VISION & VALUES: Is Social Security Reform Possible?

EDITOR’S NOTE: In the following essay, Dr. Sennholz provides perspective and proposals on the current Social Security debate.

An old English saying perfectly applies to election promises made by presidential candidates: “Vows made in a storm are forgotten in calms.” The loser need not give second thought to his promises and the winner usually is prevented from living up to the promises he made in the election storm. In his brief victory speech President Bush echoed what every president promised before him: “to strengthen Social Security for the next generation.” Surely he may set out to coach the system, as all his predecessors have done, but it is unlikely that he will be able to change its course by more than a few degrees.

Historical Perspective

The basic course of Social Security has remained largely unchanged since it was created some 70 years ago. It was born from politics and fashioned along lines of the sweeping reforms first introduced in Germany by Chancellor Bismarck during the 1880s. The United States did not have such reforms until 1935 when the Social Security Act was passed as part of President Franklin Delano Roosevelt’s New Deal program. In a time of deep Depression with the rate of unemployment at frightening levels, it intended to provide employment for young workers by retiring older workers. It established a system of compulsory old-age care, paying benefits proportionate to prior earnings for persons over 65. The act covered only workers in commercial and industrial occupations. Since then several major amendments have increased the categories of persons eligible for benefits and additional benefits have been added to the program, including disability and survivors’ benefits.

Social Security taxes have risen steadily over the years. At its introduction the maximum Social Security tax consisting of both employee and employer levies amounted to $60 a year; today it is more than $13,700. The present tax rate is 15.3 percent, which covers both Social Security and Medicare. The Social Security part of the tax is 12.4 percent of gross wages, presently up to $90,000 a year. The Medicare tax is 2.9 percent of all earnings. Workers bear the total amount – one-half directly, the other half by way of services rendered to their employers. More than 156 million workers presently (2005) are subject to Social Security laws and regulations and more than 47 million receive retirement, survivors’ and disability benefits. About one in three Social Security beneficiaries is not a retiree; some seven million people get monthly survivors’ benefits and another seven million workers and family members receive disability benefits.

The Realities of Social Security
Social Security is much more than a retirement system. It is a political welfare system, born of politics and torn by bitter conflict ever since. Its managers see no internal conflict but always bemoan “long-range financial problems” that they explain in terms of demographics. “We are living longer than ever before,” they lament. “When the Social Security program was created in 1935, a 65-year-old American had an average life expectancy of 12½ more years; today, it is 17½ years and rising.” No mention is made of many millions of victims, especially young Americans who are forced to contribute much more than they will ever receive, as well as those Americans who do not live long enough to draw out what they paid in. Little mention is ever made of the massive expansion of the system that is allocating many more benefits regardless of contributions made.

A simple calculation shows that every presently retired beneficiary withdraws in a short time what he contributed to the system. After he receives the equivalent of his own contribution, the “right” to old-age income obviously constitutes the right to support by the federal government and ultimately by his tax-paying fellowmen. The term insurance, in this respect, means public assistance.

A simple example may illustrate the case. Let us assume that a married person who regularly paid his taxes since the initiation of the system retired after 20 years of coverage, on Jan. 1, 1957. Let us further assume that he contributed the maximum payable under the law. From 1937 through 1949, he contributed 1 percent on $3,000 annual income, $30 per year, or a total of $390 in 13 years. In 1950, he would have paid 1½ percent on $3,000, or $45. From 1951 through 1953, his payment amounted to 1½ percent on $3,600 annually, or $162. In 1954, he was taxed 2 percent on $3,600, or $72. In 1955 and 1956, his taxes would have amounted to 2 percent on $4,200, or a total of $168. Altogether he paid no more than $837 during the first 20 years of coverage. If we add an equal amount of “employer contribution,” which actually came out of his pay, his total contribution to the system amounted to $1,674.

