In Other States

Why States Should
Pass the Social Security
'Opt Out' Resolution

by Paul R. Farago

ur nation is the free market leader of the world. So, it only seems natural that we choose to learn from the mistakes of mandatory pay-as-you-go schemes from around the world and change to a system of individual private retirement accounts. The incentive is great: over a reasonable period of time, a fully funded system with assets appreciating at market rates of return can finance the unfunded Social Security liability, and employment taxes can be cut dramatically.

The Oregon State Legislature asked Congress for a process for demonstrating market-based reform of public pension systems in the United States. The Oregon Legislature resolved, simply: "The Congress of the United States is urged to enact legislation amending the Social Security Act to allow the issuance of waivers to the states that will permit the design and implementation of alternatives to Social Security."

There are reasonable concerns and questions about the proposed Opt Out reform measure, even from those who support market-based systems. But once the alternatives are explained— especially that the measure will keep the Social Security promise with current and future retirees—people do support this reform.

Some people claim that the benefit structure of Social Security is "progressive" but they won’t say that the entire system is not progressive at all. For most working Americans, the Social Security tax on wages is the single largest tax they pay. This tax lands most heavily on minorities who live shorter lives and collect fewer benefits compared to their taxes and on the working poor who pay a larger share of their income in taxes and the cost of regulation.

Apart from the massive unfunded liability, the urgency of reforming Social Security, therefore, is two-fold: first, to extend market returns to those who depend upon Social Security for the greatest portion of their retirement income and who do not now enjoy a market-based return on retirement savings, and second, to remove the drag on GDP from wasting the Social Security taxes paid by people currently making savings and investments whose additional savings would also be put to productive use in the economy.

THE OREGON PLAN

After Oregon’s Legislature called on Congress to allow us to opt out of Social Security, Cascade Policy Institute published an outline of what a market-based alternative for Oregonians’ retirement savings would look like. A prominent local economist, Dr. Randall Pozdena, authored the study. He suggests that we can fund a transition to a market-based private pension system over a 23-year period with no additional taxes. The transition time could be shortened by including other financing sources, such as bonds that spread the cost to future generations, savings from other reductions in wasteful spending, privatization of underutilized state assets and extra tax revenue resulting from increased economic growth.

Dr. Pozdena’s proposal has four features:

  • All current and future retirees above a certain age would be guaranteed by the state of Oregon to receive no less than they would have under Social Security’s benefits at the time of the Opt Out, indexed for inflation.
  • All Oregonians would be completely out of the federal Social Security system—no taxes and no benefits.
  • All Oregonians would be required to invest their share of the current retirement tax of 5.26 percent of wages into mandatory individual savings accounts called OPRA’s—Oregon Private Retirement Accounts.
  • The employer’s 5.26 percent share would be paid into a state-managed fund to pay the benefits of current retirees and future retirees whose OPRA savings would not have accumulated sufficiently to meet the minimum Social Security benefit. Over the transition period, the employer share of the tax would be phased out and reduced to zero. In the long term, Oregonians below a certain age would expect to have retirement benefits several times greater than they could have expected under Social Security. Our savings will belong to us, and we will have total stewardship over our retirement decisions.

Ironically, the Oregon Opt Out is a return to previous policy. One example is three counties in Texas which formerly included a Social Security waiver system, but only for government entities—one that worked quite well. It still exists for newly formed governments. Just this year an authority formed to govern Seattle’s public transit system opted out of Social Security.

Sorting out the reasons why opting out of Social Security is a sensible choice suggests a brief review of why the mandatory pay-as-you-go scheme must be terminated.

A BRIEF HISTORY

Mandatory Social Security was adopted in the U.S. in 1935, 46 years after it was first established in Germany. In fact, it was a trust fund system until 1939 when Congress began granting benefits to those who had not paid into the system and accelerated payments to all beneficiaries. That changed Social Security in to a pay-as-you-go scheme, meaning that current taxes fund current benefits. There are no assets in the system except the promises of future taxpayers, including those not even born yet. All the surpluses have been spent running up the federal deficit. Such a pension plan in the private sector is completely illegal.

Pay-as-you-go schemes are characterized by relatively low benefits compared with market-based retirement systems. The very real risks under pay-as-you-go are seldom advertised— that taxes will increase faster than benefits, and that promises to "protect" retirees’ benefits can be changed by a simple majority in Congress and the signature of the President.

As recently as1950, total taxes were just 3percentofthe first$3,000 in wages—$90 per year. At that time,16workers paid in to the system for every beneficiary. Since 1950, taxes that represent the retirement portion of Social Security have grown to 10.52 percent on wages up to $68,400. About three workers pay in to the system for every retiree now. To illustrate the tax-and-benefit trend, in 1998 benefits will increase 2.1 percent, but the amount of wages subject to the tax will increase faster, by 4.1 percent.

