Don't Like Personal Retirement Accounts? The Other Options are Downright Scary

Commentary by Pete du Pont

Winston Churchill once said, "Democracy is the worst form of Government ... except all those others that have been tried."

Churchill's timeless words could just as easily be applied to Social Security reform. The president's Social Security reform commission is debating the merits of allowing workers to invest a small percentage of their payroll taxes into personal retirement accounts (PRAs), in the hope that this will allow each generation to help fund their own retirement, instead of relying solely on future generations. While you can argue that PRAs are not perfect, there is no question they are better than any other alternative for saving Social Security.

Critics of PRAs, like the National Committee to Preserve Social Security and Medicare, say there is no need to overhaul Social Security; the program's woes can be solved with "a number of moderate, incremental changes."

If only that were true. The changes needed to fix Social Security - if we choose not to adopt PRAs - will be economically damaging, painful and costly. Between now and 2070, according to the latest Social Security Trustees Report, Social Security faces a shortfall of about $22 trillion! Our options for making up that deficit are few: increase the money coming into the program by raising taxes, reduce the amount flowing out by cutting benefits or some combination of the two. The tax increases or benefit cuts in this case will be neither moderate, nor insignificant.

One of the burdens PRA opponents bear is to detail what reform alternatives they propose are better. A recent NCPA study examines some of the most common alternatives. For example:

Option 1: The 2 percent solution. Some suggest an immediate and permanent payroll tax hike of 2 percentage points could bridge the entire shortfall. But those who advocate the "2 percent solution," make some conceptual flaws.

First, they assume the Social Security Trust Fund contains cash and can readily pay benefits from 2016 to 2038. We know this is not the case. Whether or not you believe the bonds the trust fund holds are real assets, you have to agree that they are not the same as cash. In fact, they're more like IOUs - and we can't pay benefits with IOUs. And the price tag for cashing in all those IOUs? $5 trillion. Thus the 2-percenters are ignoring about a fourth of Social Security's long-term costs!

Second, the primary problem with this "solution," is that the additional surpluses generated by the tax hike will likely be spent on other projects - just like the current system's surplus - rather than being saved for the future.

Option 2: The government as investor. Some have suggested that the government, rather than individuals, invest payroll tax funds in the stock market in order to bolster the program with any revenue generated from the investments. Two problems: 1) as a shareholder in private companies, the government might feel the political temptation to coerce certain behaviors. 2) The government would undoubtedly also be tempted to spend any or all of the new revenue generated by the investments, leaving the program no better off than before the investments. That is why it is more desirable to put the money in personal retirement accounts that the government can't touch.

Option 3: Eliminate the earnings cap. Another idea advocated by opponents of PRAs is to increase the amount of earnings subject to the payroll tax. Currently, only the first $80,400 per year is subject to the payroll tax. Why not tax the rest?

Removing the earnings cap would constitute the largest tax increase in American history. Plus, there just aren't enough millionaires out there to balance the system through this effort alone. Besides, the highest marginal tax rate is already 42.5 percent (39.6 percent income tax rate plus 2.9 percent Medicare payroll tax rate). Adding an additional 12.4 percent (the Social Security payroll tax rate) on all income above the cap makes the highest rate about 54.9 percent. This would encourage tax evasion and discourage investment and growth.

There are many other options, including means testing benefits for wealthier retirees, raising the retirement age, reducing benefits across the board or reducing the cost of living adjustment. But regardless of how you mix and match these proposals, you still have to either increase taxes by $22 trillion, reduce benefits by $22 trillion or some combination of both.

Personal accounts give us the opportunity to generate new revenue for the system without having to raise taxes. Given the details that have yet to be worked out, transitioning to personal accounts will be a complex task, but it is still better than any alternative.