In 1957, this total lifetime payment of $1,674 entitled a retiring couple to receive $162.80 in monthly benefits. They received in 10 months and 8 days the equivalent of their total contributions. Our hypothetical retiree’s life expectancy, however, would be approximately 13 years; hers, 18 years. Assuming they survived 20 years beyond retirement, upon their deaths their total benefits would have exceeded $50,000 on total contributions of $1,674. This would be 30 times more than they paid in. For most old-timers this ratio of benefits to contributions is even greater since only a few contributed the maximum amount.

Where We Are Today
The amounts do differ today (2005); the U.S. dollar after all has lost some 90 percent of its purchasing power since 1937. But the ratio of benefits to contributions is similar for most recipients. In fact, it may even be hundredfold as Medicare benefits cover most of the medical expenses of old-age afflictions. Social Security obligations carry the full faith and credit of the U.S. government, as do all U.S. Treasury obligations. But this faith and credit assurance does not extend to the value of the dollar that meets and fulfills the obligations. The U.S. dollar depreciates at various annual rates as do the Social Security contributions made and benefits received. At an annual depreciation rate of just three percent the contributions made during some 40 to 50 working years shrink substantially in purchasing power. The benefits received thereafter must be supplemented with current payments by present taxpayers who are compelled to cover also the wide array of new benefits for a growing number of beneficiaries.

When more and more retired workers were provided with ever more expensive benefits, Congress simply raised the taxes in a series of steps – 16 times by 1980 – and nearly every year boosted the maximum earnings to be taxed. Since 1980, whenever the program’s burgeoning costs frightened its sponsors, Congress simply cut some benefits. For example, Congress enacted legislation, in a series of steps beginning this January, that raised the retirement age from 65 to 67. Yet, despite this raise and the earlier boosts in tax rates, the system faces growing financial difficulties.

Problems and Proposed Solutions
The officially designated malefactor of the system is longevity. It is made worse by 79 million “baby boomers,” who will begin retiring in 2008. In time, there will be nearly twice as many older Americans who will enjoy the benefits as there are today. By 2031, according to official estimates, the number of workers supporting one beneficiary will have fallen to barely two. A great deal of attention is being paid to American demographics and little to the essential structure of legislation and regulation that created the problem.

Ever eager to garner votes, legislators determine and enact every penny of benefits. But every blessing they bestow is also a tax on some hapless citizen. Every enrichment they devise is matched by a loss and every largess by a reduction. After all, government can bestow only what it seizes from taxpayers or borrows from lenders. In fact, the costs of the benefits, including the transmittal costs and interest charges, always exceed the benefits themselves; the army of Social Security regulators and administrators needs to be paid. At the present, the system still takes in more money than it pays out in benefits; the surplus goes in a “trust fund” of U.S. Treasury obligations and constitutes the Social Security reserve. According to official projections, the legislated benefits will begin to exceed the taxes collected in 2018 and completely exhaust the trust fund in 2042. At that time, Social Security will have to reduce its promised benefits unless changes are made.

Political skeptics are doubtful that the apparatus of politics can be moved to solve a political problem some 38 years before it actually becomes acute. Surely, for years and decades to come, politicians of all colors will discuss and vociferously debate the needs of Social Security; but it is unlikely that they will soon agree. Reform proposals point in all directions. One proposal would reduce the payroll tax rate for workers under age 55 by two percent and direct the savings into mandatory savings accounts. Another proposal would allow workers to deposit up to two percent of their wages into optional personal retirement accounts. Some critics believe that the promised benefits should be reduced or at least their growth be slowed. They would further increase the retirement age for full benefits beyond 67. Other critics would boost Social Security taxes to cover all future benefits. They would increase the present combined payroll rate of 15.3 percent to approximately 25 percent to pay for all benefits owed. The rate has been raised 20 times since the beginning of the system and probably will be raised again and again before 2042. But payroll taxes are already very high. Some 80 percent of workers pay more in Social Security taxes than they do in income taxes. And every raise in the employer contribution increases labor costs, which reduces the demand for labor and increases unemployment. The rate of unemployment of unskilled youth, especially minority youth, is already deplorably high.