The history and tradition of pay-as-you-go systems is that taxes must always go up faster than benefits. They always have, and they always will. It works exactly like a chain letter. For example,since1950Social Security taxes have increased 1,200 percent after inflation, with benefits increasing only one-third as fast. Unless the government is making promises it doesn’t intend to keep, the growth of Social Security benefits is limited to the growth of the working-age population, and, unlike market-based retirement savings systems, has no connection to underlying economic growth.

On a radio talk show recently, a caller commented that there was nothing wrong with the system; that he had put in $50,000 and would receive about $15,000 per year. He would retire soon and had lived a clean life so he would get back all he had paid in after just a few years, and intended on living quite a while longer. Conversely, if you were 39 today, and retire at 68, you will have to live to134 for Social Security to have paid you enough to compensate for not enjoying a market rate of return on your savings. If you retired just last year, you have to live to age 93 for Social Security to have been a good deal. And almost everyone under 40 believes they are more likely to see an extraterrestrial in their back yard than receive a dime of Social Security benefits when they retire. These Americans would be better off stuffing their tax into a mattress than paying it to the federal government, because they will never get it back.

Pay-as-you-go systems face in solvency because the demographics are working against them. There is ample evidence in political cartoons, if nowhere else, that mainstream Americans do understand the consequences of the Baby Boomers’ retirement, increasing longevity, and declining birth rates.

HOW DO WE KNOW WHAT TO DO?

Governments everywhere are grappling with a similar demographic problem: more retirees and fewer people paying in. In Europe, rather than reform the fundamental system and replace the fraudulent pay-as-you-go scheme with a private, market-based alternative, governments are trying to muddle through by cutting benefits and raising taxes. The citizens aren’t standing for it. Research by Cato Institute scholars and others shows that no amount of benefit cuts and tax increases can solve the demographic problem confronting mandatory, pay-as-you-go pension schemes. The details of Chile’s 16-year experience with a private, market-based alternative have reached most policy makers in the U.S. and worldwide. According to The Wall Street Journal, "The World Bank expects that at least30countrieswill initiate reforms in their pension systems in the next few years. And it is not surprising that functionaries from developed and developing countries travel to Chile to see how it is done." And Newsweek commented: "The Chilean system is perhaps the first significant social-policy idea to emanate from the Southern Hemisphere." In the first 16 years of Chile’s market-based system, pension accounts grew at 12.5 percent per year after inflation and the national savings rate increased to 24 percent.

STATE-BY-STATE ACTION WILL INTENSIFY

The Oregon Opt Out is gaining adherents and momentum. Several states have already proposed Opt Out resolutions for the upcoming sessions, and it is likely that some states will pass them in early 1998. In fact, even before Oregon’s passage of the Opt Out resolution, legislatures and governors in several states had already pressed Congress to address Social Security’s insolvency. While frustrated by the Beltway delaying tactics in the face of the looming crisis, people are very excited by the idea that there is something they can do in their own state about saving Social Security while there is still time for an orderly transition. People want to discuss this important issue, and appreciate the opportunity for their state legislators to help break the federal gridlock.

CONCLUSION

In conclusion, here’s the essence of why Opt Out resolutions passing state legislatures is a good idea. The approach involves an incremental action step not subject to veto politics. Such a resolution respects politicians’ need to minimize political risks—both at the state and federal level. It follows the method of a successful precedent—welfare reform.Like welfare reform, the simple idea of a state opting out of Social Security illustrates the incredible power of suggestion, and the way ideas can transform the parameters of the public policy debate. Increasingly, people agree that the best way to save Social Security is to put future retirement savings to work in individual, private, market-based accounts. The longer the delay, the more likely this becomes the only way to save Social Security— but the transition time increases even faster.

THE SOCIAL SECURITY SYSTEM REALITY

The Greenspan-Dole Commission’s 1983 "fix" required keeping the system solvent for 75 years, to2058.  In just 13 years, the drop-dead date of 2058 has moved forward 29 years, to 2029. In the last 10 years, the date has been moved up8 times. Now, the system is set to go into current deficit in just 15 years, in 2012, but perhaps as soon as 2006 — in just 8 years! G O G O G O G O G O V E

Paul Farago is a board member and Senior Advisor of Cascade Policy Institute, Oregon's free-market think tank.  For the last decade, after a successful career in business, he has directed a small private foundation that makes grants for education projects related to economic liberty.   Reprinted by permission from the Cascade Policy Institute.


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