The Entitlement Lie: A Conservative Reform of Social Security

As the new Republican majority in the House of Representatives contemplates spending reductions, pushed along by our new Tea Party affiliated legislators, one common refrain from the Left is that such reductions are meaningless in the greater scheme of things. They claim that spending reductions without entitlement reform is futile. We can stipulate to the need to address the so called entitlements without agreeing that non-entitlement spending can be set aside for now. This claim is a big-spender's ruse in thrifty clothing -- a diversion from the fact that all government spending must be reduced. Nonetheless, blathering on the Left can occasionally include a nugget of truth and one cannot argue with the need for addressing so-called entitlement programs.

"So-called" because the entire concept of an entitlement is an out right falsehood. In government parlance, an entitlement is a "guaranteed benefit." Yet by its very design a program such as Social Security cannot be fundamentally guaranteed. Being a program of men and not guaranteed by our Constitution -- arguably not even allowed by our Constitution -- Social Security is subject to changing political whims and economic realities. Even now, nearly eighty years following its creation, our brilliant politicians, and even conservative think tanks, can conceive only four basic means of ensuring Social Security's financial viability going forward. Each of these -- increasing tax withholding, reducing benefits, delaying benefits, and means-testing benefits -- represent a reduction in the guarantee that is at the core of the entitlement concept. Each of them represents an actual or potential reduction in the financial return on the amount the government forces us to invest in the program. Each of them gives the lie to Social Security as an entitlement.

Politically, whether you perceive it as tax and spend redistribution, the forced purchase of an annuity product, basic liberal social engineering, or an out and out Ponzi scheme, Social Security was and is by no means conservative.  Libertarians and Constitutionalists might argue we should get rid of the system entirely.  From a conservative perspective, in the interest of careful and measured change, scrapping Social Security would be too disruptive, not to mention a political impossibility. Consider instead a solution that is conservative not just in the political sense (though many will argue this point) but in the financial sense. It will remove Social Security from the ranks of the government entitlement programs while simultaneously guaranteeing our benefits with the full faith and credit of the United States.

After being a political third rail for decades, significant reform of Social Security could actually be discussed during the Bush 43 administration without dramatic negative political consequences.  Partial privatization was the watchword.  Such reforms never got off the ground and given the financial sector collapse and the beating most of our retirement accounts took in 2007 and 2008, it seems highly unlikely that privatization reforms involving any kind of self directed investing could be enacted in the near future.

Social Security's solvency problem not only persists but has been accelerated by the recent financial difficulties. The New York Times reported last year that the Social Security fund would take less in contributions than it pays out in benefits during 2010. Until recently this was not expected to happen until 2016. The cause is lower employment levels. This reduces contributions and prompts some to retire earlier than planned and start taking benefits. In its 2009 Annual Report the Social Security Administration indicated that it would exhaust its available funds around 2041.

The great lie in the program is the myth of the Social Security "trust fund." The politicians tell us this fund is set aside and protected, but the reality is otherwise. In fact the funds are merely "invested" in government bonds and allow the government to increase their deficit spending without borrowing from independent investors. This is a key point. When the government borrows from individuals and other governments, there is a proper accounting. Each investor knows what they are owed. But as contributors to Social Security, we have no such explicit account balance. We have only a vague promise that our government will pay us back when the time comes. Meanwhile, as demographics change, there are fewer and fewer workers paying a portion of their income into the system to support an ever growing number of retirees. Now the initial baby boomers are beginning to retire and the problem will accelerate.  

At the end of 2010 the Old Age and Survivors Insurance trust fund had a balance of just over $2.4 trillion. On the surface this appears huge, but with over 43 million retirees and survivors drawing benefits, the fund averages around $56,000 for each of these beneficiaries. If one considers that there are over 150 million workers also contributing to Social Security, the average trust fund balance is a scant $12,000 per participant. This is a clear demonstration that the program has always relied on current contributors to cover current retirees, and why some of us see little difference between Social Security and a Ponzi scheme. The key difference is that Ponzi schemers promise unrealistically high returns to entice investors while the government uses the force of law and can thus provide below market returns.

What kind of returns are we talking about? If Social Security had been set up as a low risk savings plan instead, how much would each retiree have? If you do not like math, bear with me as I make an example of myself.

As a youth I had various odd jobs and paid small amounts into Social Security between 1973 and 1981. I began full-time professional work in 1982 and by 1987 was earning beyond the "maximum" amount against which deductions were made for social security. Between 1982 and 2009 I "contributed" $110,000 and my employers paid in another $110,000. Even without any interest income, my account should already have over $220,000.

Since the trust fund invests in low risk (i.e. conservative) Treasury securities, it only seems fair that I be credited with the interest that would have been earned on those securities. Between 1982 and 2010, the annualized rate on 30-year treasury securities (an appropriate low risk, long-term and conservative investment choice) ranged from a high of 12.76% in 1982 to a low of 4.08% in 2009. (Note the rates were not available from the Federal Reserve source linked above for the years 2003-05 and were thus estimated in my analysis). Apply these interest rates and accrue the interest once a year and my account balance would approach $500,000 at the end of 2010. In fact I would have earned over $19,000 of interest during 2010 alone.

But we are not done. I have 13 more years before reaching the Social Security retirement age. Should I continue to earn the maximum and continue to earn a conservative interest rate of 4.0%, my account balance at the end of 2023 will be $1.03 million! All because the $405,000 that I "saved" over a 42 year period was conservatively invested in 30-year US Treasury bonds.

In fact the interest earned on my account in 2023 will amount to around $39,000. By comparison, the Social Security Administration currently informs me that should I continue working until full retirement age in 2023, I can expect a monthly benefit of around $2,420. This amounts to an interest only return of under 2.7% and when I die all my principal reverts back to the government. Now this may be a sweet deal for big spending politicians, but it is a bitter pill for the conservative investor. And if I happen to die young, before extracting any significant benefits from the program, well so much the better for the politicians.

And let's be clear, this kind of analysis applies equally well to those that have not earned and contributed the maximum amount for most of the working lives. Even cutting my contribution numbers in half to represent a worker with significantly less life time earnings still results in an account balance at retirement of over $500,000. This would allow them more benefits than Social Security in retirement and the possibility of leaving a nice chunk of change to their children.

Thus I propose to convert Social Security to a private savings program, administered by the Social Security Administration. This would be easy to implement. Computers could make the same calculations I did for every living worker and retiree in a matter of minutes. They could also reflect reductions in account balances for retirees that have already begun receiving benefits. Each and every adult American would have a visible and assured Social Security Investment Account with a balance that is tracked and reported and bears the full faith and credit of the United States of America. This account will replace the entitlement lie with an individual asset that can not be taken away on the whims of politicians. It was our money in the first place. We saved it at the insistence of the government. We want it back when we retire. How could you get more conservative than that?

David Butler is a happily married and proud father of two young men, and a small business executive living in Danville, CA.