Social Security: Another Reform Idea

There’s been so much Social Security reform talk recently that I’m skeptical about adding another idea to the discussion. However, I have had a reform idea for at least five years and wanted to share it as an alternative piece of reform that no one has mentioned – or at least I haven’t heard it yet.

There are only two ways to fix the Social Security unfunded liability shortfall. We can either increase the system’s revenue or reduce the liabilities. That’s it. I’m in favor of private accounts, but they’re just a sweetener to offset the obvious planned reductions in liabilities (future benefits).

My alternative would be just a small part of the solution. Also, I would make it 100% voluntary to those who choose to participate. The basic idea is to eliminate some of the liabilities permanently by allowing individuals an “opt-out” provision. Those who choose to “opt out” of the program would still be required to pay part of the FICA tax (to help fund part of the system), but the tax would be reduced because they agree to a lower (or no) benefit.

A 25-year old worker might be given the following option: his FICA tax will be reduced from 12.8% (including employer contributions) to 6.4% if he agrees to waive his entire right to any future Social Security benefit. The catch would be that the remaining 6.4% must be invested in a government-sponsored 401(k)-type of fund – a mix of stocks, bonds and money market funds perhaps. This way, he is forced to save for his retirement but receives the benefit of higher growth.

A 35-year old might be given a slightly different option because he has already paid much more into the system than the 25-year old. So perhaps his FICA tax would be reduced even further to only 3.5% in return for his agreement to forego any right to future Social Security benefit. Or structured slightly differently, maybe he agrees to give up only a certain percentage (say 50%) of his benefit.

The main point is that, depending upon a worker’s age, the amount of FICA tax savings and/or benefits foregone would vary.

This arrangement should benefit both the government and the worker. From the government’s standpoint, it has completely (or substantially) eliminated the worker’s liability, while continuing to collect a portion of the FICA tax to pay for existing retirees. The worker would also benefit from the proposal. Assuming a 2% inflation rate and a 7% return from the worker’s private account, he would have 50% more money in his private fund at the end of 40 years than he would have under the existing Social Security program. Even if the worker’s return over 40 years is reduced to just 5.3%, he will still make out better than the existing program – even with a contribution of just 6.4% instead of 12.8% - such is the power of compounding. (Incidentally, investing solely in 30-year government bonds would generate this return).

The only reasons the government would not agree to such a proposal is:

1) It is afraid that Americans might realize they do not need the government to control every decision they make, or

2) It knows Social Security benefits will not be available to young workers anyway, so it doesn’t see a need to eliminate long-term liabilities.

The argument that some people are not smart enough to make their investment decisions is not persuasive because the government could offer just a few limited choices of low-risk funds from which to choose.

Speaking for myself, if I was offered me the above choice, I would waive goodbye to my future benefit and start putting my money into an account which I can be confident will be there when I retire.