The Second Act: Social Security Reform

Commentary by Pete du Pont

On Tuesday evening, President George W. Bush addressed a joint session of Congress in what amounts to his first State of the Union address. Coming as no surprise to anyone, we heard a lot about his plans for cutting taxes and reforming our schools. Tax cuts were central to Bush's campaign and are receiving increasing support as the economy takes a dip, and it is becoming apparent that education is more important to this president than most of his predecessors.

The most noteworthy point, however, came when President Bush discussed another one of his central campaign issues, one that may go further in defining his legacy than any other - Social Security reform. After years of being used by politicians seeking political advantage, President Bush appears prepared to expend political capital on this issue by taking the lead to enact reforms needed to save the national retirement system for generations to come.

Currently the program is a pay-as-you-go system, in which taxes taken from the paychecks of today's workers pay the benefits of today's retirees. This type of generational transfer can work without placing an unbearable burden on workers, so long as the number of workers grows faster than the number of retirees. In 1940, the first year Social Security paid benefits, there were 42 workers for each retiree. Unfortunately, people are living longer and having fewer children. Now there are only about 3 workers for every retiree, and it will soon drop to about 2 to 1 - a costly demographic shift.

Even though the worker/retiree ratio has narrowed significantly in recent years, the government still collects more payroll taxes than is needed to pay benefits. Yet the surplus is not currently being saved, or otherwise put aside for future benefit payments. Instead, the government spends the money on other government projects, and then places IOUs in what it ironically calls the "Trust Fund." By 2015, the demographic shift will finally catch up to us and payroll tax collections won't be enough to pay all Social Security benefits as promised. That is when the IOU holding trust fund is supposed to make up the difference. But to redeem the IOUs from the Treasury, the government must either raise taxes or borrow from the public. Barring that, benefits will have to be slashed by a third.

President Bush campaigned on the idea of allowing younger workers to invest a small portion of their payroll tax dollars in a personal account similar to an IRA or 401(k). Initially, this money would come from the Social Security surplus - the amount currently collected but not needed to pay benefits. Depending on how the program is eventually structured, individuals' accounts could generate a larger benefit than workers would otherwise receive.

By 2050 the government could meet its obligations to retirees with about the same payroll tax rate we have today - 12.5 percent. By contrast without investment, according to an NCPA study by Social Security Trustee Tom Saving, we will have either four times as much debt as we have today by 2050, or a payroll tax rate (19.6 percent) that is 57 percent higher.

Personal accounts will 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, and would particularly help minority workers.

In fact, according Saving, a 20-year-old black male can expect to pay $40,979 more in Social Security taxes over an average lifetime (measured in current dollars at a discount rate of 4 percent) than he receives in benefits. Furthermore his rate of return on Social Security (benefits received for taxes paid) will only be 7/10 of 1 percent. This is because black men have lower life-expectancies, with only 64 percent of 20-year-old black men making it to normal retirement age, meaning that they on average will earn fewer retirement checks than a white male.

By investing political capital to finally reform Social Security, Bush can secure a legacy for himself as someone who used his time in the sun to solve the major problems before him. And in so doing, generations of Americans will be able to live comfortably in the twilight years without driving their children into poverty.