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Time to Dismantle ‘Pay as You Go’

Ken Nesmith

Most of us can plan reasonably for our everyday needs, like eating and sleeping, and don’t need government to help us with that. Sometimes, when we fail to manage such responsibilities and consequently impose costs on others, the government forces us to take steps towards responsibility. We’re forced to buy auto insurance, for instance, so that if we cause an accident, we have already paid money to cover the costs rather than placing the full burden on others.

Social security does the same for retirement, paternalistically forcing us to save for old age. Prussian Otto von Bismarck introduced social security in 1883. He created it as a pseudo-gift to the German working class, who were upset with the high taxes in the military state. Many historians interpret his attempt as one to lure workers away from private and community pension plans into a relationship of dependence with the state. He sold the program with a disingenuousness familiar to monitors of politics: he had a plan to ease the burden of the working class, and with this new program, government could provide for the needs of all citizens.

In the United States, Franklin Roosevelt introduced social security in 1935 as a way to ease the poverty of the elderly. Amidst a slurry of federal interventions that kept the country in protracted financial ruin, social security has stuck around. The plan was to tax workers, and give that money to the elderly. Whenever anyone retired, current workers would then fund their retirement.

Social security should be readily recognized as a pyramid scheme: benefits are only able to be paid by the ongoing recruitment of new members, who are forced to join upon getting a job. Pyramid schemes are illegal, but this one is allowed because the government is running it. All pyramid schemes eventually fail, and despite covering the entire employed population, this one will as well: the present value of the government’s obligations to members of the pyramid scheme exceeds by about $10 trillion the expected income from the ongoing enrollment and taxation of members.

That $10 trillion figure climbs daily. The situation has been worsened by several factors. For one, our national retirement account was robbed. Every cent paid to government to fund retirement wasn’t set aside, it was treated as government income, and spent as desired. Imagine if every time we made a deposit at a bank, the teller grabbed the cash, saved a buck, and went to lunch on the rest, only to inform you later that your account went bankrupt. That’s what’s happened with social security.

The situation has also been worsened by seniors’ failure to die young. When Bismarck conceived of social security, he did so with an eye on the average lifespan of the middle class worker, and planned the program to minimize benefits paid out before death. In the United States, an aging population living farther into retirement years has put a strain on the system. Ironically, the government has been bailed out by the population’s unhealthful tendencies: premature deaths caused by smoking have saved the government billions in unpaid benefits, and in part allowed the pyramid scheme to persist as long as it has. In essence, the current system gives government and society an incentive to see the elderly die as close to the retirement age of 65 as possible. Their deaths save money.

Politicians have been afraid to address the insanity of social security until now, but their plans differ starkly. We could take the system in two directions. We could extend the pyramid scheme, and raise the cost for new members so that there’s more money to pay retirees. This would raise income; on the expenditure side, we could cut benefits and pay out less money. One way to do this would be to not pay people who have enough money to live in retirement anyway. This does involve a bit of a broken promise to those who paid into the system their whole lives and will now receive nothing back, but in a pyramid scheme, promises have to be broken.

This is the core of John Kerry’s plan, although he doesn’t state it. His Web site reports that his plan is to “grow the economy” to pay for social security, but that won’t address the cost crisis. (Another part of his plan is “bipartisan action,” which is like saying you’ll solve a math problem by being friends.) Instead, he’ll either raise payroll taxes, reduce benefits, or both, despite his pathetic populist panderings to the contrary. The European nations, with aging populations and calcified, socialist economies, have a similar plan to dig deeper into the same hole, but they will do so by increasing immigration, harnessing the work of foreigners to fund current retirees. It’s not a new approach for Europe, who has a history of economic benefit on the backs of those from other lands.

We could also take the system in a different direction, by reviewing the nominal goals of social security. Let’s assume that the government did not intend the massive mandatory regressive tax that they implemented, but rather intended mandatory pension planning. How to do this? One way would be to force people to create retirement accounts, and contribute to them throughout their lifetimes. Some flexibility could be allowed in managing these accounts linking risk to reward, just as risk and reward are linked in real life. Because these would just be regular old private accounts, the government presumably couldn’t rob them (I mean, they might find a way, but it’d be harder). Creating them would cost about $1 trillion, but ending any pyramid scheme is expensive, and doing so would relieve the government of all future social security obligations.

This is the core of President Bush’s plan, although because of politics, he wouldn’t force anyone into it. If workers wanted to create a private account, they’d be free to do so. If they preferred not to, they could receive benefits under the old system. No one would be forced to change. It’s hard to reasonably object to that soft transition to a private system. Under private accounts, government could guarantee a minimal level of retirement funding for the poor at relatively minimal cost.

Chile has initiated a private account system. It’s been an unmitigated success. Rates of return that were expected to be 5-6 percent have instead been on the order of 10-13 percent. The infusion of investment capital has contributed to ongoing economic growth in Chile. Rates of return, though, are a key concern to many. Some see Enron crash and declare that we can never trust our retirement to the vagaries of the market. Even The Economist, far too often accepted as Word and Law, flubbed this point in their Oct. 9 analysis of social security, declaring private accounts less viable “in a world of flat stockmarkets.” A world of flat stockmarkets indicates a world without economic growth. In the long term, flat stockmarkets aren’t just a problem for retirement accounts. They’re an indicator that the global economy is not growing; that technological advancement and growth have ceased, and that life on earth is contracting. Retirement funding would then be the least of our problems. The relevant data is this; the government’s social security return on capital average 2 percent; the private sector, 7 percent. To doubt the market’s long-term returns is to doubt the future viability of the nation and the world.

There can be no intellectually honest, consistent defense of social security as we know it. John Kerry plans to dig the nation deeper into a pyramid scheme, worsening a serious long term threat to the fiscal solvency of the nation. It’s a prescription for a choked, stagnant national future. President Bush has not been fiscally responsible; he’s spent a disgusting amount of money. But he’s had the resolve to grasp this political “third rail” and try to recraft the system into a viable one. The honest approach is refreshing and admirable.