Is Social Security a Bad Deal?

The main flaw in Social Security is the concept of "pay-as-you-go." Social Security transfers income from today's workers to today's retirees. As the number of workers for each retiree decreases, the contribution per worker must increase.

• In 1950, the worker-to-retiree ratio was 16 to 1; today it is 3.3 to 1 and by 2030 will be less than 2 to 1.

• In 1937, the Social Security payroll tax was 2 percent on earnings up to $3,000; by 1995, it had risen to 10.52 percent on earnings up to $61,200 (plus another 1.88 percent for disability insurance and 2.9 percent for Medicare).

• Today, 76 percent of wage earners pay more Social Security taxes than federal income taxes.

Millions of elderly people rely on Social Security to provide for their retirement. More than half of the elderly receive no private pension, and more than one-third have no income from assets. These retirees, who were mostly low-wage earners, would have a higher income today if they had been allowed to invest their payroll tax dollars in mutual funds or money market accounts.

An analysis shows that almost all full-time workers would earn more from investing their (and their employers') Social Security taxes in stocks or bonds than they can expect in Social Security benefits. For example:

• A worker earning $12,600 per year when he retired at age 65 in 1995 would receive $551 per month in Social Security benefits, compared to the $1,301 per month if his Social Security taxes had always been invested in stocks instead or $574 if they had been invested in bonds.

• A worker earning $61,200 per year when he retired at age 65 in 1995 would receive $1,200 per month in Social Security benefits, compared to $3,999 per month if his Social Security taxes had always been invested in stocks instead or $2,072 if they had been invested in bonds.

Life expectancy has been increasing and the birth rate has been falling for decades. This means a pay-as-you-go system cannot be fixed. Indeed, some of the reforms suggested to restore the trust fund's actuarial balance - such as increasing payroll taxes, raising the retirement age and reducing cost-of-living increases - would make the rate of return for retirees even worse.

On the other hand, a system in which individuals contributed to their own investment accounts would yield seniors a higher retirement income, and would allow them to leave a larger estate to their children.

Source: William G. Shipman, "Retiring with Dignity: Social Security vs. Private Markets," Cato Project on Social Security Privatization, SSP No. 2, August 14, 1995, Cato Institute, 1000 Massachusetts Avenue, NW, Washington, DC 20001, (202) 842-0200.