If allowed to run its course, the exploding cost of Social Security is destined to become the greatest financial crisis in American history. The unfunded liability of the nation's largest entitlement program is twice the national debt, and if Social Security solvency is preserved simply by raising taxes and cutting benefits, the cost will exceed the combined cost of all the wars fought in our nation's history. The looming Social Security crisis is more than a financial crisis, it is a human tragedy that will force us to choose between economic opportunity for our children and retirement security for our parents.

The limit on benefit reduction imposed by the social fabric of the nation and the limit on payroll taxes imposed by the economic reality of a competitive world economy render benefit reductions and tax increases inadequate to meet the challenge. The solution lies instead in transforming our debt-based Social Security system into an investment-based system. We must take the best features of the current system and combine them with the time-tested principles of private saving and investment. [See Figure I.] In so doing we can produce a secure system that will provide benefits not only to our parents but to our children as well. In fact, Investment-Based Social Security achieves what Americans thought Social Security did all along - it helps us save during our working years to provide for our retirement years.

The Social Security Crisis. The imminent crisis in Social Security is best described by looking at the number of workers per retiree and how much each worker must pay in taxes to fund Social Security benefits. In 1937, 42 workers contributed 2 percent of their first $3,000 of wages to pay benefits for one retiree. By 1965, four workers were each being taxed 7.25 percent of the first $4,800 of wages to provide benefits for each retiree. Today, 3.3 workers are paying 12.4 percent of the first $68,400 of wages to take care of each retiree. By 2030, according to the 1998 Social Security Trustees Report, two workers will each have to pay 16.6 percent of the current law wage base to fund Social Security benefits for a single retiree. As the payroll tax spirals, the economic opportunity of children and grandchildren will be pitted against the financial security of their parents and grandparents and everyone will lose.

What Caused the Crisis? To understand how the current crisis in Social Security came about, it is helpful to look at the history of the transfer payment entitlement. Transfer payment funding of entitlements started in Germany in 1889 with a dramatic new program initiated by Chancellor Otto von Bismarck. While cloaking his program in the language of saving and investment, Bismarck taxed current workers to pay benefits to current retirees. The next generation would then be taxed to provide benefits for those currently working. Bismarck's system substituted a tax on the future earnings of unborn workers for the traditional system of saving and investment.

The transfer payment-funded entitlement has become the dominant social program in the world. The Bismarck system first spread throughout Europe and reached Australia in 1909. It came to the Americas in 1925 when Chile adopted the system. It arrived in the United States in the form of Social Security in 1935 and Medicare in 1965.

All of the world's entitlement programs that rely on transfer payment funding have two problems in common: (1) they do not create any wealth or enjoy the miracle of growth through the enormous power of compound interest, and (2) they are held hostage to demographics. The remarkable increase in life expectancy and the collapse in the birth rate have driven down the ratio of workers to retirees and driven up the cost that transfer payments impose on workers. These trends, which have dominated the last third of the 20th century, show no signs of abating in the 21st century.

The Baby Boom Generation. These problems are illustrated in America's experience with the baby boom generation. There are 77 million people in America who were born between January 1, 1946 and December 31, 1964. That generation and the explosion in the work force it produced made Medicare possible and sustained Social Security far longer than the system could have survived without it. Baby boomers, now at the peak of their earning power, are paying 60 percent of the total payroll taxes collected in America. Over the next 30 years that figure will drop to less than 2 percent and the newly retired baby boomers will be demanding benefits the current system is incapable of providing. In the 20 years after the baby boom generation starts to retire, the retirement rolls will grow almost four-and-a-half times as fast as the employment rolls.