First Step Towards Saving Social Security

Commentary by Pete du Pont

This month President Bush followed through on another campaign promise by formally appointing a bipartisan commission to craft a proposal for an investment-based reform for Social Security. The commission is comprised evenly between Republicans and Democrats and will be co-chaired by former New York Senator Daniel Patrick Moynihan and AOL Time Warner CEO Richard Parsons.

The Democratic leadership immediately howled that Bush was stacking the deck in favor of his position. But since he had promised to do just that, this should not have surprised anybody. This was never to be a body for debate over direction, leading to inaction. This was to be a body that worked out the details for a desired result - a new retirement system based on ownership and wealth creation.

We've known for a long time what ails Social Security. The problem is its current pay-as-you-go structure, in which taxes of today's workers pay the benefits of today's retirees. This generational transfer is only sustainable so long as the number of workers grows faster than the number of retirees. This is not the case today, however. Where once there were 42 workers for each retiree, today the ratio is 3 to 1 and it will soon drop to 2 to 1.

For now, payroll tax collections exceed benefit payments. The surplus is credited to the Social Security and Medicare trust funds, and is then borrowed by the government in exchange for special, nonnegotiable Treasury bonds. These bonds are not part of the official federal debt - they cannot be sold on Wall Street, or to any foreign investors. They are literally nothing more than IOUs the government writes to itself.

On paper, the trust funds have enough IOUs to "pay" Social Security benefits for about 28 months on any given day; and Medicare benefits for about 16 months. In reality, they cannot pay anything. Every asset of the trust funds is a liability of the Treasury. For the Treasury to write a check, it must first tax or borrow.

Unless the way the system is financed changes, the government will most likely pay its bills by raising the payroll tax. This will affect all workers, starting with the first dollar earned. According to the "intermediate projection" from the latest Social Security trustees report, when today's 18-year olds begin to retire, the nation's Social Security obligations will equal almost 17 percent of taxable payroll. The burden of Medicare Part A (which mainly pays hospital bills) will equal about 7 percent of payroll by mid century, bringing the total taxpayer burden to 24 percent. And if all other health programs that pay elderly medical bills are also included (e.g., Medicaid, the VA system, etc.), the burden of elderly entitlements will be about 33 percent of payroll. That's about 70 percent greater than the burden today.

The problem only gets worse over time. For example, when today's newborns retire, workers funding their benefits will face payroll taxes of 28 percent for Social Security and Medicare and over 40 percent when other elderly-care benefits are included.While dire, this is not the worst that can happen. These numbers have all been drawn from the intermediate (most likely) projections from the Trustees report and calculations from an econometric model constructed by NCPA Senior Fellow Thomas R. Saving, who currently serves as one of two public trustees for the Social Security and Medicare trust funds and was recently tapped by Bush to serve on the Moynihan-Parsons commission. The pessimistic projection concludes that by 2045, the total taxes needed to support elderly-care benefits could skyrocket to more than half of workers' incomes.

What can personal investment do for the Social Security system and the financial security of future retirees? With PRAs, Social Security obligations can be met in the year 2050 with about the same payroll tax rate that we have today. Personal accounts will also enable people who live paycheck to paycheck to accumulate literally hundreds of thousands of dollars by the time they retire. That would be a significant change, as most people born since World War II can currently expect to receive less in Social Security benefits than they pay in taxes.

This commission is only a first step, but it's an important one.