Privatizing Social Security

Studies | Social Security

No. 217
Wednesday, July 01, 1998
by Laurence J. Kotlikoff


Our Kids Are in Trouble

Figure I - Net Lifetime Taxes (Taxes Minus Benefits) Due to All Government Programs for U.S. Males

Before discussing why Social Security's problem is three times worse than the trustees acknowledge, and why the Personal Security System is the solution, it is important to view the nation's fiscal and economic problems in a broader, long-term context.

Transfers from young to old. The U.S. government has spent the last half-century taking ever larger sums of money from poor, middle-class and rich young people and giving them to poor, middle-class and rich old people. These transfers far exceed anything the young would have done for the elderly on a voluntary basis. The principal mechanisms the government has used are Social Security and Medicare. Other programs (e.g., Medicaid) and other fiscal mechanisms (e.g., accumulating large amounts of official debt and creating tax breaks for the elderly) also have been used.

In taking from the young to give to the old, politicians have made the old - who have both the time and inclination to vote - very happy. They have placated the young with the implicit message, "Don't worry, you'll get yours from the next set of young when you retire." In so doing, politicians started the biggest pyramid scheme in history. But, as with any pyramid scheme, those who are in at the beginning win big and those at the end are left holding empty promises.

"For babies born this year, 81 cents of every dollar they contribute to Social Security will never be matched by offsetting benefits."

Burdens for future generations. America's great pyramid is now crumbling. For babies born this year, projected Social Security benefits are so small relative to contributions that 81 cents of every dollar they contribute to the system represents a pure tax that will not be matched by offsetting benefits. Since Social Security's payroll tax rate is 12.4 percent, the system greets newborns with the following birthday message: "More than 10 cents of every dollar you'll ever earn is ours."

Of course Social Security is just one of the many fiscal programs facing our newborns. Adding up all programs, through an analytic method called generational accounting, the birthday greeting from Uncle Sam and Aunt Sally (a pseudonym for state and local government) is: "Unless things change a lot and very soon, you'll owe us half of every dollar you ever earn!"

Figure II - Net Lifetime Taxes (Taxes Minus Benefits) Due to All Government Programs for U.S. Females

Generational accounting. This extremely troubling picture is being provided courtesy of none other than our own federal government, specifically the Federal Reserve Bank of Cleveland (Cleveland Fed) and the Congressional Budget Office (CBO).2 Their recent generational accounting for the United States, which is based on arguably overly optimistic demographic and fiscal projections, shows lifetime net tax rates (taxes paid net of transfer payments received divided by lifetime labor earnings) of almost 50 percent for everyone born this year and afterward.3 This net tax rate is not only enormous in absolute terms, it is also huge compared to the 30 percent rate most adults now alive will pay under current law. [See the discussion below.]

Figures I and II present generational accounts in dollars and cents. As Figure I shows:4

  • The average 20-year-old male can expect to pay $182,000 in taxes over the remainder of his life in excess of any benefits he will receive from government.
  • The average 20-year-old female can expect to pay $115,000 over and above any benefits over the remainder of her life.

By contrast, 70-year-old retirees are receiving between $89,200 (males) and $101,000 (females) in net benefits!

"The average 20-year-old male can expect to pay $182,000 in taxes in excess of benefits received from all government entitlement programs."

Causes of the generational imbalance. The depth of our generational imbalance reflects two factors. First, the population is rapidly aging. By 2030, when the enormous baby boom generation will have retired, the average age in the country as a whole will be the same as that of present-day Florida. Second, the level of benefits we are giving to today's retirees and promising to future retirees is rising much faster than are the real wages of the workers expected to pay for this largesse.


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