Some critics would allow younger workers to have their own Social Security savings accounts which they could invest in stocks and bonds. Some would limit the accounts to a small percentage of Social Security taxes paid. Yet others would have Social Security itself invest its reserves in stocks and bonds, which soon would make it an important stockholder in American commerce and industry. A Cato Institute plan would create “a safety net ensuring that no worker’s retirement income would fall below 120 percent of the poverty level.” It would allow workers to place their half of the payroll tax into individually owned, privately invested accounts. Individuals who choose to adopt the Cato plan would receive “recognition bonds” amounting to the benefits already earned and redeemable at retirement. Officials would at first define and delimit the investment accounts but eventually allow a wider array of investment options. At retirement these workers could choose to acquire either an annuity or a withdrawal option assuring annual incomes equal to 120 percent of the poverty level. It should be noted that the safety net and the transition costs would place a heavy burden on the shoulders of taxpayers or force Congress to borrow the funds.

Reform’s Opponents
The National Committee to Preserve Social Security and Medicare is the most vocal, forceful and influential lobbying organization in Washington. Its 17 million supporters readily respond to Committee calls to send letters and petitions to members of Congress defending present benefits and demanding further improvements. In the past they managed to prevent any reduction in cost-of-living adjustments of benefits (COLAs). They fought any reduction of Medicare spending. They battled every effort to balance the federal budget that would cut across-the-board spending including Social Security. They repulsed every proposal to privatize Medicare and staved off attempts at privatizing any aspect of Social Security. The National Committee does not hesitate to appeal to the most powerful political spur and incentive – envy, railing against wealthy Americans and their tax breaks. It can be expected to rise up in arms against any of President Bush’s proposals no matter how ordinary and judicious they may be. It undoubtedly will demonstrate its power and influence in the political battles to come.

Social Security probably is one of the most popular and celebrated political institutions ever designed. But it also is a divisive construction that is creating unending bitter discord. The Bush Administration is about to launch its offensive to strengthen the system for the next generation; the political opposition is ready to repulse the offensive in order “to defend the system.” The outcome of the battle is as yet uncertain. Most reform proposals are new concoctions of the old welfare medicine. They are searching for another truce between beneficiaries and victims. Unfortunately, there can be no lasting peace as long as the system engages in class and inter-generational warfare. If it would allow a breath of individual freedom to enter the stale atmosphere of coercion, it would point not only toward financial solvency but also to social peace.

It is revealing and sad that not one of the proposals touches upon the basic flaw of the system: its coercive nature. None gives thought to an exit from the conscription, none ponders about ways of liquidation. They all cast nearly every American into the system and make him and her a Social Security lifer without parole.

In the coming years the Social Security program will undergo many alterations and reorganizations. No political system that seizes income and wealth from some subjects and bestows them on others is ever in a stable equilibrium. And no political system can forever create a growing burden of obligations and then shift them to future generations. Sooner or later the victim generation will resent the shifting and endeavor to lighten the load. It may repudiate the burden via inflation or other default devices and change the system that made it the pawn and prey of politics.

A Principled Solution
In battling error and injustice, it is tempting to seek compromises that adjust the differences and meet the opposition halfway. Those who fear popular censure and rejection tend to echo public opinion and come to terms with the opposition. But such a position may actually aggravate the error. Real reform must reject a happy medium. Of course, this reasoning is rejected summarily in the din of public opinion and official pronouncements. Nevertheless, the following proposal hopefully may shed some light and point to a peaceful order.

1. Telling the Truth. To restore a common ground of truth and reality, every recipient of Social Security benefits should be informed of the nature and source of his benefits. Every benefit check should carry a stub that reveals the dollar amount contributed to the system, including the accrued interest and the cumulative amount of benefits received.

