years is a long time, but it takes a long time to dig ourselves out of the unfunded liability we have to current and future retirees. We have an opportunity today to put Social Security on a fully funded basis — without cutting benefits or raising the retirement age — and to provide for a transition period during which the existing unfunded liability can be eliminated. If we wait, or if we take half-way measures to try to patch the current unsustainable system, we will be sowing seeds for future hardship for both young and old.
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The National Center for Policy Analysis is a public policy research institute founded in 1983 and internationally known for its studies on public policy issues.