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Social Security: An impending future calls for reform

By Colleen Honigsberg

April 29, 2004 9:00 pm

Most of us can probably remember the Saturday Night Live parody
of the 2000 presidential debates in which a mock Al Gore was asked
to sum up his campaign in one word, to which he responded
“lockbox.” Most of us can also remember the debates
themselves, in which Gore and George W. Bush spent a substantial
amount of time disagreeing with one another over potential reforms
to Social Security.   While the issue has since moved out of
media focus, the impending future of a bankrupt Social Security
program still exists. Social Security is a pay-as-you-go type
program, so the money being collected now is used to fund people
currently retired. As of today, the amount of money collected is
greater than the amount of money paid out, so Social Security is
said to be running a surplus. The surplus money is invested in
bonds issued by the federal government, creating a paper trail in
which the government in effect owes money to itself.   If
nothing is done to reform Social Security, the surplus, also known
as the “trust fund,” will not be around much

An impending crisis The Social Security
Administration predicts that in 2018, the total amount of benefits
paid out will be larger than the taxes taken in; the entire trust
fund is predicted to expire in 2042. At this point, the
administration will not have enough money to pay out the benefits
it has promised.  These financial problems are the result of
two main causes: increasing life longevity and changing
demographics. In 1940, soon after Social Security began, the life
expectancy of a 65-year-old was 77.5 years. It has now increased to
83.5 years. With people retiring earlier and living longer, they
spend more time receiving Social Security benefits and less time
earning taxable income. Additionally, the demographics of the
United States are changing. Not only are people living longer, but
the post-World War II baby boom generation is getting close to
retirement. With the baby boom generation’s retirement, the
population of elderly as a percentage of the U.S. population is
expected to increase from 13 percent to 20 percent. To support
these retirees without bankrupting the system, several options have
been proposed. However, the most obvious options, either raising
taxes or cutting benefits, have both been met with low public
approval, and politicians have become hesitant to push for either.
Instead, more creative solutions are being offered.

Privatizing the system Michael Darby, the
Warren C. Cordner professor of money and financial markets at the
UCLA Anderson School of Management, supports a popular reform known
to many as privatization. Under his approach, the money each person
contributes would be invested in an individual retirement account
(IRA) where it would likely earn a higher return than it does
currently with government bonds. “Three percent is not very
attractive when compared to an IRA,” Darby said.   Darby
also noted the approach could be beneficial to college students
because they will be the ones paying an additional tax if one is
imposed. Also, they will feel the effects of reduced government
spending in other areas if Social Security must borrow from the
general fund to pay the benefits it promises. “College
students are the youngest so they have the most to lose from the
current system,” he said. Robert Harding, an economics
professor, noted that while he thinks such a program would be
beneficial, the change from the current income transfer program to
a pension plan would have to be made gradually over a period of 50
or so years. In the meantime, he said he does not think there will
be any way to continue Social Security without either raising taxes
or cutting benefits or both. “There’s no way to get out
of the system without hurting someone,” Harding said. Critics
of privatization say it is risky because return on IRAs is not
guaranteed the way it is with bonds. Also, the issue of whether the
money would be invested in the name of the individual or the
government has not been determined. If the money is invested in the
name of the government, some obvious problems could arise in terms
of government control of private companies and stockholder’s
voting. Additionally, as Darby noted, Social Security distributes
income by giving lower wage-earners a disproportionately high
return, whereas higher-wage earners receive a negative return. If
the money for each individual is set into an IRA only accessible at
retirement, there would be a need to supplement the IRAs for
low-income individuals to bring them up to a social minimum.

Other potential solutions Since politicians are
hesitant to cut benefits or to raise taxes, many people think
smaller, less controversial approaches have more of a chance of
being passed. Many of these approaches focus on increasing the
labor force or increasing other forms of retirement plans. Michael
Bazdarich, a senior economist with the Anderson Forecast, suggested
tax reforms that encourage higher savings and labor-force
participation, including removing a “bias against
savings” in the current income tax system. “Saved
income is taxed when you earn it and taxed again and again when the
savings yield returns down the road. However, consumed income is
taxed only once — when you earn it,” he said. Currently, the
tax system allows only a limited amount of single-taxation savings
plans. Bazdarich said it would be worthwhile ending the
double-taxation on retirement plans by removing these limits. Like
all other solutions, a problem could arise from this approach.
Harding said that while he thinks it is a good idea, it would be
problematic for the elderly generation and other people who do not
have the money to invest in IRAs. In order to increase the labor
force, Bazdarich noted that an ease on immigration laws would be
beneficial. Another possible method to help lower the number of
retirees relative to the number of workers would be to cut taxes
for individuals working past retirement age. “Workers over 65
pay income taxes on their earnings, and they also suffer reduced
eligibility for Social Security benefits, so this is a form of
double-taxation which discourages older people from working and so
exacerbates problems in the nation’s retirement
system,” Bazdarich said. Whatever approach the government
decides to take to reform Social Security, the sooner it is
enacted, the better. Legislators know this, but few have dared to
push for reforms. “Any potential change can be portrayed as
hurting someone, whether it’s true or not,” Darby said.
“No one has reason to take on the system until the public
forces the issue. It has been tried, and the political lessons have
been learned,” he added.

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Colleen Honigsberg
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