2. A Means Test. When total benefits received in retirement equal the contributions made, the retired recipient could then apply for continued Social Security assistance by submitting to a means test showing a true need for the continued benefit. At that time, many Americans who have no real need would undoubtedly hasten to leave the system rather than apply for what amounts to public assistance. Wealthy Americans for whom Social Security benefits merely amount to pocket money would shun the assistance immediately. According to some estimates, some 20 percent of all present recipients would not miss it. Moreover, one-half of all present retirees are enjoying employer-sponsored pensions.

3. Let Youths Out. The departure of affluent Americans as well as many pensioned recipients would allow young Americans to leave the system. They are the primary victims of the present scheme that is loading trillion-dollar burdens on them. They are condemned to finance the system for some 50 years, hoping to survive and collect a meager return. In our age of inflation they must brace for continued rising tax exactions and ever-depreciating benefit claims.

4. Privatize the Remainder. When millions of older Americans have gladly left the system and millions of young Americans have rushed to leave it or choose never to join, the mode of Social Security operation will change fundamentally. Many Americans will be as free again as they want to be. The remaining system thus reduced by way of truth and freedom can now be privatized. It should be offered to a great number of private insurance companies who write policies for the protection of families. The benefits they pay are augmented by compound interest and payable in a lump sum at the end of a term of years. They also offer annuity policies which pay the insured a monthly or yearly income after a certain time. And in contrast to Social Security, all such contracts provide for hereditary transmittal of claims and savings.

5. Private Charity Revived. Some portions of Social Security may not be able to be privatized and should be taken over by charitable organizations. Throughout American history, private organizations have cared for the sick and poor. By 1900 some 150 societies, such as the Salvation Army, the Red Cross, various Christian charities, the Jewish charities, and later the Community Chests, ministered to them in the larger cities. According to some estimates, recipients of charity at times totaled one-third of New York City’s population. Early in the 20th century public funds began to supplement and often take the place of private charity. Rising taxes invariably dampened the spirits of charity and weakened its influence. The passage of the Social Security Act in 1935 revolutionized charitable activity by giving central focus to the welfare responsibility of the federal government through the Department of Health, Education and Welfare. Now is the time to reenergize this great charity system which is one of the primary virtues of all great religions – Christianity, Judaism and Islam – so that the helpless and handicapped will find the relief they need.

In the coming months, President Bush’s plan “to strengthen Social Security for the next generation” is likely to encounter much political opposition. It matters little who will prevail in the battles on the floor of the Congress; politicians will decide who will get what, when and why. It is unlikely that they will soon pass a Social Security reform act that reduces their immense power. But there are principles championed above which, if followed, may restore the light of freedom to old-age security.

About Hans F. Sennholz

Dr. Hans Sennholz earned his first doctorate from the University of Cologne in Germany and his second from New York University. He also earned two honorary doctorates. As a well-known Austrian school economist, he served as Professor of Economics at Grove City College for 36 years. Upon his retirement he became President of the Foundation for Economic Education until 1997. A prolific writer, he is the author of several books and has had some 500 essays and articles published in American publications and 36 in German journals and newspapers. In 2004 the Ludwig von Mises Institute acclaimed him with its highest award, the Schlarbaum Prize, for lifetime achievement in liberty. Many of his articles and essays are accessible on Dr. Sennholz passed away in June 2007.

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About Hans F. Sennholz

Dr. Hans Sennholz earned his first doctorate from the University of Cologne in Germany and his second from New York University. He also earned two honorary doctorates. As a well-known Austrian school economist, he served as Professor of Economics at Grove City College for 36 years. Upon his retirement he became President of the Foundation for Economic Education until 1997. A prolific writer, he is the author of several books and has had some 500 essays and articles published in American publications and 36 in German journals and newspapers. In 2004 the Ludwig von Mises Institute acclaimed him with its highest award, the Schlarbaum Prize, for lifetime achievement in liberty. Many of his articles and essays are accessible on Dr. Sennholz passed away in June 2007.