Social Security: There Is A Better Retirement System

Commentary by Pete du Pont

Eight years ago, the man soon to become President thought it a "dumb and nutty" idea to give people a choice between a private IRA and the current Social Security system to fund their retirement.

Last year nearly twice as many young people believed in UFOs as thought they would ever receive a Social Security check.

So perhaps we are making a kind of progress - more and more people are coming to understand that their promised retirement benefits are an illusion, a Washington conjurer's trick. The Social Security Administration's Intermediate Assumptions show that in 1965 there were five contributing workers for each Social Security beneficiary. Today, there are three. By the time the Baby Boomers are retired in 2030, there will be but two. Then, Social Security taxes must double to 30% of payroll, or benefits to the retired elderly must be halved. Neither course is economically or politically feasible.

The predilection of the politicians is, like the Roman Emperor Nero, to fiddle while the system burns. Tinker a little with the retirement age; fiddle with the CPI indexing formula. Raise taxes a little; lower benefits a little bit less. Or, perhaps, as the Kerrey Commission recommended last January, allow us to deposit an astonishing 1.5% of our Social Security (FICA) taxes in our own IRAs instead of sending it to Washington.

But tepid gradualism is useless in the face of an overwhelming challenge.

It is not just that the Social Security system is failing and must soon be propped up with increasing payroll taxes that will suffocate the dreams of the young. Nor is it that a fixed benefit, pay-as-you-go pension system with yields of close to zero is a 1930s anachronism in an age when market investments would produce five to ten times as much retirement income.

The crux of the matter is that a government controlled pension system that does not link benefits to contributions is violating the economic rights of American citizens. It is imposing an enormous intergenerational tax burden on the young and limiting the economic opportunity of the old.

It is also immoral, for in the words of Chilean economist José Pinera, "you are all sitting around the table figuring how to make your children pay for your retirement." The government should not own your retirement assets; you should. The government should not control the amount of your retirement check; you should. Your grandchildren should not pay for your retirement; that is your responsibility.

An information age retirement system would empower individuals to design a personal retirement plan. Such a retirement system exists in Chile. Beginning in 1980, the Chilean government guaranteed the lifetime benefits of all retirees. It then gave current workers a choice: stay in the existing government pension system with full benefits, or enter a new, private sector retirement system in which benefits are based upon the individual's contributions to an IRA and market yields on deposited funds. You must contribute 10% of your wages into your private retirement fund, but you may contribute up to 20% if you desire higher benefits upon retirement. You may choose your retirement age and your investment manager (there are now 22 government approved investment funds in Chile).

So what did Chilean workers choose? Economists predicted 1% would choose the market system in the first month; 25% did. By year-end, it was 70% and today 90% of the workforce has chosen the market system over the government one.

Over the past 14 years, the average annual yield of an individual's retirement account has been 10%. That compares to a 2.2% lifetime yield for a 45-year-old (and even less for younger people) in the U.S. Social Security system. Contributions by Chilean workers have created a huge pool of investment capital, allowing the economy to grow 7% annually, while the U.S. is averaging less than 3%. The Chilean savings rate is now 26%, compared to 4% in America.

Most important, the ordinary Chilean worker has a stake in the nation's economy. His biggest asset is not, as Pinera points out, a "small house, or used car, but the capital in his pension account. The Chilean worker is an owner; a capitalist." Indeed, he is, for the first $1,000 he contributed to his private pension account in 1981 is now worth $3,800, and his subsequent annual contributions have been compounding at the same rate.

Not bad for an idea that President Bush thought "nutty," President Clinton won't consider because he is "not going to fool with Social Security," and Congressmen and Senators consider the third rail of American politics.

The politicians need to catch up with the people. There is a better way to finance retirement pensions, and the American people should be allowed to use it.